Cliffsnotes Getting a Loan (Cliffsnotes)

Personal Finance Mystified by mutual funds? Unsure about insurance? Let CliffsNotes simplify the world of personal fina...

Author: Dianne Mylenbusch

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Personal Finance Mystified by mutual funds? Unsure about insurance? Let CliffsNotes simplify the world of personal finance — and show you how to start building wealth. Titles include: Balancing Your Checkbook with Quicken® Creating a Budget Getting a Loan Getting Out of Debt Investing for the First Time Investing in 401(k) Plans Investing in IRAs Investing in Mutual Funds Investing in the Stock Market Managing Your Money Planning Your Retirement Understanding Health Insurance Understanding Life Insurance Careers On a quest for the perfect career? Pursuing a better position? Let CliffsNotes show you how to land the job of your dreams. itles include: Delivering a Winning Job Interview Finding a Job on the Web Getting a Job Writing a Great Resume

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Getting a Loan By Dianne Mylenbusch

IN THIS BOOK ■ Learn how to establish, evaluate and rate your own credit

profile ■ Find out what financial institution offers the credit you want ■ Choose the type of affordable mortgage that best suits your

needs ■ Explore the features of federal student loan programs ■ Reinforce what you learn with CliffsNotes Review ■ Find more loan information in CliffsNotes Resource Center

and online at www.cliffsnotes.com

IDG Books Worldwide, Inc. An International Data Group Company Foster City, CA • Chicago, IL • Indianapolis, IN • New York, NY

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About the Author Dianne K. Mylenbusch is a freelance writer with a background as a midlevel executive in the consumer banking industry. Her experience spans positions in Chicago with major and midsized commercial banks, specializing in executive and professional lending.

Publisher’s Acknowledgments Editorial Project Editor: Christine Meloy Beck Acquisitions Editor: Karen J. Hansen Copy Editor: Corey Dalton Technical Editors: Bart Astor, Carole Barthel Production Indexer: York Production Services, Inc. Proofreader: York Production Services, Inc. IDG Books Indianapolis Production Department

CliffsNotes™ Getting a Loan Note: If you purchased this book without a cover you Published by should be aware that this book is stolen property. It was IDG Books Worldwide, Inc. reported as "unsold and destroyed" to the publisher, and An International Data Group Company neither the author nor the publisher has received any 919 E. Hillsdale Blvd. payment for this "stripped book." Suite 400 Foster City, CA 94404 www.idgbooks.com (IDG Books Worldwide Web site) www.cliffsnotes.com (CliffsNotes Web site) Copyright © 2000 IDG Books Worldwide, Inc. All rights reserved. No part of this book, including interior design, cover design, and icons, may be reproduced or transmitted in any form, by any means (electronic, photocopying, recording, or otherwise) without the prior written permission of the publisher. 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THE PUBLISHER AND AUTHOR MAKE NO REPRESENTATIONS OR WARRANTIES WITH RESPECT TO THE ACCURACY OR COMPLETENESS OF THE CONTENTS OF THIS BOOK AND SPECIFICALLY DISCLAIM ANY IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE. THERE ARE NO WARRANTIES WHICH EXTEND BEYOND THE DESCRIPTIONS CONTAINED IN THIS PARAGRAPH. NO WARRANTY MAY BE CREATED OR EXTENDED BY SALES REPRESENTATIVES OR WRITTEN SALES MATERIALS. THE ACCURACY AND COMPLETENESS OF THE INFORMATION PROVIDED HEREIN AND THE OPINIONS STATED HEREIN ARE NOT GUARANTEED OR WARRANTED TO PRODUCE ANY PARTICULAR RESULTS, AND THE ADVICE AND STRATEGIES CONTAINED HEREIN MAY NOT BE SUITABLE FOR EVERY INDIVIDUAL. NEITHER THE PUBLISHER NOR AUTHOR SHALL BE LIABLE FOR ANY LOSS OF PROFIT OR ANY OTHER COMMERCIAL DAMAGES, INCLUDING BUT NOT LIMITED TO SPECIAL, INCIDENTAL, CONSEQUENTIAL, OR OTHER DAMAGES. Note: This book is intended to offer general information on loans and credit. The author and publisher are not engaged in rendering legal, tax, accounting, investment, real estate, or similar professional services. Although legal, tax, accounting, investment, real estate, and similar issues addressed by this book have been checked with sources believed to be reliable, some material may be affected by changes in the laws and/or interpretation of laws since the manuscript in this book was completed. Therefore, the accuracy and completeness of the information provided herein and the opinions that have been generated are not guaranteed or warranted to produce particular results, and the strategies outlined in this book may not be suitable for every individual. If legal, accounting, tax, investment, real estate, or other expert advice is needed or appropriate, the reader is strongly encouraged to obtain the services of a professional expert. Trademarks: Cliffs, CliffsNotes, and all related logos and trade dress are registered trademarks or trademarks of Cliffs Notes, Inc. in the United States and other countries. All other brand names and product names used in this book are trade names, service marks, trademarks, or registered trademarks of their respective owners. IDG Books Worldwide, Inc. and Cliffs Notes, Inc. are not associated with any product or vendor mentioned in this book. is a registered trademark under exclusive license to IDG Books Worldwide, Inc. from International Data Group, Inc.

