Chapter 2 Consumer Credit

Answers to Think It Over

1 Any reasonable answer

2 MMM Bank wants its cardholders to develop a habit of using the credit card regularly in the
first three months so that they will keep using it in the future.

3 An interest rate of 2% per month is equivalent to an annual interest rate of 26.8%. This rate is
very high as compared with a personal loan.
(Note: Students can calculate the effective interest rate by using the ERR equation they have
learnt in Chapter 1.)

4 Advantages: convenience; safety; worldwide acceptance; repayment flexibility

Disadvantages: high interest rate; risk of credit card abuse; rejected by certain shops

Answers to Check Your Progress

Q2-1 Credit cards do not involve a fixed deadline or number of payments for repaying the
balance in full. Consumers can repay the balance by irregular or lump-sum payments.
They only need to settle the monthly minimum payment on time.

Q2-2 C

Q2-3 From a consumer’s point of view, an overdraft facility can prevent a cheque from being
dishonoured due to careless mistakes by the account holder. It also provides short-term
liquidity to consumers who are temporarily short of cash. In addition, an overdraft facility
does not involve a fixed deadline or number of payments for repaying the loan in full.
Consumers only need to settle the monthly minimum payment on time. Therefore, this
gives them greater flexibility in repaying their loan.

Q2-4 C

Q2-5 D

Q2-6 The main advantage of borrowing with lines of credit over credit cards is that interest on
lines of credit is usually lower than that on credit cards.

Q2-7 a General credit card consumption does not involve a fixed deadline or number of
payments for repaying the loan in full. However, the above instalment loan schemes

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2nd Edition: Answers to Textbook Exercises 10
 require the borrower to repay the loan by regular payments within a stated period.

b i AAA credit card. This is because the video game console costs $2,500, which is
less than the minimum loan amount of $3,000 for BBB credit card.

ii BBB credit card. As the tablet computer costs $3,000, I can obtain an interest-
free loan with AAA credit card or BBB credit card. The maximum repayment
period for BBB credit card is 24 months, longer than that for AAA credit card
(18 months). This means that the monthly payment on BBB credit card is lower.
Thus, BBB credit card is preferable.

Q2-8 This is because an instalment loan forces an individual to estimate in advance how much
he can repay each month and how long it will take to pay back the loan. Therefore, a
person will not carry the debt for too long and it will be paid off within a reasonable
period.

Q2-9 As lenders may use different methods to calculate interest and often state their interest
rates in different ways (monthly or annual), consumers may need to work out the total
interest payments under different consumer credit plans for comparison.

Q2-10 Consumers need to read the terms of the loan in order to understand the charges for late
payment, restrictions on early repayments and other penalties related to the loan. As some
credit cards (or loans) may charge different interest rates on different amounts of
outstanding balances, consumers can also know the appropriate interest rates applicable to
them by reading the terms of the loan.

Q2-11 Repayment history, credit history, outstanding debt, past delinquency and record of
bankruptcy

Q2-12 B

Q2-13 Individuals should consider their ability to repay their debts before applying for credit
cards. They should also avoid applying for too many credit cards within a short period of
time.

Answers to Try This Activity

A2-1 Other types of organisations:
• Insurance companies (e.g., Ageas, Zurich)
• Charitable organisations (e.g., Tung Wah Group of Hospitals, Caritas Hong Kong)

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2nd Edition: Answers to Textbook Exercises 11
 • Professional organisations (e.g., The Hong Kong Medical Association, The
Association of International Accountants)
• Telecommunications companies (e.g., SmarTone)

A2-2 Free answer

A2-3 This situation can be avoided in the following ways:

• Fully repay credit card debt within the interest-free repayment period
• Do not overspend with credit cards
• Do not apply for a large number of credit cards
(Any other reasonable answers)

A2-4 Free answer

Answers to Assessment
MCQ
2.1 C
2.2 C
2.3 D
2.4 B
2.5 A
2.6 B
2.7 A
2.8 A
2.9 A
2.10 D
2.11 D
2.12 D
2.13 A
2.14 C
2.15 B
2.16 C
2.17 A
2.18 B
2.19 D

Short Questions
2.20 Advantages of using lines of credit for consumption include:

