So what should you do?
Test Yourself
6-1 Why do people borrow? What are some improper uses of credit?
Whatever their age group, people tend to borrow for several major reasons.
6-2 Describe the effects of the credit crisis of 2008–2009 on borrowers.
6-3 Describe the general guidelines that lenders use to calculate an applicant’s maximum
debt burden.
6-4 How can you use the debt safety ratio to determine whether your debt obligations are
within reasonable limits?
6-5 What steps can you take to establish a good credit rating?
Here are some things you can do to build a strong credit history:
6-6 What is open account credit? Name several different types of open account credit.
6-7 What is the attraction of reward cards?
6-8 How is the interest rate typically set on bank credit cards?
6-9 Many bank card issuers impose different types of fees; briefly describe three of these
fees.
6-10 What is a debit card? How is it similar to a credit card? How does it differ?
6-11 Describe how revolving credit lines provide open account credit.
6-12 What are the basic features of a home equity credit line?
6-13 Describe credit scoring and explain how it’s used (by lenders) in making a credit
decision.
6-14 Describe the basic operations and functions of a credit bureau.
6-15 What is the most common method used to compute finance charges?
According to the Truth in Lending Act, lenders disclose the rate of interest that they charge and
6-16 The monthly statement is a key feature of bank and retail credit cards. What does this
statement typically disclose?
Critical Thinking Problems
6.1 The Ramirez Family Seeks Some Credit Card Information
Felipe and Lucia Ramirez are a newly married couple in their mid-20s. Conrad is a senior
at a state university and expects to graduate in the summer of 2015. Lucia graduated last
spring with a degree in marketing and recently started working as a sales rep for the
Momentum Systems Corporation. She supports both of them on her monthly salary of
$4,250 after taxes. The Ramirez’s currently pay all their expenses by cash or check. They
would, however, like to use a bank credit card for some of their transactions. Because
neither Felipe nor Lucia knows how to apply for a credit card, they approach you for help.
Critical Thinking Questions
1. Advise the couple on how to fill out a credit application.
The type of information requested in a typical credit application covers little more than
2. Explain to them the procedure that the bank will probably follow in processing their
application.
3. Tell them about credit scoring and how the bank will arrive at a credit decision.
The bank will use some type of credit scoring scheme will be used to make the decision. An
4. What kind of advice would you offer the Ramirez family on the “correct” use of their
card? What would you tell them about building a strong credit record?
6.2 June Starts Over After Bankruptcy
A year after declaring bankruptcy and moving with her daughter back into her parents’
home, June Maffeo is about to get a degree in nursing. As she starts out in a new career,
she also wants to begin a new life—one built on a solid financial base. June will be starting
out as a full-time nurse at a salary of $52,000 a year, and she plans to continue working at a
second (part-time) nursing job with an annual income of $10,500. She’ll be paying back
$24,000 in bankruptcy debts and wants to be able to move into an apartment within a year
and then buy a condo or house in five years. June won’t have to pay rent for the time that
she lives with her parents. She also will have child care at no cost, which will continue after
she and her daughter are able to move out on their own. While the living arrangement
with her parents is great financially, the accommodations are “tight,” and June’s work
hours interfere with her parents’ routines. Everyone agrees that one more year of this is
about all the family can take. However, before June is able to make a move—even into a
rented apartment—she’ll have to reestablish credit over and above paying off her
bankruptcy debts. To rent the kind of place she’d like, she needs to have a good credit
record for a year; to buy a home, she must sustain that credit standing for at least three to
five years.
Critical Thinking Questions
1. In addition to opening checking and savings accounts, what else might June do to begin
establishing credit with a bank?
2. Although June is unlikely to be able to obtain a major bank credit card for at least a
year, how might she begin establishing credit with local merchants?
3. What’s one way she might be able to obtain a bank credit card? Explain.
4. How often should June monitor her credit standing with credit reporting services?
5. What general advice would you offer for getting June back on track to a new life
financially?
Terms Found in the Chapter
affinity cards
A standard bank credit card issued in conjunction with some
charitable, political, or other nonprofit organization.
annual percentage
rate (APR)
The actual or true rate of interest paid over the life of a loan; includes
all fees and costs.
average daily
balance
(ADB) method
A method of computing finance charges by applying interest charges
to the ADB of the account over the billing period.
balance transfer
A program that enables cardholders to readily transfer credit balances
from one card to another.
bank credit card
.