Table of Contents Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1 Why Do You Need This Book? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1 How to Use This Book . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2 Don’t Miss Our Web Site . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3 Chapter 1: Rating Your Credit Like a Pro . . . . . . . . . . . . . . . . . . .5 Evaluating Your Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5 Character . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6 Capacity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7 Collateral . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7 How Your Profile Fits in the Credit Rating Criteria . . . . . . . . . . . . . . . . . . . . .8 Employment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8 Residence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8 Occupation and income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9 Your assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9 Current outstanding obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9 Previous credit history . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9 Credit scoring . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10 The Credit Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11 Ordering your credit report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12 Evaluating your credit report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14 Understanding the rating codes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17 Chapter 2: Establishing or Re-Establishing Your Credit . . . . . .19 Establishing Initial Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19 Start a checking/savings account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19 Secure a personal loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20 Apply for a merchant charge card . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20 Apply for a secured bank credit card . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21 Seek help from a relative or friend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21 Request a cosigner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21 Repairing a Poor Credit History . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23 Correcting Errors in Your Credit Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23 Laws to Protect You . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 Chapter 3: Where to Get a Loan . . . . . . . . . . . . . . . . . . . . . . . . . .27 Where Do I Turn? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27 Commercial banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28

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CliffsNotes Getting a Loan

Savings and loan associations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28 Consumer finance companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29 Credit unions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .30 Life insurance companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .30 Brokerage firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31 Types of Consumer Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33 Installment loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33 Single-payment loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33 Open-end credit or a personal line of credit . . . . . . . . . . . . . . . . . . . . . . .34 Home equity loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .35 Choosing a Loan Type and Institution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36 Chapter 4: Applying for Retail Financing . . . . . . . . . . . . . . . . . .38 Understanding Retail Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38 Filling Out the Financing Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .39 Making Retail Financing Work for You . . . . . . . . . . . . . . . . . . . . . . . . . . . . .40 Chapter 5: Applying for a Mortgage . . . . . . . . . . . . . . . . . . . . . .44 Which Mortgage Plan Is Right for You? . . . . . . . . . . . . . . . . . . . . . . . . . . . . .44 Fixed-rate mortgages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45 Adjustable-rate mortgage (ARM) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45 FHA and VA insured loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46 Seller financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47 Considering Payments, Costs, and Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48 Figuring the monthly mortgage payment . . . . . . . . . . . . . . . . . . . . . . . . .48 How much can you afford? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .50 Closing costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .52 Buy-downs and buy-ups . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .53 Chapter 6: Getting a Loan from Your House . . . . . . . . . . . . . . . .54 Refinancing Your Mortgage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .54 Taking Out a Home Equity Loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .57 Reasons to borrow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .58 Determining your equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .59 Searching for the best offer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .59 Chapter 7: Applying for an Auto Loan . . . . . . . . . . . . . . . . . . . . .62 Finding Out What You Can Afford . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .62 Features of an Auto Loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63 Sources for Auto Loan Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 Comparing Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65

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Chapter 8: Applying for an Educational Loan . . . . . . . . . . . . . . .66 What’s a FAFSA? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .67 Stafford Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .68 Student eligibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .69 Loan amount provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .70 Interest rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .71 Lenders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .71 Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .71 Application process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .72 Repayment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .72 PLUS Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73 Eligibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73 Loan amount provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .74 Interest rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .74 Lenders and fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .74 Application process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .74 Repayment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .74 Perkins Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .75 Loan amount provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .75 Expanded lending option (ELO) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .75 Interest rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .76 Application process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .76 Repayment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .76 Repayment Time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .77 Forbearance and deferment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .77 Graduated and income-sensitive repayment alternatives . . . . . . . . . . . . . .78 Loan consolidation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .78 Alternative lending for parents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79 Chapter 9: Borrowing Through a Credit Card . . . . . . . . . . . . . . .80 Choosing the Right Kind of Card for You . . . . . . . . . . . . . . . . . . . . . . . . . . .80 Merchant cards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .81 Bank credit cards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .82 Secured credit cards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83 Travel and entertainment cards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .84 Understanding and Evaluating Card Costs . . . . . . . . . . . . . . . . . . . . . . . . . . .85 Interest rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .85 Methods of interest computation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .85 Annual fee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .86 Miscellaneous fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .87