NSS BAFS: Basics of Personal Financial Management © Pearson Education Asia Limited 2014
2nd Edition: Answers to Textbook Exercises 12
 • Lines of credit are convenient for consumers as they can borrow money anytime they
like. Also, once the line of credit is approved, consumers do not need to apply for a
new loan every time they need money.
• Lines of credit do not involve a fixed deadline or number of payments for repaying
the loan in full. Consumers only need to settle the monthly minimum payment on
time. Therefore, this gives them greater flexibility in repaying loans.
• Interest on lines of credit is usually lower than that on credit cards and overdrafts.
(Any two of the above, 2 marks for each point)

2.21 Disadvantages of using overdrafts include:

• As overdrafts give consumers flexibility in repaying their loan, they can be a trap for
creating debt if used improperly. (2 marks)
• The interest charges on overdrafts are relatively high. (2 marks)

2.22 Affinity cards are credit cards that are jointly offered by a financial institution (e.g., a
bank) and a non-financial group (e.g., a university, a retailer or an airline). (2 marks)
By using affinity cards, cardholders can enjoy discounts and other benefits from
purchases with their credit cards. (2 marks)

2.23 Credit cards do not involve a fixed deadline or number of payments for repaying the loan
in full. Consumers can repay the loan anytime by irregular or lump-sum payments. They
only need to settle the monthly minimum payment on time. (2 marks)
Instalment loans involve a fixed number of payments for repaying both the loan principal
and the interest. Consumers have a fixed repayment schedule. (2 marks)

2.24 Using credit cards is more convenient than using cash because consumers do not have to
carry large sums of cash around. They can avoid the trouble of looking for an automatic
teller machine (ATM) or delaying a purchase due to a lack of cash. (2 marks)
Using credit cards is safer than using cash because consumers do not have to carry a large
amount of cash with them. This reduces the risk of theft and robbery and therefore offers
better protection to consumers. (2 marks)

2.25 A credit record is a detailed report of the credit and repayment history of an individual,
and whether he has filed for bankruptcy. (2 marks)
It helps lenders determine the creditworthiness of credit applicants, which facilitates their
loan-approval decisions. (2 marks)
Borrowers can check their credit record to ensure that the information about them is
accurate. They can also check if there has been any identity theft or possible credit fraud.
(2 marks)

NSS BAFS: Basics of Personal Financial Management © Pearson Education Asia Limited 2014
2nd Edition: Answers to Textbook Exercises 13
2.26 a Individuals can maintain a good personal credit record in the following ways:
• Plan for consumption: Individuals should understand how much they can afford
to consume. They should draw up some guidelines on consumption (e.g., when
to use credit and when to use cash).
• Review spending habits regularly: Individuals should distinguish between
necessary and unnecessary consumption. They should check their actual
spending every month to make sure they do not overspend on things that are
unnecessary.
• Use consumer credit with discipline: Individuals should use consumer credit for
convenience, but not for buying things that they cannot afford.
• Avoid a sudden increase in credit card applications: A sudden increase in credit
card applications may cause lenders to suspect that the individual is in financial
trouble.
• Consider their repayment ability when applying for loans: Individuals should
think about their ability to repay their debts before applying for credit cards or
loans. They should not apply for credit cards or loans just for the gifts.
• Pay all bills on time: Lenders do not care why people do not pay their bills.
Some people might have been too busy or simply lost their bills, but lenders will
just think that they were unable to pay. Any past due accounts will most likely
lower a person’s credit score, resulting in a poor credit record.
(Any three of the above, 2 marks for each point)

b If an individual has a good personal credit record, he can obtain credit more easily
and possibly at lower interest rates. (2 marks)

2.27 With credit cards, high interest is charged on the outstanding balance. If the borrower
does not repay the balance in full within the interest-free repayment period, debt will
quickly accumulate. (3 marks)
On the other hand, instalment loans lack flexibility in repayment schedules. If a borrower
faces an unexpected financial problem such as losing his job, the instalment arrangement
can push him into financial trouble or even bankruptcy. (3 marks)

