Lecture 6

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CONTENTS
I - USING CREDIT
• The basic concepts of credit
• Types of open account credit
• Opening and managing open forms of credit
• Using credit wisely

II - USING CONSUMER LOANS

• Basic features of consumer loans
• Managing your credit
• Single payment loans
• Installment loans
• Buy on time OR Pay cash?

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Using credit
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Basic concepts of credit

• Credit = borrowing/debt
• Why use credit?
• To avoid paying cash for large outlays:
• Spreading payments overtime makes big-ticket items more affordable.
• Consumers get the use of an expensive asset right away.
• To meet a financial emergency (note: using savings in such
circumstances is preferred)
• For convenience
• For investment purposes

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Improper Uses of Credit
không đúng

• Over-spending
• Credit becomes more readily available and easier to obtain
=> It was there for the taking !
=> Overspending becomes a way of life –
The movie: Confessions Of A Shopaholic
• Too much convenience and people use their credit cards to make even
routine purchases.
• Overspenders tend to overestimate their affordability as still they can
make the minimum payments each month.

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Improper Uses of Credit

• Solutions for over-spending:

Should not routinely use credit:
➢ to meet basic daily expenses.
➢ to make impulse purchases, especially expensive ones.
➢ to purchase nondurable (short lived) goods and services.

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Establishing credit

Build a strong
• Open a checking and credit history • Limit the use of credit to
savings account. your ability to repay the
• Use credit => build a • Consistently make debt.
record of being a reliable payments on time, month • Debt safety ratio = 10 –
credit customer. after month. 15% AND Monthly
• Obtain a small loan & • Foreseen late payment repayment burden < 20%
repay it promptly. => discuss with the lender
for extension permission.
First steps Credit limit

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How Much Credit Can You Stand ?
▪ Debt Safety Ratio

𝑻𝒐𝒕𝒂𝒍 𝑴𝒐𝒏𝒕𝒉𝒍𝒚 𝑪𝒐𝒏𝒔𝒖𝒎𝒆𝒓 𝑪𝒓𝒆𝒅𝒊𝒕 𝑶𝒃𝒍𝒊𝒈𝒂𝒕𝒊𝒐𝒏𝒔

Debt Safety Ratio =
𝑴𝒐𝒏𝒕𝒉𝒍𝒚 𝑻𝒂𝒌𝒆 − 𝒉𝒐𝒎𝒆 𝑷𝒂𝒚

➢ Maximum: 20%
➢ Recommend: 10% to 15%, even lower if possible
➢ Example:
Take-home pay = $2,500/month
20% maximum means monthly consumer credit payments < $500

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 Current Monthly (or Min.)
A - Type of Loan Lender Monthly consumer loan
Payment
● Auto and personal loans 1 Ford Motor Credit $ 360.00 payments & Debt safety
2 Bank of America 115.00 ratio
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●Education loans 1 U.S Dept. of Education 75.00
2 Changes needed to reach a new debt safety ratio
●Overdraft protection line 1 Bank of America 30.00
1. New (Target) debt safety ratio: 15.00%
●Personal line of credit 2. At current take-home pay of $4,105.00
●Credit cards 1 Bank of America Visa 28.00 total monthly payments must equal:
2 Fidelity MC 31.00 Total monthly take-home pay x Target debt safety ratio $615.75
New monthly payments
3 JC Peny 28.00
3. With current monthly payment of $739.00
4 total take-home pay must equal: $4,926.67
●Home equity line 1 Bank of America 72.00 New take-home pay
TOTAL MONTHLY PAYMENTS $ $739.00
B- Monthly Take-Home Pay 1 Charles $ 1,855.00
2 Angie 2,250.00
TOTAL MONTHLY PAYMENTS $4,105.00
C- Debt Safety Ratio 18.00% 9
Types Of Open Accounts Credit

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Bank Credit Cards thẻ tín dụng ngân hàng

• Definition:
➢ a card issued by a bank or other financial institution
➢ allows the holder to charge a purchase at any establishment that accepts
it.
• Features:
➢Line of credit: hạn mức tín dụng
➢ The maximum amount that a cardholder can owe at any time.
➢ Depend on: (1) the applicant’s request; (2) issuer’s investigation results.
➢Cash advances ứng dụng tiền mặt
➢ A loan that can be obtained by a credit card (cash at bank or withdrawal from ATM)
➢Balance transfer
➢ A cardholder can transfer credit balances from one card (the old one) to another.