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Grace period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .87 Minimum payment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .87 Balance transfers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .87 Getting a Cash Advance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .88 When does interest accrue? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .88 Are service fees assessed? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .89 Searching for the Best Credit Card Deal . . . . . . . . . . . . . . . . . . . . . . . . . . . . .89 Chapter 10: Know Your Rights . . . . . . . . . . . . . . . . . . . . . . . . . . .91 Credit and Women . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .92 Establishing and transferring credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .93 A woman’s legal rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .94 Credit and Seniors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .95 Establishing credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .95 A senior’s legal rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .95 Credit and Young Adults . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .96 Chapter 11: Managing Your Credit Wisely . . . . . . . . . . . . . . . . .98 Finding Yourself in Trouble . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .99 What Do I Do Now? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .100 Examine your debts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .100 Communicate with your creditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .101 Prioritize your debts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .102 Negotiate with your creditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103 Deal with collection agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .104 Seek help with the Consumer Credit Counseling Service . . . . . . . . . . . .104 Restructure your debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .105 Reduce your expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .106 Seek supplemental income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .106 As a Last Resort . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .107 Repossession . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .107 Bankruptcy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .108 CliffsNotes Review

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .111

CliffsNotes Resource Center . . . . . . . . . . . . . . . . . . . . . . . . . . .114 Books . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .114 Internet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .115 Send Us Your Favorite Tips . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .116 Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118

INTRODUCTION Getting a loan means getting credit. That seems easy enough to understand, especially when you’re looking for a car loan, boat loan, or home loan. However, to completely understand credit, you need to look at credit as a way of life. You live in a “cashless” society, where plastic credit cards are more common in wallets than paper money. Learning about credit is a journey toward building one of the most important financial tools you can use — not only to make purchases, but also to enhance your reputation and standard of living. Does it matter how you handle your credit? You bet! The manner in which you establish, develop, and maintain your credit is a direct reflection of your credibility, trustworthiness, and ability to repay your debt. It can affect your future employment and credit-seeking opportunities. Your focus is to make credit work for you, not for credit to overwhelm you in excessive debt. In this book, I share my knowledge of credit from both sides of the desk: as a loan administrator and as a credit-using consumer. Here you learn how to establish and properly maintain your credit. You explore the variety of avenues where credit is available: store charge cards and bank credit cards, as well as loans for your home, car, higher education, and major appliances. Finally, you identify the early warning signs of credit trouble, its unfortunate consequences, and how to seek counseling and fix your situation.

Why Do You Need This Book? Can you answer yes to any of these questions? ■

Do you need to learn about establishing your credit?

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CliffsNotes Getting a Loan ■

Do you not have time to read 500 pages on mortgage loans?

■

Do you need to apply for an educational loan?

■

Do you want to be able to properly evaluate credit card offers?

If so, then CliffsNotes Getting a Loan is for you!

How to Use This Book You’re the boss here. You get to decide how to read this book. You can read it from cover to cover or just look for the information you want and put it back on the shelf for later. However, I’ll tell you about a few ways I recommend to search for your topics. ■

Use the index in the back of the book to find what you’re looking for.

■

Flip through the book, looking for your topic in the running heads at the top of each page.

■

Look for your topic in the Table of Contents in the front of the book.

■

Look at the In This Chapter list at the beginning of each chapter.

■

Look for additional information in the Resource Center or test your knowledge in the Review section.

■

Flip through the book until you find what you’re looking for; I organized the book in a logical, task-oriented way.

To reinforce your learning, check out the Review and the Resource Center at the back of the book. To help you find important information in the book, look for the following icons in the text:

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Introduction

3

This icon points out information worth keeping in mind.

A tip icon highlights helpful hints or advice.

A warning icon alerts you to situations that you want to avoid.

Don’t Miss Our Web Site Keep up with the changing world of consumer credit by visiting the CliffsNotes Web site at www.cliffsnotes.com. Here’s what you find: ■

Interactive tools that are fun and informative

■

Links to interesting Web sites

■

Additional resources to help you continue your learning

At www.cliffsnotes.com, you can even register for a new feature called CliffsNotes Daily, which offers you newsletters on a variety of topics, delivered right to your e-mail inbox each business day. If you haven’t yet discovered the Internet and are wondering how to get online, pick up Getting on the Internet, new from CliffsNotes. You’ll learn just what you need to make your online connection quickly and easily. See you at www.cliffsnotes.com!

