FIN533 Chapter 4: Consumer Credit and Debt Management

The Cost of Credit

• Dollar cost of borrowing: I = PxrxT
• Simple interest: calculated on the declining balance, interest is paid only on the amount of original principal not yet repaid
• Add-on interest: interest is calculated on the full amount of the original principal, added to the principal, and the total of both is divided by the number of payments to be made

Cost of Open Credit

• Adjusted balance method: finance charges are calculated after payments made in the billing period have been subtracted
• Average daily balance method: creditors add balances for each day in the billing period, divide by the number of days, and multiply by the monthly interest rate
• Two-cycle average daily balance method: creditors use average daily balance for two consecutive billing cycles
• Previous balance method: gives no credit for payments made during the billing period

Managing Your Debts

• Notify creditors if you can't make a payment
• Objective: develop a plan to manage your debts

Tackling the Trade-Offs

• Term versus interest costs: longer loans-lower payments, but more total interest
• Lender risk versus interest rate: ways to reduce the lender's risk and the interest rate include accepting a variable interest rate, providing collateral, making a large down payment, and having a shorter loan term

The Cost of Credit (continued)

• Simple interest: computed on principal only and without compounding

Sources of Consumer Credit

• Inexpensive loans: parents or family members, loans based on assets (e.g. using Certificate of Deposit (CD) as collateral)
• Medium-priced loans: commercial banks, savings and loan associations, and credit unions
• Expensive loans: finance and check cashing companies, retailers such as car or appliance dealers, and bank credit cards and cash advances

The Cost of Credit (continued)

• Finance charge: the total dollar amount you pay to use credit, including interest costs, service charges, credit-related insurance premiums, or appraisal fees
• Annual percentage rate (APR): the percentage cost of credit on a yearly basis, used to compare rates with other sources of credit

Base Rate Vs. BLR in Malaysia

• Base Rate (BR) replaced the Base Lending Rate (BLR) in Malaysia
• Banks are still required to display both BLR and BR on their branches and websites

Warning Signs of Debt Problems

• Paying only the minimum balance each month
• Increasing the total balance due each month
• Missing or alternating payments or paying late
• Intentionally using overdraft protection or taking frequent cash advances
• Using savings to pay routine bills
• Getting second or third payment notices
• Using up your savings
• Borrowing money to pay old debts
• Not knowing how much you owe
• Going over your credit limit on credit cards
• Having little or no savings for the unexpected
• Being denied credit due to a credit report
• Having a credit card revoked by the issuer

Consumer Credit Counseling Services

• Non-profit credit counseling services can assist consumers with debt problems
• In Malaysia, Agensi Kaunseling dan Pengurusan Kredit (AKPK) provides credit counseling services
• The Fair Debt Collection Practices Act regulates debt collection agencies

Managing Your Debts (continued)

• If you can't pay your bills, postpone further credit purchases, talk with your creditors, or seek help from a non-profit credit counseling service
• You can dispute the debt or pay it within five days of receiving a written notice from the debt collector
• You can request verification of the debt within 30 days