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Bank Credit Cards – Costs (cont.)

Interest charge Other fees

• Rate on merchandise purchase < rate • Annual fee
on cash advances • Transaction fee
• No interest charged within the “grace • Late-payment fee
period”. But interest may be added • Over-the-limit charges
for cash advances. • Foreign transaction fee
• If you pay less than the full balance • Fees for not using the credit card
due, you will be charged interest on
what’s left.
• If you can’t pay the whole balance off,
you will usually have to pay at least a
minimum balance.

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Debit cards

• Definition
• Cardholders can charge against the checking account, instead of the
credit

• Features
• Can be used for merchandise purchase, cash withdrawals from ATMs.
• No protection from the bank in case of card theft or loss.
• Fees: flat annual fees, transaction fee (for using the card).
• Prepaid card.

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Debit cards

• Example of prepaid card:

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Retail Charge Card
• A card that can only be used to make purchases from a single retailer or
group of related retailers.
• Cardholders may get merchandise discounts or rewards points when they
buy from the sponsoring merchant. Some cards offer cash back, reward
points, air miles and other benefits
• Some cards are co-branded, which allows cardholders to use the cards at
any other retailer that takes cards from the bank or card network.

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Retail Charge Card
• Characteristics:
➢You’re expected to pay the balance in full every month.
➢They have high interest rates.
➢They have limited use.
➢They typically have low credit limits.
➢They can lead to overspending.
➢Rewards and perks

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Retail Charge Card
• Examples:

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Revolving Line of Credit
▪ An agreement that permits an account holder to borrow money repeatedly
up to a set dollar limit while repaying a portion of the current balance due
in regular payments. Each payment, minus the interest and fees charged,
reload the amount available to the account holder.
▪ Credit cards and lines of credit both work on the principle of revolving
credit.
▪ Generally approved with no date of expiration
▪ Because of the convenience and flexibility of revolving credit
=> a higher interest rate typically is charged on it compared to
traditional installment loans.
▪ Examples of revolving credit:
credit cards, home equity lines of credit (HELOCs), and personal and
business lines of credit.
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Revolving Line of Credit
▪ Credit Cards vs. Revolving Line of Credit:
➢ No physical card involved in using a line of credit as there is with a
credit card
➢ A line of credit does not require the customer to make a purchase. It
allows money to be transferred into a customer's bank account for any
reason without requiring an actual transaction using that money.
▪ 3 major forms:
1) Overdraft protection line
2) Unsecured personal lines of credit
3) Home equity credit lines.

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Overdraft Protection Line
• A line of credit linked to a checking account that allows a
depositor to overdraw the account up to a specified amount.
• Sometimes, overdraft protection is provided by linking the bank’s
credit card to your checking account
=> can be treated as an advance from your checking
account.
• Don’t take it as a license to routinely overdraw your account!
• It’s best viewed as an emergency source of credit.

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Unsecured Personal Line
• A line of credit made available to an individual on an as-needed
basis.
• The credit line checks are not channeled through your normal
checking account, but to the personal line of credit approved by
the bank.
• Require no collateral.
• It usually is difficult to get an unsecured LOC approved unless you
are a well-established business or an individual with an
excellent credit rating.
Source: www.debt.org
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Home Equity Credit Line
• A line of credit issued against the existing equity in a home.
• Example: muốn nhận tiền 145, thế chấp nhà cho ngân hàng để vay , đc vay 75% và hạn mức tín dụng được vay là
273-220(tien the chap nhà gốc) = 53750