2.28 James should buy the smartphone using a credit card. (1 mark)
To James, the $5,000 is a small purchase which he can easily afford. Therefore, he should
buy the smartphone using a credit card as this is more convenient than using an instalment
loan. (2 marks)
James only needs to remember to repay the outstanding balance within the interest-free
repayment period to avoid high interest costs. (1 mark)

NSS BAFS: Basics of Personal Financial Management © Pearson Education Asia Limited 2014
2nd Edition: Answers to Textbook Exercises 14
Application Problems
2.29 a I disagree with him. (1 mark)
Credit cards charge high interest on a cardholder’s unpaid balances. If Billy only
repays the monthly minimum payment, he will have to pay a large amount of
interest. (2 marks)
Not only is he unable to have more money to spend, his debt will also accumulate
quickly. This may push him into financial trouble. (1 mark)

b Possible reasons why Billy’s credit card application was unsuccessful:

• Billy usually applies for a credit card every few months but he applied for three
credit cards last month. This sudden increase in credit card applications may
have caused the credit card issuer to suspect that he was in financial trouble and
thus reject his application. (3 marks)
• As Billy only repays the monthly minimum payment and the interest charges on
credit cards are high, he may have a large amount of outstanding debt. This may
have resulted in a poor personal credit record which caused the credit card issuer
to reject his application. (3 marks)

c Billy can increase his chances of successfully applying for credit cards in the
following ways:
• Billy should not apply for credit cards just for their gifts. He should consider his
repayment ability and needs before applying for credit cards. (2 marks)
• Billy should fully repay his credit card balances every month upon receiving the
credit card statement. (2 marks)

2.30 a Advantages of borrowing with an overdraft over an instalment loan:

• An overdraft provides short-term liquidity to individuals who are temporarily
short of cash. Individuals can borrow money for as little as one day. However,
the loan period is longer for an instalment loan. (2 marks)
• An overdraft does not involve a fixed deadline or number of payments for
repaying the loan in full. Consumers only need to settle the monthly minimum
payment on time. Therefore, they can enjoy repayment flexibility. However, an
instalment loan has a fixed repayment schedule. (2 marks)

b Advantages of borrowing with an instalment loan over an overdraft:

• An instalment loan forces the borrower to plan for the repayment, for example,
by how much he can afford to pay for each instalment. This cannot be done with
an overdraft as it does not involve a fixed repayment schedule. (2 marks)
• Interest on an instalment loan is usually lower than that on an overdraft.

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2nd Edition: Answers to Textbook Exercises 15
 (2 marks)

c I would recommend that Derek choose an overdraft. (1 mark)

As Derek does not have a permanent job, he does not have a stable income. (1 mark)
If he chooses an instalment loan, he may not have enough money to repay the
instalments and may get into financial trouble. (1 mark)
However, an overdraft offers repayment flexibility. Derek can repay the loan
according to his repayment ability. (1 mark)

2.31 a A revolving loan is a type of credit that allows consumers to borrow and repay
money anytime up to a pre-approved amount. (2 marks)
An instalment loan is a loan with a fixed number of payments for repaying both the
loan principal and the interest. (2 marks)

b He should choose Loan A. (1 mark)

This is because a revolving loan only requires the borrower to pay the monthly
minimum payment. It does not involve a fixed deadline or number of payments for
repaying the loan in full. (1 mark)
However, an instalment loan requires the borrower to fully repay the loan with a
fixed number of payments within the repayment period. (1 mark)
Therefore, the monthly instalments for Loan B and Loan C should be greater than the
monthly minimum payment for Loan A. Charlie can repay less money in the coming
year by choosing Loan A. (1 mark)

c He should choose Loan A. (1 mark)

A revolving loan only charges interest on the outstanding amount. If Charlie chooses
Loan A, he can borrow as much money as he needs in the future (up to $150,000).
He only needs to pay interest on the amount he borrows. (2 marks)
However, if he chooses Loan C, he has to pay interest on the $150,000 he borrows
whether he needs more money or not. Even if he only needs $100,000, he has to pay
interest on the other $50,000. (2 marks)
Therefore, Loan A can help Charlie save on paying unnecessary interest and is more
preferable than Loan C. (1 mark)

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2nd Edition: Answers to Textbook Exercises 16