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CHAPTER 1

RATING YOUR CREDIT LIKE A PRO I N T H I S C HAPT E R ■

Learning the basic premise of the credit-approval decision

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Evaluating your credit and rating your own credit profile

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Ordering, evaluating, and reviewing your credit report

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Understanding the meaning of the credit report codes

Monitoring your credit history is part of good money management. In this chapter, you learn how to rate your own credit background before applying for your loan. You examine the basis of most credit decisions, what lenders call the Three Cs. You rate yourself in a sample credit scoring guide, which helps you get a better handle on the qualities lenders seek in a successful loan applicant. Finally, you learn how to obtain your own credit report and how to interpret the information and codes in your report.

Evaluating Your Credit The decision-making process of loan approval isn’t clear-cut. One lender may focus strictly on the established guidelines of that specific lending institution and credit scoring; another lender may consider the overall impression you gave during your interview. Whatever method the lender may use, the assessment of your creditability and your ability to repay the debt is the basic premise of credit approval. You can

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CliffsNotes Getting a Loan categorize the many factors involved in evaluating an individual’s credit as character, capacity, and collateral — otherwise known as the Three Cs.

Character Your character forms your integrity, credibility, and willingness to repay your debt. The lender reviews your credit report, which indicates ratings of your past and present credit and answers such questions as: ■

Do you repay your debts on time?

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Do you periodically exceed your credit limit?

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Where do you have available credit currently?

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How much credit do you have outstanding?

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Where have you had credit in the past?

The lender also looks for signs of stability: ■

How long have you been on the job?

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How long have you been in the same line of work?

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Is your income verifiable?

■

Do you own or rent your home?

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How long have you lived in the same place?

Stability is the key word here in employment and residence and in how well you have managed your past and present credit. The lender wants to know whether you will do the utmost to repay your debts even if you meet with a sudden financial setback. The lender judges your character and reputation.

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Capacity Capacity revolves around your ability to repay your debt. Your potential lender asks about your monthly income and current expenses in order to examine an important aspect of your capacity, the debt-to-income ratio. You can calculate this ratio yourself. In Figure 1-1, fill in the averages of three months of your income and expenses. Simply add the three months of expenses and divide by three to find the average. Do the same with the three months of income. On the lines indicated, fill in the average of your three months of expenses and add the monthly payment of the proposed loan you are requesting. Then, divide that amount by the average of your three months of income. The result is your debt-to-income ratio. Figure 1-1: (

Figuring your debt-to-income ratio. +

)

=

%

(Expenses [average of 3 months] + New loan payment) Income [average of 3 months] = Debt-to-Income Ratio

The debt-to-income ratio is a guideline to help you and the lender determine how much monthly debt your income can handle. If the ratio is over 45 to 50 percent, the financial institution may not give you any more credit because your income may not be able to handle additional expenses. The debt-to-income ratio varies among financial institutions; some allow for more debt than others do. Ask before you apply.

Collateral Collateral includes stocks, bonds, CDs, savings accounts, or property that you own and that you can pledge as security of

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CliffsNotes Getting a Loan repayment of your loan. Having collateral to pledge helps you overcome other areas of your loan application that may be lacking credibility or stability — if your lengths of employment and residence are too short to qualify for the loan you want. You can liquidate, or cash in, any assets such as savings accounts, certificates of deposit, stock investments, or property to pay off your loan if you are unable to do so otherwise.

How Your Profile Fits in the Credit Rating Criteria Looking at specific criteria that lenders use in their credit decision-making process can help you gain insight into the process as a whole. Lenders look for established money management tools and evidence of living within your means.

Employment Creditors like stability in employment and consider employees who have been on the job a long time more likely to maintain their current earning capability and to repay their debts.

Residence Length of residence is also an indicator of your stability. Your chances of receiving approval on your loan application are more favorable if you own your home. If you rent, the credit grantor is interested in your length of your present and previous residences. Credit grantors consider the lengths of employment and residence as major factors when initially reviewing credit applications.

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9

Occupation and income A professional or a skilled worker ranks higher on a credit application than an unskilled or transient worker who may have jumped from job to job. Consistency and a steady increase in income are other important factors in the credit decision-making process. Lenders like to see a progression in your income level and long-term employment, as opposed to job-hopping, seasonal work, and a varied income.

Your assets Having a checking and/or savings account indicates that you’re already on your way to managing your money. Adding to your savings account and managing your checking account wisely show the lender your responsible intentions. Lenders consider these two factors important initial steps in money management.

Current outstanding obligations A loan application requires you to list all your current debts. You must list the balances on your current loans, bank credit cards (such as Visa and MasterCard), and store charge cards. The lender can then compute your debt-to-income ratio. Hopefully, this ratio indicates that you’re managing your debt well and living within your means.

