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Educational Consumer Tips

Consumer Credit

Author: Rachel Gelb
Category: Finance

Credit is a convenience. It allows you to charge a meal on your credit card, pay for an appliance with an installment plan, or take out a loan to buy a house. With credit you can make a purchase when you lack ready cash, and you can enjoy the purchase while you are paying for it.

But, the convenience of credit has strings attached; credit is a service you pay for. Money is a commodity, and in most cases when you borrow it, or delay payment for a purchase, you pay "rent."

Interest is the "rental fee" charged for the use of money that belongs to a bank, retailer, or other lender. And, the costs of credit can be substantial, even though the price of a single installment may seem easily affordable.

If you are thinking of applying for a loan, or opening a credit card account, it pays to do some homework first. Understanding how the system works can help you figure out how much credit will cost you, whether you can afford it, and how to shop around for the best terms.

Credit Terminology

There are two basic forms of credit:

·          Open-end credit includes credit cards, department store "charge cards," and check overdraft accounts that let you write checks for more than your actual bank balance. In most cases, interest is charged if the purchase amount is not paid within a specific amount of time (the grace period).

The customer usually can choose how much of the monthly bill to pay at any one time. While a minimum payment is specified by the lender, paying only this amount ensures the cardholder will be charged interest on any balance outstanding.

·          Closed-end credit includes installment loans and purchases. A specified amount is borrowed (for installment purchases, the amount is the selling price of the merchandise), and is repaid in monthly installments over a specified period of time.

Offered by banks, savings and loans companies, credit unions, finance companies, other financial institutions, and some dealers and retailers, this form of credit can be used to finance both small and major purchases, such as an appliance, automobile, house, or college tuition.

Open-end Credit: Shopping for a Credit Card

Federal law requires all credit card solicitations and applications to contain certain basic information that can help you determine the costs of buying on credit, and shop around for the best deal. The four key items to look for are the:

·          Annual percentage rate (APR);

·          Method of calculating the finance charge;

·          Grace period; and

·          Annual fee.

The finance charge is the total dollar amount you pay to use credit. The annual percentage rate (APR) is the percentage cost of that credit on a yearly basis. Bank cards' APRs can range from a low of about 8 percent to a high of 22 percent or more, with the average of about 18.5 percent, or 1.5 percent a month.

Some banks also offer variable-rate credit card accounts, in which the APR changes depending on a specified interest rate index, such as the prime rate, or the market rates on short-term government securities. The finance charge you pay is determined by applying the APR to your balance, or the amount you owe.

Creditors use a number of different methods to calculate the balance owed. Some creditors subtract all payments made during the billing period before adding finance charges; this is known as the adjusted balance method.

Others use the previous balance method, which gives you no credit payments during the billing period. In this case, the finance charge is applied to the balance at the end of the previous billing period.

Under the average daily balance method, your balances for each day in the current billing period are added together and then divided by the number of days in the billing period.

Another critical factor in determining the cost of credit is the "free" or "grace" period - the amount of time, if any, that the creditor gives you to pay your bill before finance charges begin. If there is no grace period, you begin to pay interest on the day your purchases are posted to your account. This means that even if you pay your bill in full and on time, you will still be charged interest. Grace periods typically range from about 21 days to 30 days.

Annual fees are charges, by many financial institutions, for the privilege of carrying their card. The average annual fee is $18 for a standard card, or it can be as high as $35 to $60 for "premium" cards that provide a higher line of credit. Some banks offer cards with no annual fee, but a relatively high APR, and some have waived annual fees to attract and retain cardholders.

Other charges to consider when you shop for the best credit card deal, include:

·          The minimum payment required each billing period, calculated as a percentage of the outstanding balance;

·          The amount of any late fee, or penalty fee, charged for late payments, or for exceeding your credit limit;

·          Any transaction fees for purchases.

Which Card Is For You?

How can you translate an evaluation of all these factors into the best credit card deal for you? The answer depends, in large part, on your own habits and preferences as a credit user.

