Chapter 6 Using Credit Chapter Outline Learning Goals I. The Basic Concepts of Credit A. Why We Use Credit B. Improper Uses of Credit C. Impact of the Credit Crisis on Borrowers D. Establishing Credit 1. First Steps in Establishing Credit 2. Build a Strong Credit History 3. How Much Credit Can You Handle? *Concept Check* 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. Then There Are Those Other Fees 5. Balance Transfers 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 1. Prepaid Cards E. Revolving Credit Lines 1. Overdraft Protection 2. Unsecured Personal Lines 3. Home Equity Credit Lines *Concept Check* 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 *Concept Check* 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 E. Using the Services of a Credit Counselor *Concept Check* Summary Financial Planning Exercises Applying Personal Finance How’s Your Credit? Critical Thinking Cases 6.1 The Morales Family Seeks Some Credit Card Information 6.2 Nancy Starts Over After Bankruptcy Money Online! Major Topics Managing credit is an important part of personal financial planning. Consumer credit can be used in one form or another to purchase just about every type of good or service imaginable. It is a convenient way to make transactions, but when consumer credit is misused it can lead to real problems. It is important for you to understand where consumer credit fits into your financial plans so that it is used wisely. This chapter covers the following major topics: 1. Consumer credit enables the user to pay for relatively expensive purchases, to deal with financial emergencies, and to enjoy the convenience of using credit. 2. Disadvantages to using consumer credit generally arise from abuse of credit—people borrow more than they can handle—and this can eventually lead to bankruptcy. 3. Open account credit is the most popular form of consumer credit. It is provided by banks, stores, and other merchants and includes bank credit cards, retail charge cards, travel and entertainment cards, and personal revolving credit lines, which include overdraft protection and home equity loans. 4. Formal application for open account credit involves a credit investigation; a credit report will probably be obtained from one of the major credit bureaus. 5. Finance charges are typically based on a variation of the average daily balance method. 6. Using open account credit wisely involves choosing the right card or line of credit, avoiding credit problems and fraud, and not abusing credit. Key Concepts Open account credit is a very important concept in the understanding of your personal financial plan. Improper use of this type of credit can lead to disaster, but wise use of open account credit can help you implement your overall plan. To understand the application of open account credit, you should understand some of the key terminology, including the following terms: 1. Debt safety ratio 2. Credit history 3. Credit limit 4. Bank credit cards 5. Retail charge cards 6. Cash advance 7. Debit cards 8. Revolving line of credit 9. Overdraft protection 10. Home equity credit lines 11. Credit bureau 12. Credit scoring 13. Finance charges 14. Credit card fraud 15. Personal bankruptcy 16. Credit counseling Answers to Concept Check Questions 6-1. People typically borrow money to pay for items or services that cost more than they can afford to pay out of current income. By spreading payments over time, expensive items become more affordable, and as a result, consumers can obtain the immediate use of an asset without having to fully pay for it for many years. Other reasons for borrowing include: • Financial emergencies—when unexpected expenses arise; • Convenience—it can be easier to pay with a credit card than by writing a check; • Investment purposes—when investors partially finance the purchase of securities with borrowed funds. The biggest danger in borrowing is overspending. Credit is so easily available it is not all that difficult to spend beyond your means. This, of course, can lead to serious financial strain (as it becomes harder and harder to repay the growing debt load) and ultimately bankruptcy. Usually, such problems are brought on by improperly using credit; i.e., by using credit to: (1) meet basic living expenses; (2) make impulse purchases (especially the expensive ones); (3) purchase a lot of nondurable (short-lived) goods and services; and (4) use one form of credit to make payments on other debt. 6-2. As the economy slowed and unemployment increased during the wake of the financial crisis of 2008-2009, overly indebted households had problems making their mortgage payments. As a result, they drastically cut spending on housing and consumer durables and also many sold their houses to reduce debt. This reduced the overall GDP and exacerbated the downward spiral in home prices. As consumers adapted to the financial crisis, their total indebtedness relative to disposable income fell between 2008 and 2011. About two-thirds of the reduction is due to home and consumer loan defaults. Ongoing foreclosures will likely reduce debt even further. Despite