Previous credit history After you fill out the loan application, your lender orders a credit report. After the lender reviews the credit report, he or she knows your current obligations and your payment history. The credit report shows whether you pay your bills on

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CliffsNotes Getting a Loan time or late. If the credit report shows that you were late in meeting your payments, the lender assumes that you will continue this pattern and usually rejects your application for credit. If extenuating circumstances caused your late payments, be truthful and clarify the details. Before applying for credit, you should obtain and review your own credit report, in case you need to clear up any negative information in it. Receiving your credit report may take two to four weeks, and clearing up errors can take six months. Accuracy and honesty are key factors in completing your loan application. Additional debts appearing on your credit report but not on your application (known as undisclosed obligations) are reason enough for loan rejection. Lenders are human, too; they show understanding to past credit problems if you can truthfully substantiate the reason for such problems and explain how you are now correcting them.

Credit scoring In a credit scoring schedule, points are given to various categories. As you can see from the sample scoring schedule in Figure 1-2, higher points are awarded to such areas as professional occupation, higher income, lesser debt, and owning your home.

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Chapter 1: Rating Your Credit Like a Pro Figure 1-2:

11

Credit scoring sample.

Type of Residence Own your home 3 Rent 2 Live w/parents 1 Occupation Professional 3 Skilled 2 Unskilled 1

Current Monthly Debt $0-250 1 $250 & up 0

Length of Residence Over 6 years 4 6-4 years 3 3-1 years 2 Less than 1 year 1 Length of Employment More than 5 years 3 3-5 years 2 1-3 years 1

Previous Residence 6-3 years 2 3-0 years 1 Monthly Income Over $1,200 5 $1,200-1,000 4 $1,000-800 3 $800-600 2 $600-1 1

Money Management/Credit History Loan at this bank 4 Loan elsewhere 3 Credit cards 2 Checking/savings accounts 1

Total Points

Take a minute now to circle the numbers in Figure 1-2 that apply to your situation and them add them up. If you earn more than 16 points, you have a good chance of being approved for a loan. This credit scoring guide is merely a sample to help you understand the criteria used in the credit decision-making process. It is not a concrete system that all financial institutions use.

The Credit Report The credit report is a compilation of your past and present credit obligations, as well as other pertinent personal information. The three main credit bureaus in the United States are Trans Union, Equifax, and Experian. All three report similar information.

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CliffsNotes Getting a Loan The credit bureaus have customers, called subscribers, who review and rate your payment history and then transmit this information to the bureau. The subscribers include merchants/stores, banks, loan companies, other financial institutions, insurance companies, and, often, potential employers. Any time you apply for credit, the credit bureau is alerted.

Ordering your credit report Before you apply for any type of credit, order your credit report and review the information registered. You can then straighten out any negative or inaccurate ratings before your loan application. To acquire your credit report, contact one (or two or three) of the main credit bureaus in the U.S. by letter and request a copy of your report. For security purposes, they require your written authorization to release such information. Figure 1-3 shows a sample letter. You must accurately list all the pertinent information in this letter. Include middle initials, Jr. or Sr., if appropriate, and previous addresses if you have moved frequently. In order for the credit bureau to identify you further, include a copy of some identification, such as a driver’s license, an employee ID, or a paid utility bill. You should receive your credit report within two weeks after the credit bureau receives your payment and written request.

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Chapter 1: Rating Your Credit Like a Pro Figure 1-3:

13

Request for credit report.

Date Name of Credit Bureau Address of Credit Bureau Dear Sir, I would appreciate it very much if you would send me a copy of my credit report. Name Soc. Sec.# Birthdate Current Address Previous Address Spouse's Name & Soc. Sec.# Enclosed you will find a check for $ to pay for the cost of the report and a copy of my (driver's license, employee ID, and so on) as identification. Please send a copy of my report to my home address as shown above ( or to the following address ). Please call me at (

)

, should you have any questions.

Thank you for your cooperation. Very truly yours,

(Signature)

You’re entitled to a free credit report if a creditor denied your application within the last 60 days. Otherwise, you probably have to pay a service fee for each report. You can send your letter of request, check for the service fee and proof of identification to the local addresses of any of the three credit

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CliffsNotes Getting a Loan bureaus in your area. If no local offices are available to you, use the following addresses and toll-free telephone numbers of the headquarters of each major bureau. Call ahead to verify the amount of the service fee and any change in the headquarter address. Experian (TRW) P.O. Box 2104 Allen, TX 75013 (800) 831-5614 Trans Union P.O. Box 390 Springfield, PA 19064 (800) 916-8800 Equifax P.O. Box 740193 Atlanta, GA 30374-0193 (888) 397-3742

Evaluating your credit report When you receive your credit report, you may be surprised to see what the reporting bureau has recorded and what it has omitted. Not all creditors subscribe to the same credit bureau, so you may find that each bureau has just some information of your credit history and not the complete picture. Look at the information that is available on your credit report, as shown in Figure 1-4. As an identifying measure, your credit report lists your name, Social Security number, birth date, telephone number, current and previous addresses, spouse’s name, employer, your job position, and your employer’s address.