If you are an "identification" user-that is, you rarely charge purchases, but use your credit card mainly as an ID for cashing checks, making hotel reservations, etc.,-your best choice is a "major" or widely accepted card with a low (or no) annual fee.

If you are among the 35 percent of credit card holders who charge purchases, and usually pay their credit car bills in full each month, the APR is not the most important consideration for you. Instead, as a "non-revolving" credit user, you should look for a low (or no) annual fee, and a long grace period.

If you are a "revolving" credit user-you use your card to purchase goods and services, but frequently pay only a portion of the balance due each month-look for a low APR and a creditor that uses the adjusted balance, or average daily balance method, to calculate your balance.

If you prefer to pay a lower monthly minimum, look for cards offering that feature. But, remember that making low minimum payments means it will take longer to pay off a given amount of credit, and you will pay more interest in the process.

For both "non-revolving" and "revolving" credit users, a "premium" card with its higher credit limit may be useful, if the card will frequently be used for travel, or large purchases. But, keep in mind that you will generally pay a higher annual fee for these "gold" cards.

If you plan to make frequent charges, you may want to look for low (or no) transaction fees, and low (or no) penalty fees for exceeding credit limit.

And, depending on personal preference, additional services offered by creditors may be a factor in your choice of credit cards. Such services include: frequent-flyer points; travel, or rental car insurance; purchase protection; check writing privileges; cash availability through 24-hour automatic teller machines (ATMs); or any other extras.

You May Qualify for a "Secured" Credit Card

Most credit cards are "unsecured" -that is, they allow you to use credit without having to put up with any of your own assets as collateral. But for persons whose credit history prevents acceptance by a traditional credit card issuer, there is an alternative-"a secured credit card" account.

Secured credit cards require you to place a deposit in a bank, savings and loan company, or a company specializing in this type of offer. You are then granted a line of credit, with the credit limit based on a percentage of your deposit. These cards can be useful in rebuilding damaged credit record.

However, before applying for a secured card, you should get the answers to the following questions:

·          What is the processing fee? Processing fees for opening a secured credit card account may range as high as $50 to $100 , and may not be refundable if your application is rejected.

·          What are the additional fees, or charges? Ask the same questions that would apply to a traditional, unsecured credit card account.

·          Where will the deposit be held? Look for an established recognized financial institution. If the institution is a savings and loan company, ask whether it is FSLIC-insured.

·          Will the account pay interest? Most secured accounts pay interest on the unused portion of your deposit. Be sure to ask about, and compare, rates.

Cutting Credit Costs - Being aware of the following facts and precautions can help you cut your credit costs.

·          Avoid holding more credit cards than you need. Each card has a credit line, and the total could reach a sizable figure, thus reducing the amount of other credit available to you.

·          With travel and entertainment cards, such as American Express and Diners Club, you must pay off your charge balance each month. Thus, there are no interest charges-although there is an annual fee. These cards may offer additional credit services, such as credit for travel tickets. Before basing your choice of a card on the availability of such services, take the time to compare the full costs of credit, including annual fees, and any other charges.

·          Before selecting a card because of its extra service features (check-writing privileges, or cash availability through ATMs, for example), consider whether you actually will need, or use those services, and take into account any additional fees.

·          It is also a good idea to compare the discount prices of merchandise, available through some creditors' discount catalog programs, with the prices you might find in stores, or retail catalogs.

·          If you are considering a variable-rate credit card, remember that, unless the card issuer specifies a maximum interest rate, the rate can go as high as the interest rate ceiling specified by the state law where the creditor is located (and some states do not have any interest rate ceiling).

·          Many charitable organizations offer credit cards to members, with a portion of the issuing bank's revenues from the card reverting to the charity. Before accepting such an offer, compare the credit terms offered with those of other card issuers, and consider the alternative of simply making a donation to a cause.

Avoiding Credit Card Fraud Follow the safeguards to protect yourself from credit card fraud:

·          Before signing a credit card bill, verify that the amounts, and total, are correctly shown in ink. After signing the bill, detach, and destroy, any carbons.