A couple buys a home for $285,000. Some ten years later, it’s worth $365,000.
The original mortgage currently has a balance of $220,000.
The couple’s equity in their home: $145,000 ($365,000 - $220,000)
The bank may agree to offer the couple a home equity credit line from 75% up to
cho vay tới 75%
100% of the market value of the house.
được vay 273750
_ At 75%: 75% x $365,000 = $273,750
 Funds available: $273,750 – $220,000 = $53,750 trừ đi khoản phải trả thế chấp ==>hạn mức tín dụng

_ At 100% : 100% x $365,000 = $365,000

 Funds available: $365,000 – $220,000 = $145,000 (100% of the equity)
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Opening a credit card

• Fill in a credit card

application.
• Issuer perform credit
investigation.
• The issuer may turn to the
credit bureau for a credit
report on you

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CIC – Credit scoring in VN

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Computing financing charges
• Annual percentage rate (APR): the actual or true rate of
interest paid over the life of a loan; includes all fees and costs.
• Average daily balance (ADB) method: Used by bank to
compute finance charges by applying interest charges to the
average daily balance of the account over the billing period.
thời hạn thanh toán

𝑆𝑢𝑚 𝑜𝑓 𝑏𝑎𝑙𝑎𝑛𝑐𝑒𝑠 𝑎𝑡 𝑡ℎ𝑒 𝑒𝑛𝑑 𝑜𝑓 𝑒𝑎𝑐ℎ 𝑑𝑎𝑦

𝐴𝐷𝐵 =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑑𝑎𝑦𝑠 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑖𝑙𝑙𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒

➢ADB including new purchases

➢ADB excluding new purchases
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ADB including new purchases
• Calculate finance charges and the new balance if new purchases
are included.
DAILY BALANCE including new purchases
= Beginning balance – (Payments + Credits) + (Purchases + Fees)

NEW BALANCE
= Previous balance + (Finance charges + New purchases + Fees) –
(Payments + Credits)

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Example - ADB including new purchases
Mrs. Alice’s credit card statement showed the following transactions for March
of 2014:
Date Transactions Amount ($)
1st March Previous balance 7,312
5th March Purchase 289.12
16th March Purchase 27.26
20th March Payment 315.00
22nd March Purchase 4.19

Her card uses the average daily balance method, a periodic rate with an APR
of 17.2%. Calculate the finance charge and new balance.

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Example - ADB including new purchases
Sum of daily
Date Transactions Balance ($) No. of days
balances
1-Mar $7,312.00 4 $29,248.00
5-Mar $289.12 $7,601.12 11 $83,612.32
16-Mar $27.26 $7,628.38 4 $30,513.52
20-Mar ($315.00) $7,313.38 2 $14,626.76
22-Mar $4.19 $7,317.57 10 $73,175.70
TOTAL 31 $231,176.30

$231,176.30 17.2%
𝐴𝐷𝐵 = = $7,457.30 𝑀𝑜𝑛𝑡ℎ𝑙𝑦 𝑝𝑒𝑟𝑖𝑜𝑑𝑖𝑐 𝑟𝑎𝑡𝑒 = = 1.4333%
31 12

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 Example - ADB including new purchases
là interest tính chi phí chưa thanh toán
fee

𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝑐ℎ𝑎𝑟𝑔𝑒 = $7,457.30 × 1.4333% = $𝟏𝟎𝟔. 𝟖𝟗

𝑁𝑒𝑤 𝑏𝑎𝑙𝑎𝑛𝑐𝑒 = $7,312 + $106.89 + $289.12 + $27.26 + $4.19 − $315.00

= $𝟕, 𝟒𝟐𝟒. 𝟒𝟔

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Example - ADB excluding new purchase
• Calculate finance charges and the new balance if new purchases
are excluded.
DAILY BALANCE excluding new purchases
= Beginning balance – (Payments + Credits) + Fees

NEW BALANCE
= Previous balance + (Finance charges + New purchases + Fees) –
(Payments + Credits)

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Example - ADB excluding new purchase
Sum of daily
Date Transactions Balance ($) No. of days
balances
1-Mar $7,312.00 19 $138,928.00
20-Mar ($315.00) $6,997.00 12 $83,964.00
TOTAL 31 $222,892.00

