Credit and Debt Management Flashcards
Disadvantages of Using Credit
Overspending
Associated costs
Less flexibility with budget
Factors that weight on Credit Score
Home Ownership
Residential and Job Stability
Education
Income
Questions to judge credit worthiness
Do you have checking and savings accounts and use them regularly?
Do you use them properly, or are there frequent overdrafts?
Have you used credit properly before by repaying your debts on a timely basis?
Equal Credit Opportunity Act
Individuals cannot be discriminated against because of race, color, age, sex, marital status, or other related factors. This does not mean that someone is automatically given a loan because of one or several of these characteristics. It means that lenders may not deny him a loan because of any one of them.
Lenders do not use such factors in credit-scoring formulas. Age may matter, but if you are 62 or older, you must be given at least as many points as someone under 62, and
You have to receive a response from a creditor within 30 days after your application indicating whether your request has been approved or denied. If it was denied, the response must be in writing, and it must either explain the reasons for the denial or indicate your right to an explanation.
Three Forms of Credit
A regular (or 30-day) account
A revolving account
A retail installment account.
Open End Account
When you establish an open-end account, you will sign an agreement that covers all credit purchases and cash advances made in the account. This agreement is binding as long as the account is open.
Closed End Account
A credit agreement covering a single purchase with a set repayment schedule is a closed-end account. A closed-end account requires a separate retail installment contract for each purchase. These accounts are usually for large amounts and longer periods of time.
Charge Account
A regular charge account is a credit account with a merchant, in which complete payment at the end of the billing cycle usually avoids all interest changes.
Long Term Debt Ratio
The long-term debt ratio relates the amount of funds available for debt repayment to the size of the debt payments. In effect, this ratio is the number of times you could make your debt payments with your current income. It focuses on long-term obligations such as home mortgage payments, auto loan payments, and any other long-term credit obligations. A long-term debt coverage ratio below 2.5 is not financially desirable.
Debt Resolution Rule
Financial planners use the debt resolution rule to help control debt obligations. These exclude borrowing associated with education and home financing. The debt resolution rule forces you to repay all your outstanding debt obligations every 4 years.
The logic behind this rule is that consumer credit should be short-term in nature. If it lasts over 4 years, it’s not short-term. Unfortunately, it’s all too easy to rely on consumer credit as a long-term source of funding. Given its relative costs, this type of funding should be used sparingly.
Debt Limit Ratio
The debt limit ratio is simply a measure of the percentage of your take-home pay or income taken up by non-mortgage debt payments. The recommended maximum debt limit ratio should not exceed 20%.
Fixed Rate Loan
A fixed-rate loan is not tied to market interest rates and maintains a single interest rate for the entire duration of the loan. Regardless of whether market interest rates swing up or down, the interest rate you pay remains fixed. The vast majority of consumer loans have fixed rates.
Variable Rate Loans
A variable- or adjustable-rate loan is tied to a market interest rate, such as the prime rate or the six-month Treasury bill rate. The interest rate you pay varies as that market rate changes.
Prime Rate
The prime rate is the interest rate banks charge to their most creditworthy customers. Most consumer loans are set above the prime rate or the Treasury bill rate. For example, your loan might be set at 4 percent over prime. In this case, if the prime rate is 9 percent at the moment, the rate you pay on your variable-rate loan would be 13 percent. If the prime rate drops to 8 percent, your rate would change to 12 percent.
Not all variable-rate loans are the same. For example, rates may be adjusted at different, but fixed, intervals. Some loans adjust every month, others every year. The less frequently the loan adjusts, the less you have to worry about rate changes.
Convertible Loan
A convertible loan is a variable-rate loan that can be converted into a fixed-rate loan at the borrower’s option at specified dates in the future. Although convertible loans are much less common than variable or fixed-rate loans, they do offer the advantage of the lower cost of a variable-rate loan while still being able to lock into the savings of a fixed-rate loan.
Home Equity Loan/ Home Equity Line of Credit (HELOC)
With a home equity loan, or a home equity line of credit (HELOC), your credit is secured by your ownership in your home. Banks typically let you borrow up to 75 to 80 percent of the equity in your home. The equity in your home is the difference between the appraised fair market value of your home and the amount owed on the mortgage.
Two Forms of Home Equity Loans
Closed-end credit, which is a home equity loan
Open-end credit, which is a home equity line of credit.
Advantage of Home Equity Loans
An advantage of home equity loans is that they generally carry a lower interest rate than other consumer loans. Home equity loans and lines of credit are secured loans which lenders consider less risky, therefore lenders are willing to charge lower interest rates for them.
Tax Deductibility of Home Equity Loans
In the past interest paid on home equity loans was typically deductible, but The Tax Cuts and Jobs Act of 2017, suspends from 2018 until 2026 the deduction for interest paid on home equity loans and lines of credit, unless they are used to buy, build, or substantially improve the taxpayer’s home that secures the loan.
Disadvantages of Home Equity Loans
The major disadvantage of a home equity loan or a home equity line of credit is that it puts your home at risk. You pledge your home as collateral for the loan, which means the lender can repossess your home and sell it to satisfy your debt. Many homeowners take out home equity lines of credit to consolidate their credit card debts to make them tax-deductible and pay them back at lower interest rates. However, some credit card debt can be discharged under Chapter 7 bankruptcy laws while home equity loans are secured and must be paid back in full.