·          When you receive a personalized credit card application in the mail and do not intend to apply for the card, tear up the application before discarding it.

·          Do not write your credit card number on return cards, or mailers, that can be easily pulled open.

·          Avoid giving your credit card number to a telephone solicitor. If you want to learn more about the product or service offered, ask the caller to mail further information to you.

·          Contact the merchant if you place a phone order, using your credit card, and do not receive the merchandise within a reasonable period. If a charge for unordered, or undelivered, goods appears on you credit card statement, notify the card issuer, in writing right away.

·          Keep a record, in a secure place, of all your credit card account numbers and expiration dates, the name used on the card, and the phone number to call if a card is lost, or stolen. If a card is missing, call the card issuer immediately.

·          Generally, you are responsible for up to $50 of unauthorized charges made on a stolen credit card, before you notify the card issuer that the card is missing. When considering the purchase of credit card insurance, take into account this legal limit on your liability.

Close-end Credit: Shopping for a Loan

If you are in the market for a large loan for a major purchase, shopping around for the best value can save you hundreds of dollars.

The federal Truth-In-Lending Act requires all lenders to provide prospective borrowers with two critical items of information that can help you compare terms: the annual percentage rate (APR), and the finance charge.

Just as with your credit card accounts, the APR is the interest rate you pay for credit on a yearly basis. The finance charge is the total dollar amount that the loan will cost you, including interest charges and sometimes other costs such as: service charges; processing fees; some credit-related insurance premiums; or appraisal fees.

Even when you are aware of the terms a creditor is offering, it is easy to underestimate the difference in dollars the various terms can make.

Today, adjustable-rate loans, in which the interest rate varies based on a formula related to some measure of prevailing interest rates, have made it necessary to carefully compare lending institutions when shopping for a mortgage, home equity loan, or auto loan.

With an adjustable-rate loan, the starting rate--the APR you will pay for the first year of the loan--may be lower than the rate for a fixed-rate loan offered by the same lender. But if the interest rates rise, the APR will also rise, by a set number of percentage points (the margin), as spelled out in the loan agreement.

No one, of course, can predict whether interest rates will rise, fall, or remain the same. So, how do you choose between a fixed-rate, and an adjustable-rate loan?

First, it is critical to consider how high the adjustable rate might go. If the APR were to climb to its legal limit, could you still afford the monthly limits? All adjustable-rate mortgages, and home equity loans, have a lifetime cap--a ceiling on how high the interest rate can climb. Federal law does not require caps, however, on adjustable-rate auto loans.

Consider, too, whether there is enough difference between the APR of the fixed-rate loan, and the starting rate of the adjustable-rate loan, to justify your giving up the security of fixed monthly payments.

Other questions to ask, and terms to compare regarding adjustable-rate loans, include: How often does this rate change? Can the loan be converted to a fixed-rate loan at some future time? (Conversion can be an advantage if interest rates skyrocket, although extra fees are often involved, and the fixed-rate you receive may be somewhat higher than what you might be able to find elsewhere at the time you convert.)

In the final analysis, only you can determine the degree of risk with which you feel comfortable. You may also want to ask your tax adviser, or accountant, for advice on the relative advantages and disadvantages of fixed-rate and adjustable-rate loans.

Shopping for an Installment Loan

The following guidelines can help prospective borrowers shop around for an installment loan that offers the best rates and terms.

·          Establish the amount of the purchase that you can finance with ready cash, and the amount you must borrow.

·          If you have used a particular lending institution satisfactorily in the past, begin your credit shopping there.

·          Talk to a loan officer and ask what the APR, and finance charge, would be for the loan amount you are contemplating.

·          Ask what the monthly payments would be on the loan over a specific period of time. If the lending institution offers an adjustable-rate loan, ask what the payments would be of the rate increased to the maximum, or its lifetime cap. Also, ask whether there is any annual cap, or limit on how much the rate can increase in any one year.