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15

Next comes the meat of your report, the actual credit history. At first glance, the history can seem confusing due to the somewhat cryptic nature of the report. Abbreviations and codes are next to the names of the stores and financial institutions where you have or had credit. Figure 1-4 gives you an idea of the information you see, starting on the left-hand side of the credit report: ■

Creditor’s name

■

Your account number

■

Ownership designation (I for individual; J for joint; U for undisclosed)

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Opening date of your account

■

Number of months the report covers

■

Date of last activity

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Total credit line extended for each account

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Term of the loan: Amount of time you have to pay off the loan from the date it was approved

■

Current outstanding balance

■

Past due amount

■

Account status, which indicates the type of credit (R for revolving credit or I for installment loan), coupled with your payment rating (refer to Figure 1-4)

■

Date of last reporting by subscriber (creditor) to credit bureau (company issuing this report)

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Figure 1-4:

Sample credit report

Name:

SSN:

Smith, Sondra

Birth Date:

10-8-64

333-55-7777

Telephone:

(123)555-4444 Spouse's Name:

Current Address:

567 Valley Road, Rolling Hills, PA 12345

Kevin Smith

Previous Address:

33255 Eastland Ave., Flatland, PA 12354 Position:

Employer:

American Consultants

Consultant

Employer's Address:

999 Westcourse, Hilldale, PA 39000 Company Account Number Whose Date Months Day of High Term Name Acct. Opened Reviewed Last Activity Credit Sears C&S AMEX FNB

11251514 29539000010047 355411251611 54229778

05/86 11/86 06/87 05/85

I I I I

68 48 24 48

10/91 11/90 10/91 10/91

3500 9388 48M 500 5000 340

Company All Items as of Date Reported Date Name Balance Past Due Status Reported Sears C&S AMEX FNB

0 0 0 3000

680

R1 I1 O1 R3

12/91 11/90 12/91 12/91

When you receive your report, carefully examine it for any errors and omissions. Act to correct any negative ratings. Supply written proof to the lender clarifying any errors. Of course, if negative ratings that are correct appear on your report, you can’t change them. Negative ratings appear on your report for seven years.

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17

Understanding the rating codes The credit report discloses brief but key information for each subscriber, merchant, or bank where you have credit. The number codes following R (for a revolving charge account) or I (for an installment loan) describe how fast you make your payments and are the focus of many a lender’s decision. Take a look at Table 1-1, which shows the number codes that follow R or I and their explanation. (The code descriptions are in Table 1-2; Chapter 11 has more information.) Table 1-1: Payment Codes Code

Meaning

00

Account approved but too new to rate

01

Pays as agreed, within 30 days

02

Pays over 30 days but less than 60 days; not more than 1 payment due

03

Pays over 60 days but less than 90 days; not more than 2 payments due

04

Pays over 90 days but less than 120 days; not more than 3 payments due

05

Pays in 120 days or more

08

Repossession

8A

Repossession (voluntary)

8R

Repossession (legal)

09

Judgment, charge-off, skip, bankruptcy, placed for collection

9B

Collection

UR

Unrated

The report is a reflection of your credibility. If a lender made an error in reporting the manner of your repayment schedule, you need to understand the report’s interpretation and correct the situation.

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CliffsNotes Getting a Loan Now look at the abbreviated letter codes in Table 1-2 and review their meaning. Table 1-2: Code Descriptions Code

Meaning

Charge off

Unpaid balance is written off by creditor

Coll Acct

Account past due and assigned to collection agency/creditor’s collection department

Curr Acct

Open account in good standing

Cur was Coll

Account now current but was in collection

Cur was D1

Account now current but was past due

Cur was For

Account now current but was in foreclosure

Inquiry

Credit inquiry recently requested by creditor

Judgment

Legal judgment against you; still outstanding

Lien

Federal, state, or local taxes due

Paid Acct

Account closed and not rated

Pd Chg-off

Account paid but was a charge-off

Pd Coll Acct

Account paid but was a collection

Paid not AA

Account paid, but some payments made past due dates

Pd Repo

Account paid but was a repossession

Refinanced

Account refinanced

Repo

Creditor took back purchase/item and balance remains

SCNL

Creditor cannot locate debtor

Volun Repo

Voluntary repossession

Be responsible in monitoring your credit history. Miscommunication between debtor and creditor, as well as human error in reporting, can damage your credit report and potential future credit requests.

