Credit and Debt Management - Personal Financial Planning - Lecture Slides, Slides for Finance. Ankit Institute of Technology and Science
saritae13 February 2013

Credit and Debt Management - Personal Financial Planning - Lecture Slides, Slides for Finance. Ankit Institute of Technology and Science

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This is the Lecture Slides of Personal Financial Planning Dealing With Cra and the Tax Collectors, Tax Returns, Payment of Tax, Electronic Filing, Source Withholdings, Electronic Tax Payments etc. Key important points ar...
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Chapter 3 - Managing Your Taxes

Credit and Debt Management

Agenda • Review of learning goals • Key chapter terms and definitions • Basic concepts of credit • Improper use of credit • Establishing credit • Types of open account credit • Bank credit cards • Rebate (co-branded) credit cards • Other credit cards and charge accounts • Debit cards • Revolving credit lines • Opening an account • Summary • Internet links and on-line resources


Chapter 6 - Learning Goals

1. Describe the reasons for using consumer credit, and identify its benefits and problems.

2. Develop a plan to establish a strong credit history. 3. Distinguish among the different forms of open account credit. 4. Understand how to choose the right credit cards and recognize

their advantages and disadvantages. 5. Understand how to avoid credit problems, how to protect

yourself against credit card fraud, and understand the personal bankruptcy process.

Learning Goals

Key Chapter Terms • Debt safety ratio • Open account credit • Credit limit • Credit statement • Bank credit card • Line of credit • Cash advance • Balance transfer • Rebate (co-branded) credit card • Grace period • Retail charge card • Prestige cards • Affinity cards • Secured (collateralized credit cards)

• Student credit card • Debit card • Prepaid card • Revolving line of credit • Overdraft protection line • Unsecured personal credit line • Home equity credit line • Credit investigation • Credit bureau • Annual percentage rate (APR) • Average daily balance method • Daily balance method • Consumer proposal • Straight bankruptcy • Personal bankruptcy • Credit counsellor


Definitions Debt Safety Ratio

• The proportion of total monthly consumer credit obligations to monthly take-home pay.

• Low 10% • Manageable 15% • Maximum 20%

pay home-keMonthly ta paymentscredit consumer monthly Totalratiosafety Debt =


Definitions Open account credit

• A form of credit extended to a consumer in advance of any type of transaction; type of credit that accompanies charge accounts and credit cards.


Definitions Credit Limit

• A specified amount beyond which a customer may not borrow or purchase on credit.


Definitions Credit Statement

• A monthly statement that summarizes the transactions, interest charges, fees, and payments in a consumer credit account.


Definitions Bank Credit Card

• A credit card issued by a bank or other financial institution that allows the holder to charge purchases at any establishment that accepts it; can also be used to obtain cash advances.


Definitions Line of Credit

• The maximum amount of credit a customer is allowed to have outstanding at any point in time.


Definitions Cash Advance

• A loan that can be obtained by a bank credit cardholder at any participating bank or financial institution; it begins to accrue interest immediately and requires no formal application


Definitions Balance Transfer

• A program that enables cardholders to readily transfer credit balances from one card to another.


Definitions Rebate (co-branded) credit card

• A bank credit card that combines features of a traditional bank credit card with an additional incentive, such as rebates and airline mileage.


Definitions Grace Period

– A short period of time, usually 17 to 26 days, during which you can pay your credit card bill in full and not incur any interest charges.


Definitions Retail Charge Card

– A type of credit card issued by retailers and oil companies that allows customers to charge goods and services up to a pre- established amount.


Definitions 30-day (regular) charge account

– A charge account that requires customers to pay the full amount billed within 10 to 20 days after the billing date.


Definitions Travel and Entertainment (T&E) Card

– A credit card, such as American Express or Diner’s Club, accepted by travel and entertainment-related establishments, as well as a growing number of other businesses and stores.


Definitions Prestige Card

– A type of bank or T&E card that offers higher credit limits, has stricter requirements for qualification, and generally offers more features than its “regular” counterpart.


Definitions Affinity Card

– A standard bank credit card issued in conjunction with some charitable, political, or other sponsoring non-profit organization.