the fact that interest rates fell to record lows, the decline in housing prices made it harder for households to refinance mortgages. In addition, the consumer demand for cash and safe government securities increased, while banks became more reluctant to make riskier loans. Much of the extra public borrowing required to help stimulate the economy was financed by the increased saver demand for safe assets and as a result, the government bond yields dropped as government indebtedness rose. Installment and revolving credit by lenders was reduced to diminish exposure to credit risk. Deleveraging was caused by both tightening credit conditions and voluntary household credit decisions. While debt continues to fall, reduced home equity will likely constrain consumer spending and dampen GDP growth. The crisis has changed the borrowing and spending environment for consumers who now look for greater value and more transparency in financial transactions. 6-3. As a general guideline, your monthly debt repayment burden should not exceed 20% of your monthly take-home pay. 6-4. To measure how you are doing, the consumer credit industry employs the debt safety ratio, this is computed as: 6-5. To establish a good credit rating: • Use credit only when you an afford it and only when the repayment schedule fits comfortably into the family budget—in short, do not over-extend yourself. • Fulfill all the terms of the credit. • Be consistent in making payments on time. • Consult creditors immediately if you cannot meet payments as agreed. • Be truthful when applying for credit—if you are not, you may have some explaining to do to reconcile what you say with what your credit record has to say about you. • A woman should always use her own name in filing a credit application, and she should maintain her own credit file, separate from her husband’s. 6-6. Open account credit is credit extended to a consumer in advance of any transactions. Credit is extended as long as the consumer does not exceed the established credit limit and payments are made in accordance with the terms specified. Financial institutions and retail stores are the main providers of open account credit, which can be in the form of bank credit cards, retail charge cards, 30-day charge accounts, travel and entertainment cards, and revolving lines of credit. Typically, a store or bank agrees to allow the consumer to buy or borrow up to a specified limit on open account. A line of credit is the maximum amount that the holder of a credit card can owe at any time. The amount of the line is set by the issuer based upon an investigation of the applicant’s credit and financial status and upon the applicant’s request. Lines of credit offered by issuers of bank cards can reach $25,000 or more, but for the most part, they range from $2,000 to $5,000. A line of credit is a customary part of bank credit cards and many types of retail charge cards (e.g., cards issued by major department stores); however, some charge cards (like gasoline credit cards) do not come with lines of credit, nor do travel and entertainment cards—whatever has been charged on these cards has to be paid in full in the next billing cycle. You can use your credit card to obtain a cash advance in exactly the same way you do to purchase any other service or piece of merchandise. You present your card at the teller window of any participating bank (or other financial institution), and along with proper identification, can obtain a cash advance of just about any amount you want, so long as you do not exceed your credit limit—though some banks may have limits as to how much they will advance to non-customers. Alternatively, you can use your card at any participating ATM to obtain cash advances, though the amount of such advances is usually limited to some nominal amount (of, say, $200 or $300). There is usually a fee for a cash advance, regardless of how it is obtained. However, ATMs may charge an additional fee for using the service of the machine. You receive an advance on an overdraft line if you write a check that overdraws your checking account. Then the overdraft protection line will automatically advance the funds necessary to put the account back into the black. While a separate line of credit might be set up at the bank to handle the overdraft protection, it is becoming increasingly common today to simply link the bank’s credit card to your checking account (then, if your checking account becomes overdrawn, the bank simply taps your credit card line and transfers the necessary funds to your checking account). 6-7. Reward cards combine traditional bank or T&E card features with a special incentive, such as frequent flier miles or rebates on cars or other merchandise based on purchases up to a limit. Unless you charge a lot and pay balances in full, however, these cards may not make sense, as they often carry higher interest rates. 