$222,892.00
𝐴𝐷𝐵 = = $7,190.06
31

𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝑐ℎ𝑎𝑟𝑔𝑒 = $7,190.06 × 1.4333% = $𝟏𝟎𝟑. 𝟎𝟔

𝑁𝑒𝑤 𝑏𝑎𝑙𝑎𝑛𝑐𝑒 = $7,312 + $103.06 + $289.12 + $27.26 + $4.19 − $315.00

= $𝟕, 𝟒𝟐𝟎. 𝟔𝟑
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Managing your credit card
• Review bank statements
➢Review should be done promptly each month.
➢Save your receipts and use them to verify statement entries before
paying.
➢Any problem, inform the issuer and follow up in writing within 60 days
after the postmark on the bill.
• Payments
➢Pay the total new balance on statement each month => avoid future
finance charges.
➢Pay the minimum monthly payment specified on the statement =>
incur additional financial charges in the following months.
➢Fail to pay minimum monthly payment => default, bank can take
necessary legal action.
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Using credit wisely

• Shop around for the best deal

• Avoid credit problems
• Credit card fraud
• Bankruptcy: paying the price
for credit abuse.
• Use the service of a credit
counselor.

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Using credit wisely
DO DON’T

Only charge what you can afford Exceed your credit limit

Always pay your bills on time Use frequent cash advances

Understand your card terms & conditions Lend out your credit card

Create an emergency fund Use balance transfers

Limit the number of credit cards you have Cosign on debts you can’t afford

Recognize signs of credit troubles Pay one credit card with another credit card

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Using consumer loans
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Basic features of consumer loans
• When?
➢to finance goods that are too expensive to buy from current
income.
➢to fund a college education
➢to pay for certain types of non-durable items (e.g. expensive
vacations)
• Definition
➢formal, negotiated contracts that specify both the terms for
borrowing and repayment schedule
• Interest rates: fixed OR variable

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Consumer loans vs. Open credit

Consumer loans Credit

• formal, negotiated contracts • standard contracts

• one-shot transactions made for • can be used again and again
specific purposes • with credit card/check.
• no credit card/check issued • to finance repeated purchase of
• used to pay for big-ticket items. low cost goods and services

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Types of consumer loans

Personal loans Education loans Auto loans

Loans for other

Consolidation loans
durable goods

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Repayment arrangements
Single payment Installment payment
Loan collateral • Readily marketable items • Collateral can be:
• Enough value to cover the loan • the asset purchased with money
• Lenders don’t take physical from the loan.
possession, but instead file a lien. • financial assets
• second mortgages
Loan maturity • Usually less than 1 year • Various maturity.
Loan repayment • At a single point in time, on maturity • Monthly payments until maturity.
date. • Early repayment may be subject to a
• Early repayment may be subject to a prepayment penalty.
prepayment penalty.
• Loan rollover may be discussed with
lenders in case of money shortage.
Others • Lender usually requires credit
insurance.
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Finance charges & Annual percentage rate
phương thức trả góp

Single payment method Installment method

Simple interest method X X

Discount method X

Add-on method X

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Single payment – Single interest method
Mrs. Alice borrows $1,000 for two years at 8% annual rate of
interest.

𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝑐ℎ𝑎𝑟𝑔𝑒 = $1,000 × 0.08 × 2 = $160

The borrower receives $1,000, and in 2 years will be required to

pay back $1,160.

𝐴𝑣𝑒. 𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝐶ℎ𝑎𝑟𝑔𝑒 $160/2

𝐴𝑅𝑃 = = = 𝟎. 𝟎𝟖 𝒐𝒓 𝟖%
𝐴𝑣𝑒 𝑙𝑜𝑎𝑛 𝑏𝑎𝑙𝑎𝑛𝑐𝑒 𝑜𝑢𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 $1,000
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Single payment – Discount method
𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝑐ℎ𝑎𝑟𝑔𝑒 = $1,000 × 0.08 × 2 = $160

The borrower receives $840 ($1,000 - $160), and in 2 years will

be required to pay back $1,000.