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CHAPTER 2

ESTABLISHING OR RE-ESTABLISHING YOUR CREDIT I N T H I S C HAPT E R ■

Establishing credit for the first time

■

Clearing up previous poor credit and credit-report mistakes

■

Reviewing the federal laws that protect consumer credit

Having a good credit rating is a wonderful financial tool, but having that good rating takes good management from you, both to establish that credit rating initially and to maintain your good rating. In this chapter, you explore different options of establishing credit. If you have credit problems and need to re-establish your good credit rating, you find various methods of clearing up your credit history and learn about the laws that protect you.

Establishing Initial Credit The benefits of having available credit sound inviting and filled with opportunities for a more comfortable life — and you can’t wait to jump right in! So how do you start, and where do you go? Here are some suggestions.

Start a checking/savings account Establishing yourself with a bank by maintaining a checking account or a savings account is a good first step in money management.

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CliffsNotes Getting a Loan Properly managing a checking account by not overdrawing the balance and periodically adding to some kind of savings or investment account shows the bank that you are traveling responsibly down the money-management road.

Secure a personal loan After you accumulate some money in your savings account, consider transferring that money to a certificate of deposit (CD) with a higher interest rate for a specific period of time. Then request a small personal loan, secured with your CD, from your banker. For example, if you have a one-year, $2,000 CD, apply for a $1,000 loan for one year. You continue to earn interest on your CD while establishing further credibility with your bank by making timely loan payments. The bank avoids any risk of default on the loan because it has collateral (see Chapter 1) to pay the loan if you don’t make payments. You can’t access the funds in the CD until you repay the loan entirely.

Apply for a merchant charge card Find a store that has a short-term, 90-day payment system similar to a layaway program. In this kind of payment system, you choose an item, such as a microwave oven. The store holds your selection until you finish paying for it, within the 90-day period. When you have completely paid for the microwave, you get it and the start of a credit background with that store. You may want to repeat this buy-it-and-pay-it-off process one or two times to build up better your credit relationship with that store. After you have established a proven track record of timely payments, you can request a store charge card.

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Chapter 2: Establishing or Re-Establishing Your Credit

21

Apply for a secured bank credit card Securing a bank credit card with collateral, such as a savings account or CD, is similar to establishing a personal secured loan. In both situations, you pledge collateral in case of default. However, through a bank credit card such as Visa or MasterCard, you receive a line of credit, offering you greater flexibility and eliminating the need to reapply each time for an installment loan. Getting a secured credit card sounds like an ideal start to credit, but do your homework. Not all banks adopt this arrangement, preferring to solicit and maintain only unsecured credit cards. Shop around.

Seek help from a relative or friend When a bank has seen an account managed responsibly, it will issue a card to a second party of the cardholder’s choice. Ask a relative or good friend whom you know has a good credit background to request another card in your name, under your friend’s account number. Discipline is important in this option: Don’t use the card! Hide it so you have no temptation to use it. Your relative or friend’s good credit standing enables you to establish your own credit. After your credit is recorded with the credit-reporting agency, you’re in a better position to apply for your own bank credit card. After six to nine months, contact the credit bureaus (see Chapter 1) to confirm that they have recorded your credit background.

Request a cosigner If you can’t get a loan on your own, try to get a relative or good friend with an excellent credit background to act as a cosigner. Basically, your relative or friend guarantees to repay

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CliffsNotes Getting a Loan your loan if you don’t pay it back. Your cosigner needs to already have a good credit rating to support the loan amount. You usually register this type of loan with the credit bureaus in both names. If you default, the negative rating gets reported on your credit, as well as the cosigner’s. Take a moment and complete the following worksheet, which can help you organize your plan to get your credit rolling. Call around to stores and banks to determine their available services. List the answers on the worksheet. Worksheet for Establishing Credit 1. Names of banks where you could establish checking and

savings accounts and certificates of deposit. _________________________________________ _________________________________________ 2. Names of relatives/friends who are willing to cosign a

loan or credit card. _________________________________________ _________________________________________ 3. Names of stores where you can set up a layaway program

and that have their own store charge cards. _________________________________________ _________________________________________ 4. Names of banks that offer secured credit cards and the

amount of security deposit that each bank requires. _________________________________________ _________________________________________

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Repairing a Poor Credit History Maybe you’ve handled your credit poorly in the past by consistently paying late or not at all. What do you do to repair your credit history and start anew? If you need to re-establish your credit history, you can follow the suggestions to establish credit earlier in this chapter. If you can explain the reasons behind your poor payment history, make sure you do so in your interview with the lender. Be truthful, and follow up by putting your explanation in writing. If you apply for a loan or credit card by mail, attach a written explanation of such reasons. This written explanation indicates a mature attitude toward credit. Hopefully, other factors such as stable employment and income and established bank accounts can help confirm your creditability. Negative credit ratings sometimes don’t magically disappear from your credit report after seven years. Be diligent and monitor your credit report. You need to contact the credit bureaus in writing requesting the update and attach all supporting loan or credit documents if the credit bureaus fail to remove the negative ratings.