A credit card issued by a bank or other financial institution that allows
the holder to charge purchases at any establishment that accepts it.
base rate
The rate of interest a bank uses as a base for loans to individuals and
small to midsize businesses
cash advance
A loan that can be obtained by a bank credit cardholder at any
participating bank or financial institution.
credit bureau
An organization that collects and stores credit information about
individual borrowers.
credit counselor
A professional financial advisor who assists overextended consumers
in repairing budgets for both spending and debt repayment.
credit investigation
An investigation that involves contacting credit references or
corresponding with a credit bureau to verify information on a credit
application.
credit limit
A specified amount beyond which a customer may not borrow or
purchase on credit.
credit scoring
A method of evaluating an applicant’s creditworthiness by assigning
values to such factors as income, existing debts, and credit references.
credit statement
A monthly statement summarizing the transactions, interest charges,
fees, and payments in a consumer credit account.
debt safety ratio
The proportion of total monthly consumer credit obligations to
monthly take-home pay.
grace period
A short period of time, usually 20 to 30 days, during which you can
pay your credit card bill in full and not incur any interest charges.
home equity credit
line
A line of credit issued against the existing equity in a home.
line of credit
The maximum amount of credit a customer is allowed to have
outstanding at any point in time.
minimum monthly
payment
In open account credit, a minimum specified percentage of the new
account balance that must be paid in order to remain current.
open account credit
A form of credit extended to a consumer in advance of any
transaction.
overdraft protection
line
A line of credit linked to a checking account that allows a depositor to
overdraw the account up to a specified amount.
personal
bankruptcy
A form of legal recourse open to insolvent debtors, who may petition
a court for protection from creditors and arrange for the orderly
liquidation and distribution of their assets.
prepaid card
A plastic card with a magnetic strip or microchip that stores the
amount of money the purchaser has to spend and from which is
deducted the value of each purchase.
retail charge card
A type of credit card issued by retailers that allows customers to
charge goods and services up to a preestablished amount.
revolving line of
credit
A type of open account credit offered by banks and other financial
institutions that can be accessed by writing checks against demand
deposit or specially designated credit line accounts.
reward (co-
branded)
credit card
A bank credit card that combines features of a traditional bank credit
card with an additional incentive, such as rebates and airline mileage.
secured
(collateralized)
credit cards
A type of credit card that’s secured with some form of collateral, such
as a bank CD.
student credit card
A credit card marketed specifically to college students.
unsecured personal
credit line
A line of credit made available to an individual on an as-needed basis.
Wage Earner Plan
An arrangement for scheduled debt repayment over future years that is
an alternative to straight bankruptcy; used when a person has a steady
source of income and there is a reasonable chance of repayment
within 3 to 5 years.
Chapter Outline
Learning Goals
I. The Basic Concepts of Credit
A. Why We Use Credit
B. Improper Uses of Credit
C. Establishing Credit
1. First Steps in Establishing Credit
2. Build a Strong Credit History
3. How Much Credit Can You Handle?
II. Credit Cards and Other Types of Open Account Credit
A. Bank Credit Cards
1. Line of Credit
2. Cash Advances
3. Interest Charges
4. Other Fees
B. Special Types of Bank Credit Cards
1. Reward Cards
2. Affinity Cards
3. Secured Credit Cards
4. Student Credit Cards
C. Retail Charge Cards
D. Debit Cards
E. Revolving Credit Lines
1. Overdraft Protection
2. Unsecured Personal Lines
3. Home Equity Credit Lines
III. Obtaining and Managing Open Forms of Credit
A. Opening an Account
1. The Credit Application
2. The Credit Investigation
3. The Credit Bureau
B. The Credit Decision
C. Computing Finance Charges
D. Managing Your Credit Cards
1. The Statement
2. Payments
IV. Using Credit Wisely
A. Shop Around for the Best Deal
B. Avoiding Credit Problems
C. Credit Card Fraud
D. Bankruptcy: Paying the Price for Credit Abuse
1. Wage Earner Plan
2. Straight Bankruptcy
Planning over a lifetime
Financial Impact of Personal Choices