6-8. Most issuers now use a variable rate tied to the prime rate—prime plus a certain amount with stated minimum and maximum rates. Generally, interest starts accruing immediately on cash advances and many times at a higher rate than that charged on purchases. If you pay your balance in full every month, most purchases will not be charged interest whereas cash advances will. Additionally, a cash advance usually incurs a fee, so effectively the cost of a cash advance can be significantly higher than that of a purchase. 6-9. Many bank credit card issuers impose fees besides the finance charge. These include: a. Annual fees for the “privilege” of being able to use certain credit cards. These fees usually range between $25 and $40. b. Transaction fees for cash advances. These are normally about $5 per cash advance or three percent of the amount obtained, whichever is higher. Balance transfers are a type of cash advance and may also incur fees. c. Late-payment fees and over-the-limit charges are also added by some cards. d. Inactivity fees are now being assessed by some cards on customers who do not use their cards within a given period. e. Foreign transaction fees may be assessed when you use your card in a foreign country. In addition to fees, many cards reserve the right to increase the interest rates they charge you if you are late on your payments or do not pay the minimum amounts. The true or effective cost of borrowing must reflect all costs involved and not just the interest charges. So obviously, all of these fees add to the effective cost of borrowing. 6-10. A debit card provides direct access to your checking account and works just like writing a check. When you use the debit card, the amount of the purchase is deducted directly from your checking account. It is similar to a credit card in that it looks like a credit card and is presented in the store just like a credit card. It differs from a credit card in that it does not provide credit or deferred payment. 6-11. Revolving lines of credit are a form of open account credit that are offered by banks and some other financial institutions. The borrower accesses the funds by writing checks rather than using a credit card. 6-12. A home equity credit line is a personal line of credit that is secured with a second mortgage on the borrower’s home. This means that a family can borrow against the equity in their home. The typical home equity credit line has a minimum of $10,000 in available credit and an advance period of 5 to 20 years during which the homeowner then taps into the credit by writing a check or using a special credit card. At the end of the advance period, borrowing must stop and the credit must be repaid over a period of 10 to 20 years. 6-13. Credit scoring is where values will be assigned to such factors as age, annual income, marital status, length of employment, whether the applicant owns or rents a home, etc. These variables lead to an overall “credit score;” if the score equals or exceeds a predetermined minimum, the applicant will be given credit; if not, the credit will be refused (though borderline cases may be granted credit on a limited basis). In essence, credit scoring is a highly mechanical process whereby the credit decision itself is based largely on the credit score obtained. 6-14. A credit bureau is a type of reporting agency that gathers and sells information about individual borrowers. Lenders who do not know you personally use credit bureaus as a cost-effective way to verify your employment and credit history. There are three sources of credit bureau information: creditors who subscribe to the bureau, other creditors who supply information at your request, and publicly recorded court documents. The information gathered usually includes: • Your name, social security number, age, number of dependents, and current and previous addresses; • Your employment history; • Your credit history, including loans, credit cards, payment records, and account balances; • Public court records; • Names of financial institutions that have recently requested your credit information. By law, if the information in your credit bureau report is incorrect, it must be deleted and lenders receiving the report within the last six months must be notified of the correction. You should notify the credit bureau in writing of the error, including proof to verify your claim; then request a copy of the report to make sure the correction was made. If there is a dispute that cannot easily be settled, you are entitled to add to your file a short statement giving your side of the story. Your explanation must be included with future lender reports. 6-15. Most bank and retail charge card issuers use one of four variations of the average daily balance (ADB) method, which applies the interest rate to the average daily balance of the account over the billing period. The most common method (used by an estimated 95 percent of bank card issuers) is the average daily balance including new purchases. 6-16. The monthly statement shows all transactions, payments, account balances, finance charges, credit available, and the required minimum payment. Merchandise and cash advance transactions are often separated on these statements, as different interest rates may be used to calculate the interest on them, and the interest usually starts to accrue immediately on cash advances. 