·          Take a careful look at your personal financial situation -- your income, expenses, and debts -- to determine whether you can afford to make monthly payments, without putting too much stress on your budget.

·          Check the ads in the business section of your local newspaper to compare rates offered by other lending institutions. You might also ask friends, and business associates, for recommendations of lenders. Once you have identified several prospects, visit each lender's office to ask about loan rates, and terms, and the application process.

·          Ask about the lender's policy on prepayment; some lenders will allow you to pay off your loan ahead of time, or make larger payments, while others impose penalties for prepayment.

·          Also, check the fees, or penalties, for late payments, bad checks, or defaulting the loan.

·          Compare the rates, and terms, of the lending institutions you have interviewed. Once you have identified the lender with the best offer, take a careful look at the loan contract you receive, and make sure you understand, and agree with, all items before signing.

·          The agreement may include a paragraph on credit insurance, which pays off the debt in full if death, or major illness, occurs before the final payment is made. Credit insurance is actually term life insurance with rates that do not vary by age, and with no evidence of insurability required. This can mean relatively high rates, particularly for young people. Credit insurance is optional; you cannot be denied a loan if you decide not to buy it.

Your Credit Record

Although creditors usually consider a number of factors in deciding whether to grant credit, most rely heavily on your credit history. To learn how you have handled credit in the past, most creditors purchase a report from your local credit bureau.

Your credit bureau report is based on information regularly reported to the bureau by the retailers and creditors with whom you have credit cards, a loan, or other financial dealings. It also contains matters of public record, such as bankruptcy, and court judgments against you.

Under the Fair Credit Reporting Act, if you apply for a loan, and are turned down because of information contained in your credit bureau report, the creditor must identify the credit bureau involved. At your request, which can be made by mail or in person, the credit bureau must provide a summary of your credit file. If you act within 30 days of being denied credit, there is no charge for this service.

You have the right to dispute any information in your credit record that you consider inaccurate, outdated, or incomplete. To register your objection, write the credit bureau, explaining why you believe the information is incorrect.

Unless your dispute is frivolous or irrelevant, the credit bureau must reinvestigate the matter, and delete the information from your report, if it cannot verify the disputed facts. If you disagree with the results of the reinvestigation, you are entitled to write a brief statement explaining your side of the story. Your statement will become part of your credit bureau report.

If the negative information in your report is accurate, however, only time can ensure its removal. Credit bureaus are generally permitted to report bankruptcies for 10 years, and other negative information for 7 years. There is nothing that you (or anyone else) can do to remove accurate information from your credit file, unless the reporting period has expired. Do not be mislead by "credit repair" ads aimed at persons with bad credit histories, judgments, or bankruptcies. Promises to "repair" or "clean up" a bad credit history can almost never be kept.

Tips to Remember

·          Credit can be a valuable convenience. It can also become a heavy burden on the consumer who used it indiscriminately.

·          Following are some early signs of a credit situation that may be headed for trouble:

·          Not paying your bills on time, or juggling bill-paying each month;

·          Making only minimum payments on large credit card bills;

·          Not knowing how much you owe; 

·          Regularly using your overdraft credit on your checking account to pay bills;

·          Living up to your income, without saving anything for emergencies; and

·          Being denied credit because of negative credit report.

·          If you recognize one or more of these warning signs, the following guidelines may help you get back on track:

·          Analyze where your money is going. Establish a budget and stick to it.

·          Contact your creditors if you are facing temporary problems in making payments. They may be willing to work out a modified payment plan that reduces payments to a more manageable level.


If you are thinking about turning to a company that offers debt consolidation loans, debt counseling, or debt reorganization, investigate the company thoroughly before signing any agreement. Check the company's reliability record with the local Better Business Bureau, and your state, or local consumer protection office.

And, remember that some businesses offering debt "relief" charge substantial fees, but fail to follow through on the services they provide. Be certain you understand exactly what services the business provides, and what they will cost you. Do not rely on oral promises that are not spelled out in a written contract.