Definitions Secured (collateralized) credit cards

– A type of credit card that’s secured with some form of collateral, such as a bank GIC.


The Basic Concepts of Credit

Why Borrow?

• Avoid paying cash for large purchases (like a car)

• Meet financial emergencies

• Convenience

• Investment purposes


Improper Uses of Credit

• Meet basic living expenses

• Make impulse purchases

• Purchase non-durable goods (like restaurant meals)


Rule of Thumb!


Don’t let credit squash you!


Establishing Credit

• Open checking and savings accounts.

• Get one card and make small purchases.

• Build a good credit history by: – Not getting overextended. – Fulfilling all terms of credit obligations. – Consistently paying on time. – Immediately notifying creditors if unable to pay. – Being truthful when applying.


How much credit can you stand

Total monthly consumer credit payments Monthly take-home pay

Monthly consumer credit payments (excluding mortgage) should not exceed 20% of your

monthly net income.



What is Debt Capacity?

Debt capacity is defined as the amount of debt that an individual can be reasonably expected to repay given the terms of the loan agreement, and the current and future financial position of the individual. The individual’s financial position is often measured through the evaluation of one’s assets, liabilities, cash flows, income and expenditures.

What is Debt Capacity?

Some questions that the text addresses in regards to the issue of overindebtedness are:

• How much debt can one take? • Is there an optimal level of debt that one can take? • What are the factors that affect this optimal level of debt? • How can one manage one’s credit and debt effectively?

Liquidity and Solvency

• Liquidity is the ability of an individual to meet its current debt service payments in the short run.

• Solvency is the ability an individual to meet all debt obligations in the long run.

Assets vs. Cash Flows

An individual has two means with which they can repay a loan. – The individual can either sell off an asset and use

the proceeds to make the debt repayment – The individual can repay debt loans through the

use of cash from income earned


• Because the future is uncertain expected cash flows and future asset values are never for certain. In this sense risk can be used to measure the likelihood that an individual may be unable to repay all debt service charges. The variability of risk concerns both cash flows and asset values.

Risk – Cash Flows

Some causes that can affect cash flows (earnings) include: – Loss of employment – Pay Cuts – Death of a Family Breadwinner – Disability – Failure of Business

Risk – Asset Value

Asset values can also be affected by some of the following: – Depreciation due to wear and tear – Negative changes in the economy – Increases in interest rates – Disasters such as fires, or floods – Obsolescence of one’s professional skills

How Much Debt can you Afford?

• No actual theory on an exact optimal level of debt

• The optimal level of debt for an individual largely rests in the spending objectives and risk tolerance of the individual

• A useful way to asses your debt capacity is to budget your income and expenditures

How Much Debt can you Afford?

• When you budget the entire period of your loan you have taken into account both the liquidity and solvency properties of the debt

• This can be added to the family budget that was discussed in chapter 4

• Remember to add to it all the additional expenses that will be incurred in the purchase of a particular asset

Debt Service Ratios

• Another way to evaluate your debt capacity is through the usage of debt service ratios as many loan application agencies use these ratios as a simple screening process

• The two ratios are the gross debt service ratio and total debt service ratio.

Debt Service Ratios

• These ratios are only useful when looking at households with an average income between $40,000 and $60,000

• They do not take risk or taxes into effect

Gross Debt Service Ratio

GDS = annual mortgage payments + property taxes gross family income

The industry benchmark for this ratio is 30% or under.

Total Debt Service Ratio

TDS = mortgage payments + property taxes + other debt payments gross family income

The industry benchmark for this ratio is 40% or under.

Matching Assets and Debts

• As in accounting and finance the Matching Principle applies to personal finance as well

• Assets with long expected economic lives (ie. a house) should be financed through long-term debt

• The inverse holds true, where assets with very short economic lives (ie. groceries) should be paid in cash as they are consumed almost immediately.

Steps for Women in Establishing Credit

• Consistently use your own legal name to build credit history.

Ex: Mary Brown, not Mrs. John Brown

• Have information reported to credit bureau in your name as well as your husband’s.

• Consider retaining separate credit file when you marry.


Open Account Credit

• Credit extended to a consumer in advance of any transaction.