6-17. When choosing a credit card, you should compare annual fees, rates of interest, grace periods, how balances are calculated, and additional fees. You should also look at your spending patterns. If you pay off balances each month, look for no annual fees and a long grace period—even if that means choosing a card with a high rate of interest (which does not affect you since you do not carry balances anyway). However, if you normally carry a high credit balance, then look for cards that charge a low rate of interest on unpaid balances, even if that means you have to pay an annual fee on the card, and avoid two-cycle balance calculations. For rebate cards, calculate the annual cost with and without the incentive, based on your own spending habits, to see whether the incentive is worth having or not. 6-18. Steps to avoid credit problems include exercising discipline when using credit, limiting the number of credit card accounts you have, and reducing the number of cards you carry. Many problems can be resolved simply by calling the credit card company and speaking with their representative. If you do run into problems paying off credit card balances, first stop using your credit cards until you pay off the balances, pay off the highest interest cards first. It may make sense to transfer balances from higher-interest cards to a lower-interest card or to consolidate the loans and use a home equity line to repay the balances. However, using home equity can be risky—if you don’t change bad credit habits, you could lose your home. 6-19. The biggest source of credit card fraud is stolen account numbers—usually obtained by dishonest employees or thieves going through an establishment’s trash. Some things that you can do to reduce your chances of being a victim of credit card fraud are: • Never give your credit card account number over the phone to people who call you. • When paying for something by check, never put your credit card account number on the check, and do not let the store clerk do it either. • Never put your phone number or address on credit/charge slips. • When using your card to make a purchase, always keep your eye on your card. • Draw a line through any blank spaces on a credit card slip so the totals cannot be altered. • Destroy all carbon copies and old credit card slips. • If your card is lost or stolen, report it to the card issuer immediately. • Use only secure sites when using your card for Internet purchases. 6-20. A wage earner plan (as defined in Chapter 13 of the U.S. Bankruptcy Code) is a plan for scheduled debt repayment over future years. It may be a viable alternative to straight bankruptcy when a person has a steady source of income and has a reasonable chance to repay his or her debt in three to five years. In this instance, the debtor retains the use of, and keeps title to, all of his or her assets. Straight bankruptcy (Chapter 7 of Bankruptcy Code), in contrast, is a legal procedure that results in “wiping the slate clean and starting anew.” The debtor is released of the majority, but not all, of his or her indebtedness and also relinquishes possession of or equity interest in the majority, but again not necessarily all, of his or her assets. This procedure is usually viewed as more severe than a wage earner plan. Financial Planning Exercises 1. Jessica is wise to begin establishing a good credit history early. She should start by opening bank accounts (checking and savings) and applying for a few credit cards. She should use these cards sparingly and pay bills promptly. Having a student loan helps establish her credit history, as by making payments on time, she demonstrates her ability to meet her loan obligations. 2. Unfortunately, the financial crisis of 2008-2009 was closely related to readily available credit, limited oversight, and consumer overuse of credit. In light of the credit meltdown that occurred, the lesson for consumers should be to avoid the trap of overextended routine spending through credit cards, save to payoff purchases rather than using credit for routine purchases, avoid impulse buying, pay off bills, rather than only making only minimum payments on credit cards, and use credit only for products and services that outlive the credit payments. Avoid debt that will endanger the payment of mortgage payments and reduce exposure to credit risk. 3. If Robert makes payments of $410 and his take-home pay is $1,685, his debt safety ratio is $410/$1,685 = .24 or 24%, which is slightly above the maximum suggested limit of 20%; as such, Robert should be cautious about incurring any more debt before he pays off his current obligations. If his take-home pay were $850 and his payments were $150 per month, his debt safety ratio would be $150/$850 = .18 or 18%, which is within the recommended guidelines. However, 18% is close to the maximum suggested limit of 20%, so Robert would do well to try to reduce his debt load. 4. Students will calculate their own debt safety ratios using the following equation: Then they should comment on their personal