Another disadvantage is when the value of your home drops significantly in price, and due to a home equity loan, you owe more than the house is worth. If the house needs to be sold to satisfy creditors this could be a significant problem. Also you may be unable to lease your home during the term of the loan to provide you with extra income to pay your debts.
Major Consumer Credit Laws
Truth in Lending Act
Fair Credit Billing Act
Equal Credit Opportunity Act
Fair Debt Collection Practices Act
Fair Credit Reporting Reform Act
Truth in Lending Act
Passed in 1968, the Truth in Lending Act requires lenders to disclose the true cost of consumer credit, explaining all charges, terms and conditions involved. It requires that the consumer be provided with the total finance charge and annual percentage rate on the loan.
Fair Credit Billing Act (1975)
Fair Credit Billing Act (1975) sets procedures for correcting billing errors on open credit accounts. It also allows consumers to withhold payment for defective goods purchased with a credit card. In addition, it sets limits on the time some information can be kept in your credit file.
Equal Credit Opportunity Act
Equal Credit Opportunity Act (1975) prohibits credit discrimination on the basis of sex and marital status. It also requires lenders to provide a written statement explaining any adverse action taken.
The Equal Credit Opportunity Act was amended in 1977. The amendment prohibits credit discrimination based on race, national origin, religion, age, or receipt of public assistance.
Fair Debt Collection Practices Act (1978)
Fair Debt Collection Practices Act (1978) prohibits unfair, abusive, and deceptive practices by debt collectors, and establishes procedures for debt collection.
Fair Credit Reporting Reform Act
The Fair Credit Reporting Reform Act of 1996 (updated version of the Fair Credit Reporting Act of 1971) requires that consumers be provided with the name of any credit agency supplying a credit report that leads to the denial of credit. It gives consumers the right to know what is in their credit reports and challenge incorrect information. It also requires that employers get written permission from current or prospective employees before reviewing their credit files. In addition, it allows consumers to sue creditors if reporting errors are not corrected.
The Gramm-Leach Bliley Financial Modernization Act of 1999 (GLB Act)
The Gramm-Leach Bliley Financial Modernization Act of 1999 (GLB Act) contains provisions that safeguard the privacy of consumer information held by financial institutions. These provisions protect an individual’s personal financial information by placing restrictions on when firms can disclose this information to others. The GLB Act requires that financial institutions send privacy notices to consumers that explain their information-sharing practices, and which give individuals an opportunity to “opt-out” or decline to have some of their personal information shared with third parties.
Three Major Components of Privacy Requirements
The Financial Privacy Rule
The Safeguards Rule
The Pretexting Provisions
Financial Privacy Rule
The Financial Privacy Rule regulates how financial institutions may gather and subsequently disclose personal financial information to others. This rule also places restrictions on the use of information that companies receive from third parties, whether these companies are financial institutions or not.
The Safeguards Rule
The Safeguards Rule requires financial institutions to create and implement procedures to protect the personal financial information they obtain from customers. This rule also applies to companies, such as credit bureaus, who receive this information directly from other financial institutions.
Pretexting Provisions
The Pretexting Provisions protect individuals whose personal financial information has been obtained by others under false pretenses.
Opt out Rights
The GLB Act provides customers and consumers with the opportunity to opt-out or prohibit the financial institution from disclosing certain non-public personal financial information to third parties.
Chapter 7
Chapter 7 eliminates a consumer’s debt by having a trustee sell some of the debtor’s personal property to repay their creditors.
Filing Requirements for Chapter 7
Filing requirements for Chapter 7 became more stringent with the passage of the new bankruptcy law. The intent of the new bankruptcy law was to prohibit high-income debtors from wiping out their credit card debt without any repayment. Now debtors must pay all charges made to credit cards within three months prior to filing.
Means Test for Chapter 7 Filing
Individuals who file for Chapter 7 must have their finances examined to determine if they are capable of repaying their creditors. The first step is to measure their current monthly income against their state’s median income amounts. Current monthly income is averaged over the six month period prior to filing for bankruptcy. If income is less or equal to the state’s median, then a person can file for Chapter 7. If income exceeds the median, then a “means test” must be applied.
Purpose of Means Test
The purpose of the means test is to determine whether there is enough disposable income available to repay at least a portion of unsecured debts over a five-year repayment period. Disposable income is determined by subtracting certain allowed expenses and required debt payments from current income. The higher the disposable income, the more likely that Chapter 7 will not apply, and debtors would need to file for Chapter 13 bankruptcy protection instead.
Debt discharge after Chapter 7 Filing
Most debts are discharged after 115 days from the date of filing for Chapter 7, but certain obligations must still be repaid. These include outstanding payments for child support, alimony, income taxes less than three years past due, student loans and secured debt. Debt that is secured by collateral such as home mortgages and car loans are expected to be repaid, and creditors can repossess the collateral property if necessary.
Chapter 13 Bankruptcy Filing
Chapter 13 allows debtors to keep all of their personal assets, but they are obligated to repay their debt in full, over a period of time. Homeowners may choose the Chapter 13 bankruptcy option because it protects their homes from repossession as long as they continue to meet their repayment obligations. Any secured property that was bought within a year of filing must be fully repaid, including cars bought for personal use within the past 2 ½ years.
Eligibility to File Chapter 13
Debtors are eligible to file for Chapter 13 if their secured debt (e.g., mortgage or car loans), is less than $1,257,850 (2020) and their unsecured debt (e.g., credit card debt), is less than $419,275 (2020). These amounts are adjusted for inflation every three years to reflect changes in the Consumer Price Index. The next adjustment will occur on April 1, 2022.