If you need help in dealing with a severe or potentially long-term debt problems, you may want to contact your local, non-profit, Consumer Credit Counseling Service (CCCS). Counselors with the CCCS will try to work out a repayment plan that is acceptable to you and your creditors, and will also help you set up a detailed and realistic budget. Their services are offered free, or for a minimal charge.

Credit Counseling

There are many indicators of financial difficulties. Any of the following should trigger a warning signal that you may be exceeding your financial limits:

·          More than 20% of your take-home pay every month is going to installment and other kinds of loan repayments, with the exception of your mortgage. If you're paying more, you may be over extending yourself, especially if your mortgage payments amount to more than 25 to 30 percent of your take home pay.

·          You pay revolving credit accounts with the minimum amount required each month. During this time, your overall debts on revolving accounts continue to rise.

·          You're borrowing to pay routine expenses such as groceries and utilities.

·          You alternate payments to creditors paying one creditor one month, another the next, and so on.

·          You have less than 3 months take-home pay in savings for emergencies, and you're finding it impossible to set anything aside.

·          You're depending on over-time and/or additional part-time income to pay for ongoing household expenses.

·          You're receiving second reminders, collection notices or are being threatened with court action.

If one or more of these categories describes your situation, there are several things you should do. First, examine your situation carefully. From your paystubs, bank statements, and store receipts determine, as best you can, where your money has been going in the past few months. Do not overlook those "small" out-of-pocket-expenses such as movies and liquor, because they can quickly become "BIG" expenses. Also list your monthly income (actual take-home pay), not gross wages. Compare your income with your expenses to see where you stand.

If you see no way to remedy your situation immediately, contact your creditors and explain what your problem is and what you plan to do to correct it. In some instances creditors will agree to extend the payment period, let you pay interest but not principal for several months. It may also be possible to rearrange your payments in some other way that will relieve some of the stress, yet allow you to pay those debts off.

Individuals with an assortment of debts are often attracted to the idea of a consolidation loan. Be cautious of such an arrangement. Consumers are often disillusioned by the simple appearance of one payment per month, but fail to see that these loans may continue indefinitely. Also be cautious of "pyramiding" loans or borrowing to pay for something before you've paid off a loan for a similar purpose.

If you are finding that you're unable to stop this debt merry-go-round on your own, you may wish to contact an expert. Due to our heavy reliance on credit, accompanied by uncertain economic times, the demand for credit counseling services has greatly increased in recent years.

Credit counseling services have trained professionals who work with individuals to help them set up and manage a realistic budget. In some instances, they will contact creditors and try to arrange a repayment program that will be acceptable to everyone concerned. Utility cut-offs, threatened housing foreclosures, repossessions and other delinquent accounts are considered priority. When these crisis situations have been resolved, the counselor develops a debt repayment program that both the client and cr editors can accept.

The counselor will attempt to put every available dollar towards the repayment program and at the same time make the family budget livable. In some instances, the client may be asked to turn over his pay each month to the counselor for direct dispersion to creditors until the debts are paid.

Before signing a contract, or making any type of agreement, make sure that you're dealing with a legitimate credit counselor. Beware of agencies that advertise debt counseling services, but keep a major portion of your funds as a fee for service.

Important Questions to Ask When Choosing a Credit Counselor

If you decide that you need additional credit advice and assistance, or if you are considering working with a credit counselor for the first time, asking questions like these can help you find the best counselor for you.

·          What services do you offer?
Look for an organization that offers a range of services, including budget counseling, savings and debt management classes, and counselors who are trained and certified in consumer credit, money and debt management, and budgeting. Counselors should discuss your entire financial situation with you, and help you develop a personalized plan to solve your money problems now and avoid others in the future. An initial counseling session typically lasts an hour, with an offer of follow-up sessions. Avoid organizations that push a debt management plan as your only option before they spend a significant amount of time analyzing your financial situation. DMPs are not for everyone. You should sign up for a DMP only after a certified credit counselor has spent time thoroughly reviewing your financial situation, and has offered you customized advice on managing your money.