𝐴𝑣𝑒. 𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝐶ℎ𝑎𝑟𝑔𝑒 $160/2

𝐴𝑅𝑃 = =
𝐴𝑣𝑒 𝑙𝑜𝑎𝑛 𝑏𝑎𝑙𝑎𝑛𝑐𝑒 𝑜𝑢𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 $840

= 𝟎. 𝟎𝟗𝟓𝟐 𝒐𝒓 𝟗. 𝟓𝟐%

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Installment – Single interest method
Monthly Payment Analysis for a Simple Interest Installment Loan
(Assumes a $1,000, 8%, 12-Month Loan)

Interest
Month Beg. Balance Monthly Payment Principal End. Balance
Charges
1 $1,000.00 $86.99 $6.67 $80.32 $919.68
2 919.68 $86.99 $6.13 $80.86 $838.82 Because interest is
3 838.82 $86.99 $5.59 $81.40 $757.42 charged only on
4 757.42 $86.99 $5.05 $81.94 $675.49 the outstanding
5 675.49 $86.99 $4.50 $82.49 $593.00
balance, APR on
6 593.00 $86.99 $3.95 $83.04 $509.97
a simple interest
7 509.97 $86.99 $3.40 $83.59 $426.38
8 426.38 $86.99 $2.84 $84.15 $342.23 installment loan
9 342.23 $86.99 $2.28 $84.71 $257.52 will always equal
10 257.52 $86.99 $1.72 $85.27 $172.25 the stated rate –
11 172.25 $86.99 $1.15 $85.84 $86.41 8%
12 86.41 $86.99 $0.58 $86.41 $0.00
TOTAL $1,043.86 $43.86 $1,000.00

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Installment – Add-on method
𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝑐ℎ𝑎𝑟𝑔𝑒 = $1,000 × 0.08 = $80
Q: Why are add-on
IL’s monthly payment
$1,000 + $80 and APR higher than
𝑀𝑜𝑛𝑡ℎ𝑙𝑦 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 = = $90 those of simple
12
interest IL?

90 90 90
$1,000 = + 2 + ⋯+ 12
𝐴𝑅𝑃 𝐴𝑅𝑃 𝐴𝑅𝑃
1+ 1+ 1+
12 12 12

𝐴𝑅𝑃 = 𝟏𝟒. 𝟒𝟓%

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Buy on time or Pay cash?
A. Cost of Borrowing
1 Terms of the loan
a. Amount of the loan 12,000.00
b. Length of the loan (in years) 3.00
c. Loan interest rate (annual rate) 8.00%
d. Monthly payment 376.04
2 Total loan payment made 13,537.31
3 Less: Principal amount of the loan 12,000.00
4 Total interest paid over the life of loan (line 2 - 3) 1,537.31
5 Tax considerations:
● Is this a home equity loan (where interest expenses
YES √ NO
can be deducted from taxes)?.......

● Do you itemize deductions on your federal tax returns? √ YES NO

● If you answered yes to BOTH questions, then proceed

to line 6; if you answered no to either one or both of
the questions, then proceed to line 8 and use line 4 as
the after-tax interest cost of the loan.
6 What federal tax back are you in?
(use either 10, 15, 25, 28, 33, or 35%) 28.00%
Taxes saved due to interest deductions
7 (line 4 x tax rate, from line 6) 0
8 Total after-tax interest cost on the loan (line 4 - line 7) 1,537.31
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Buy on time or Pay cash?

B. Cost of Paying Cash

9 Annual interest earned on savings 480
Annual rate of interest earned on savings 4.00%
Amount of loan 12,000.00
10 Annual after-tax interest earnings (line 9 x [1 - tax rate]) 345.6
11 Total after-tax interest earnings over life of loan (line 10 x line 1b) 1036.8
C. Net Cost of Borrowing
Difference in cost of borrowing vs. cost of paying cash
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(line 8 - line 11) 500.51

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