credit situation based on the ratio (low = 10%, manageable = 15%, and maximum = 20%) and describe any corrective actions they must take. 5. Rebecca’s consumer debt safety ratio is calculated as follows: Use worksheet 6.1. If Rebecca wants her debt safety ratio to be only 12.5% of her current take-home pay, she must reduce her total monthly payments to $415 ($3,320 x .125). If Rebecca wants her current consumer debt load to equal 12.5% of take-home pay, then she would have to increase her take-home pay to $5,160 ($645 = 0.125 x Take-home pay or Take-home pay = $645 ÷ 0.125) See Worksheet 6.1 for Problem 4 on next page. 6. The main features and implications of the Credit Card Act of 2009: In the past, credit card companies could change interest rates and other aspects of the agreement with no notice. They could even change terms retroactively such that they applied two months before you were notified. The new law requires credit card companies to give 45 days’ notice before changing your agreement. Similarly, credit card companies previously could raise your interest rate if your credit report deteriorated or if you were late on even just one payment. The new law allows credit card companies to apply a new interest rate only to new balances after you are 60 days delinquent paying on your account. Just as importantly, your old balance can only be charged your old interest rate. 7. Assuming that the latest balance on Debora’s overdraft account is $862, and with a minimum monthly payment of 5% of the latest balance, her payment on the overdraft account would be: $862 x 5% = $862 x .05 = $43.10 or $45, when rounded to the nearest five dollar figure. 8. If David and Joan have a home appraised at $180,000 and a mortgage balance of only $90,000, they have equity in the home of $90,000 ($180,000 – $90,000). If an S&L will lend money on the home at a loan-to-value ratio of 75%, the S&L would be willing to lend up to $135,000, or .75 x $180,000. Subtracting the first mortgage of $90,000, the Meads could qualify for a home equity loan of $45,000. According to the latest provisions of the tax code, all of the interest paid on their home equity loan would be fully deductible (for federal tax purposes). It makes no difference what the house originally cost; the only thing that matters is that the amount of indebtedness on the house not exceed its fair market value (which is virtually impossible given a loan-to-value ratio of 75%). Other than that, a homeowner is allowed to fully deduct the interest charges on home equity loans of up to $100,000; since the Meads’ home equity line is within this limit (theirs is a $45,000 line), the interest on it is fully deductible. Note: under current tax laws, the total amount of itemized deductions as reported on Schedule A may be reduced for taxpayers with adjusted gross incomes greater than a certain level. Also, if taxpayers do not itemize deductions and take the standard deduction instead, the tax deductibility feature of a home equity loan would not make a difference in the amount of taxes owed. 9. If Gabriel has a balance of $380 on her retail credit card, the calculation of the monthly interest on her account would be: $380 x (21% 12) = $380 x 0.0175 = $6.65 This calculation assumes that the balance was computed by the average daily balance method. 10. If Isaac plans to pay his balance in full each month, the interest rate on his credit card would not matter. Virtually, all cards do not charge a fee if the cardholder’s balance is paid in full each billing cycle, provided no late fees or over-the-limit fees apply. Therefore, he would go with the card which does not have an annual fee. However, if he knows he will carry a significant balance from one billing cycle to the next, he may well be better off with the card that charges an annual fee and a lower interest rate. The higher his balance, the more attractive such a card would become. Isaac should also consider the method the lender uses to calculate the balances on which they apply finance charges. The most common method (used by an estimated 95 percent of bank card issuers) is the ADB, including new purchases. Card issuers can also use an ADB method that excludes new purchases. Balance calculations under each of these methods affect the finance charger that Isaac will have to pay. 11. Janine has a fairly large balance of $14,500 on her credit cards. If her current cards charge her 12% per year, she would be paying $1,740/year or $145/month ($14,500 x .12/12) in interest on this amount. Therefore, if she feels she would not be able to pay off this balance fairly rapidly, she might indeed wish to transfer her balance to a 0% interest rate card for 9 months. If such a card charges a 2% transfer fee, she would pay $290 to transfer her $14,500 balance. She would have paid that amount in interest in 2 months anyway by leaving her balance with her old cards. Most cards have a maximum amount charged to transfer a balance, such as $65 or $75. However, since Janine has multiple cards, she might be charged that maximum several times. Janine should call the customer