If you were on a DMP with an organization that closed down, ask any credit counselor that you are considering what they can do to help you retain the benefits of your DMP.

·          Are you licensed to offer your services in my state?
Many states require that an organization register or obtain a license before offering credit counseling, debt management plans, and similar services. Do not hire an organization that has not fulfilled the requirements for your state.

·          Do you offer free information?
Avoid organizations that charge for information about the nature of their services.

·          Will I have a formal written agreement or contract with you?
Don’t commit to participate in a DMP over the telephone. Get all verbal promises in writing. Read all documents carefully before you sign them. If you are told you need to act immediately, consider finding another organization.

·          What are the qualifications of your counselors? Are they accredited or certified by an outside organization? If so, which one? If not, how are they trained?
Try to use an organization whose counselors are trained by an outside organization that is not affiliated with creditors.

·          Have other consumers been satisfied with the service that they received?
Once you’ve identified credit counseling organizations that suit your needs, check them out with your state Attorney General, local consumer protection agency, and Better Business Bureau. These organizations can tell you if consumers have filed complaints about them. The absence of complaints doesn’t guarantee legitimacy, but complaints from other consumers may alert you to problems.

·          What are your fees? Are there set-up and/or monthly fees?
Get a detailed price quote in writing, and specifically ask whether all the fees are covered in the quote. If you’re concerned that you cannot afford to pay your fees, ask if the organization waives or reduces fees when providing counseling to consumers in your circumstances. If an organization won’t help you because you can’t afford to pay, look elsewhere for help.

·          How are your employees paid? Are the employees or the organization paid more if I sign up for certain services, pay a fee, or make a contribution to your organization?
Employees who are counseling you to purchase certain services may receive a commission if you choose to sign up for those services. Many credit counseling organizations receive additional compensation from creditors if you enroll in a DMP. If the organization will not disclose what compensation it receives from creditors, or how employees are compensated, go elsewhere for help.

·          What do you do to keep personal information about your clients (for example, name, address, phone number, and financial information) confidential and secure?
Credit counseling organizations handle your most sensitive financial information. The organization should have safeguards in place to protect the privacy of this information and prevent misuse.

·          Your Better Business Bureau, bank, credit union, church, and local service agency may also be able to provide you with more information.

Unfortunately, when you're behind in your payments it's not unusual to be hounded by bill collectors. If this is the case, you need to be aware of the Fair Debt Collection Practices Act of 1978. This outlines what a bill collector can and cannot do. While this law applies only to independent bill collectors (not the creditor or his lawyer), complaining about pressure tactics to your creditor maybe of help. If you are subjected to any of the following tactics, do not hesitate to contact your local consumer protection agency:

·          If the bill collector threatens to expose your situation to your employer or friends. According to the law, they may not contact your employer without your permission or only in the event that they want to find out if you really work there or to find out where you live.

·          They send you letters that appear to have come from a credit bureau or government agency. Or they send you notices that appear to be a court summons.

·          They use abusive language when speaking with you either over the phone or in person.

·          You're called late at night or the calls are in continuous succession. Bill collectors are permitted to call between the hours of 8:00 a.m. to 9:00 p.m. at your home or place of employment (at reasonable intervals). However, you can get them to stop calling you at work if you indicate that they're endangering your job. You should follow up with a letter that makes the same statement.

·          They try to collect more than is due the creditor.

·          They misrepresent themselves. For example, they pose as repairmen in order to gain entry to your home and makes notes or takes something of value.

·          Beware of individuals who introduce themselves as survey-takers and proceed to ask you questions about your financial status. Information given under these circumstances can be used against you.

·          If the creditors continue to contact you after you have written them requesting that they stop, or you have communicated to them that your case has been turned over to a lawyer. They may contact you only once after this point in order to inform you of further legal actions that are being taken.

About the Author: Rachel Gelb is Communications and Marketing Manager for BBB serving Eastern Massachusetts, Maine, Rhode Island and Vermont. Find Rachel on Google +.

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