• Consumer can buy/borrow up to a specified amount, the credit limit.

• Usually, interest can be avoided by paying balance in full.


Bank Credit Cards:

• Issued by financial institutions

• Features include: – Line of credit dependent upon

applicant’s financial status and ability to pay

– Cash advances and balance transfers – Other services or rebates – Interest rates and fees


Other Credit Cards & Charge Accounts:

• Retail charge cards (ex: Sears)

• 30-day charge accounts

• Travel & entertainment cards

• Prestige cards

• Affinity cards

• Secured credit cards

• Student credit cards


Debit Card:

• Looks like a credit card but works like writing a check—accesses your checking account.

• Does not provide line of credit.

• Greater liability exposure in event of fraudulent use.

• Prepaid card is a debit card with fixed amount available—does not access your checking account.


Revolving Credit Lines:

• Open account credit offered by banks and other financial institutions.

• Usually offer higher credit lines and lower interest rates than credit cards!

• Money accessed by writing checks.


Forms of revolving credit:

• Overdraft protection lines

• Unsecured personal credit lines – Available on an as-needed basis

• Home equity credit lines – Secured by the equity in owner’s

home – Interest tax deductible (if you itemize

deductions) Credit

Obtaining and Managing Open Account Credit

Steps in opening an account:

1. Complete and submit application.

2. Lender investigates creditworthiness.

3. Lender obtains credit bureau report.

4. Lender makes credit decision; may use credit scoring.


The Lender

The Credit Application Applicant submits information on income, marital status, employment history, existing accounts, etc.

The Credit Bureau

Reporting agency that gathers and sells info about people. Gets information from: subscribing creditors creditors you use as reference public documents

Credit Bureau submits report back to lender; lender then makes

The Credit Decision Credit

Obtaining Open Account Credit

Verifies application; turns it over to the Credit Bureau.

Computing Finance Charges

• Lenders must disclose – Annual percentage rate (APR), the true rate of interest

paid over life of loan. – Method used in computing finance charges.


Managing Your Credit Cards

• Review statements promptly each month and verify each entry.

• Pay at least the minimum monthly payment by due date.

• Returned merchandise credited to your account.


Using Credit Wisely

• Shop around, comparing:

– Annual fees & other fees


– Length of grace period

– Balance method


+ Short, interest-free loan

+ Simplified record keeping + Easier resolution to unsatisfactory

purchases + Convenience and emergencies

• Disadvantages of Credit Cards – Easy to overspend – High interest costs

Advantages and Disadvantages of Credit Cards


Avoid credit problems by

• Using discipline when purchasing. • Reducing the number of cards you carry. • Being selective in accepting preapproved credit offers. • Not making new charges. • Paying more than the minimum. • Paying off cards with highest finance charges first. • Transferring balances to card with low introductory rate and

paying off quickly.


Important Consumer Credit Legislation

• Key legislation deals with – Credit discrimination. – Disclosure of credit information. – Billing procedures, errors, complaints, and recourse on

unsatisfactory purchases. – Disclosure of finance charges, other fees, credit terms,

and loss of credit card. – Protection against collector harassment.


Credit Card Fraud

• Never give account number to someone who calls you—you must initiate the call.

• Use only secure Internet sites. • Never put credit card info on checks or personal info on

charge slips. • Keep your eye on your card! • Draw line through blank spaces on slip. • Destroy old cards and shred old statements and slips. • Report lost or stolen cards immediately!


Alternative Credit Markets

• Payday loans • Pawnbrokers

Options if you’re getting into trouble...

• File Bankruptcy – Consumer Proposals – Straight Bankruptcy

• Try credit counselors – Help you prepare a budget and repayment schedule. – Deal with creditors to possibly reduce some interest

& fees.


Internet Links and On-Line Resources

• Financial Consumer Agency of Canada (FCAC) to learn about credit scores and how credit card rates are calculated.

• Charge Cards – a site where you can compare credit card features and rates.

• Money Sense’s Credit Card Calculator • SafeCanada Web site to safeguard your identity • Equifax Canada • Transunion • Credit Counselling Canada • pbs on credit cards

Web Links

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