service number on the new credit card offer, explain her situation, and ask them to calculate what her fees would be to transfer the balance. She should also inquire what the regular rate will be on the new card, because she will have to pay that on her unpaid balance once the special offer time period is over. She should also be aware that if she pays late on such an offer, many times the rate will automatically go up to the card’s regular rate and even higher if she has several late pays. 12. The calculation of Joel’s interest is as follows: 13. Credit cards provide a line of credit and can be used worldwide as well as on the Internet to make purchases or pay for services. Credit cards also allow the holder to obtain cash advances, either from a financial institution or at an ATM machine. Other features offered by credit cards may include a buyer protection plan on merchandise purchased with the card, travel accident insurance, auto rental insurance coverage or other added attractions, such as a rebates or frequent flyer miles. Even though most credit cards carry a fairly high interest rate, cardholders who pay their balance in full each month usually pay no interest or finance charges. So in essence, such card users are the beneficiaries of a short, free loan each month. The main drawback to credit cards is the tendency of some cardholders to overspend, go into debt and incur high interest charges. Debit cards do not provide credit but rather are like writing a check. Purchases on debit cards come directly from one’s checking account and therefore incur no finance charges. People who have difficulty managing credit many times prefer a debit card because they are not as tempted to overspend. However, some merchants charge a fee to debit card users, and some issuers charge transaction fees. Debit cardholders can have overdraft problems when they fail to record transactions in their checkbooks William would be a convenience user of either type card. He is a disciplined spender and probably would not be tempted to overspend. He likely will not need credit for emergency purposes, either, as he has a sizeable emergency fund of $8,500 built up. William might want to consider a credit card with a rebate or frequent flyer miles. With his disciplined approach to spending, he could charge purchases, pay them in full each month, and rack up points or miles. Also, when a credit card is stolen, the most the cardholder can be out is $50. When a debit card is stolen, the cardholder can possibly lose a lot more, plus the money has been removed from his or her account and the burden falls to the cardholder to get the money restored to his or her account. In the meantime, before the money is restored the debit cardholder is denied use of his or her funds. On the other hand, if fraudulent charges appear on one’s credit card statement, the credit cardholder contests the charges and doesn’t pay the bill. 14. Lei should immediately notify the credit card issuer of any charges on her statement which are not hers. The customer service representative of the issuing card can give her more information concerning the purchases so that she can determine if she indeed made them and forgot or if they are fraudulent. Her liability would be limited to $50 on any charges she did not make. 15. The 5 Cs of credit are character, capacity, collateral, capital, and condition. Refer to the “Financial Road Sign”. a. Harvey certainly seems to be a person of great character. He was active in clubs and community service while in college, serving frequently in a leadership role. b. His capacity to service a loan would depend on his other sources of income. We are not told if he has another job lined up or not. If he has other income, that would greatly increase his capacity to repay the loan, particularly since he has no other debts to service. However, if he does not have other income, the $10,000 expected cash flow from his investment is certainly not enough for him to live off of plus pay on his loan. c. Harvey might consider offering his car as collateral for this loan, since he owns it free and clear. Backing a loan with collateral would likely allow him to obtain a much lower interest rate on the loan, since the bank would have an asset to seize in the event he did not repay his loan as promised. The lower the interest rate, the lesser it would cost Harvey to service his loan, which in turn would also increase his capacity to repay the loan. d. Harvey has a fair amount of capital for a young person who has just completed college. He owns his car, which is valued at $10,000, plus he has $6,000 in savings. This should be a positive for him. e. However, the current condition of the economy will probably work against Harvey. Even though an economic recovery is predicted soon, it may not be soon enough for Harvey’s business to generate the cash flow he anticipates. A high percentage of new businesses fail in the first year, and a slow economy usually increases the likelihood of failure. Solutions to Critical Thinking Cases 6.1 The Morales Family Seeks Some Credit Card Information 1. Conrad and Ingrid should expect to provide information with respect to family, housing, employment and income, assets and liabilities, existing charge accounts and credit references. They should provide this information as honestly, accurately, and thoroughly as possible, because it will be verified in the process of the credit investigation. 2. The bank will analyze and verify the accuracy of the data in the credit application. It will likely get a credit report from a credit bureau in order to check on past payment habits. Further investigation by the bank may involve contacting references listed on the credit application. Generally, only in the case where a credit report cannot be obtained or when the credit report is marginal will the bank check credit references. 3. The bank may use subjective techniques to evaluate and assess the applicant’s credit worthiness, or they may use some type of credit scoring scheme. In the credit scoring approach, the bank assigns values to certain factors and then calculates a credit score. This score can then be compared to predetermined values in order to decide whether or not to extend the requested credit. Regardless of what techniques are used, the bank will ultimately make a decision to accept, reject, or issue some type of restricted credit. Applicants are notified of the decision, and those who are granted credit are sent a personalized credit card along with materials describing the credit terms and procedures to be used. 4. The Morales family should understand that a credit card is a powerful tool that can provide them with many of the things they want. At the same time, if it is not used properly, they can get into a lot of financial trouble. They should make sure that the goods and services they charge on their cards fit into their needs as expressed in their financial plans. If they use the credit card for everyday needs, then they should pay off the entire balance each month. This means that they are living within their budget and are just using the credit card for convenience. If they make a substantial purchase with the card, they should know beforehand how the purchase fits into their financial plans and how the payments are to be met. Any use of the card as a way of buying permanent goods or expensive services must not damage their long-term financial goals. Additionally, proper use of a credit card can build a strong credit record. The lenders will report the Morales family payment history and outstanding balances to the credit bureau. Any problems will show up quickly, but good use of the credit will also be reported, thus building their credit history. Sound use includes one-time payments, staying within credit limits, and making their payments on time. 6.2 Nancy Starts Over After Bankruptcy 1. Obviously, the first thing Nancy has to do is pay back the $24,000 in bankruptcy debt— and the sooner that can be done, the better! She has to show that she now has the discipline to pay off the debt that she owes. She also has to be careful about taking on any new debt—though that probably will not be much of a problem, since she is likely to find new debt very hard to come by. Finally, if she has any monthly bills (like phone bills, etc.), she should make sure she always pays them on time. 2. She might look into the possibility of obtaining a charge card from one or two major department stores in her area. While Nancy has to be careful about taking on new debt, she might be able to get approval for a charge card with a low credit limit—say, $250–$300. Then she has to make sure that she uses it judiciously and that she promptly pays the account balance in full each month. 3. For at least a year or so, probably the only way she will be able to obtain a bank credit card is to sign up for a secured credit card. Nancy can do that by using part of her savings to purchase a CD, which will then act as collateral for the credit card. Again, she will have to take care to use the card sparingly and make payments on time, preferably in full, every month. 4. For the first year or two, Nancy should monitor her credit report every six months, then after that, every year or so for the next five to seven years. If she finds any discrepancies in the report, she should contact the credit bureau immediately (in writing). If she is making progress in her fight to get out of debt, that should be reflected in her credit report; if it is not, she should let the credit bureau know. 5. Nancy needs to know that it is possible to start over again. In addition, she should take the time to reflect on the past and determine what went wrong—knowing that, she can take steps to make sure it does not happen again. She should not overspend, not take on more debt than she can afford, and not let the debt build up. She should make sure that the repayment of the debt fits into her monthly budget and that she stays current on all her bills and credit lines. Solution Manual for PFIN Personal Finance Lawrence J. Gitman, Michael D. Joehnk, Randall S. Billingsley 9781285082578
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