Correcting Errors in Your Credit Report What if you find that someone else’s negative credit information is on your report? Up to 40 percent of all credit reports have errors. Your credit information — and that of millions of other people — goes through many hands in the process of being recorded with a credit bureau. As a result, reporting errors such as the following can occur:

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Someone else’s account information is on your report: The information probably belongs to someone with a similar name and was transferred to or jointly named to your record.

■

Information on the account is outdated: Legally, a credit bureau can list negative information for only seven years and bankruptcy for ten years.

■

Tax liens that you paid and judgments in your favor are not shown as paid and released: You made the payment and the paperwork was completed, but the payment wasn’t recorded at the credit bureau.

■

Multiple listings are indicated for one account: In this scenario, previous reportings of an outstanding credit account may not have been deleted and then updated. Instead, numerous updates were registered, making it seem that the borrower had more outstanding debt than claimed.

■

Personal data is inaccurate: Your name is misspelled, a Jr. is omitted, or your previous address or the name of your former spouse is listed on your account. Any of these examples can open up your credit to more errors and confusion.

If any of these errors apply to your report, follow these procedures: 1. Contact the credit bureau.

Contact the bureau in writing (see Chapter 1 for addresses), describing the error in detail and your request for a correction. The letter is a record of your efforts and acts as a reference for future correspondence. If you receive a form to resolve the dispute, fill it out completely and keep a copy for your records. Also, attach any supporting documents, such as release of lien or judgment,

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25

a paid and cancelled installment note, or any written correspondence from the creditor from whom you originally got the loan. This paperwork can confirm the settlement of the payment and help to process the correction at the credit bureau. 2. Mail documentation by certified mail.

Mail your letter, resolution form, and all supporting documents to the credit bureau via signed receipt, certified mail to assure proper handling. Make sure you keep copies of all letters and documentation and the certified-mail receipt signed by whomever received the package at the credit bureau. 3. Continue to be diligent in contacting the credit bureau

by telephone and by written correspondence until you receive satisfactory information. Unfortunately, correcting your credit report is not a quick fix. By law, the credit bureau must respond to you within a “reasonable time period,” but the process can be slow. Once you receive all supporting documents, the credit bureau takes over and contacts its subscriber, the creditor whose rating you question. Now it’s the creditor’s job to delve into the dispute and either correct it or confirm it. After the creditor makes a decision, it notifies the credit bureau. The bureau then contacts you regarding the outcome and either amends or maintains the information on your report. If your dispute is resolved, the credit bureau sends you an updated report showing the negative information removed.

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CliffsNotes Getting a Loan Keep in mind that the creditor is the subscriber, or paying customer, of the credit bureau. The creditor is the one who evaluates and rates your credit. The bureau merely transfers this information to its records. If you are not satisfied with the outcome of the creditor’s investigation, continue to pursue the matter with the creditor in the same manner as you did with the credit bureau. Mark your calendar for three months down the road and request another credit report just to confirm that the error did not reappear. Human error, paperwork, and computer inputting can make the dispute rise again from the ashes.

Laws to Protect You As the consumer credit industry has evolved so, too, have the laws to protect the consumer. Two important federal laws enforced by the Federal Trade Commission protect your rights: ■

The Fair Credit Billing Act establishes steps for resolving billing errors on credit cards.

■

The Fair Credit Reporting Act gives consumers the right to know what information is being reported to credit bureaus. The government established it to protect the consumer’s right to privacy of credit-related information, how such information is gathered, and how it is reported. The act also gives consumers the right to access their own credit reports and review the information.

For a full explanation of the Fair Credit Billing and Reporting Acts, contact the Federal Trade Commission at 6th & Pennsylvania Avenue, NW, Washington, DC 20580.

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CHAPTER 3

WHERE TO GET A LOAN I N T H I S C HAPT E R ■

Learning about the different types of financial institutions where you can get credit

■

Reviewing credit features of each financial institution

■

Determining what kind of institution and loan best suit your needs

In the past, financial institutions specialized in certain kinds of loans. You found business loans at commercial banks, home mortgages at savings and loans, and, if you had little or a poor credit history, personal loans at finance companies. But times and laws have changed, producing financial institutions with broader-based services. One-stop shopping at your bank, savings and loan, or credit union now presents you with many financial services. In this chapter, you find out about the features of six different types of financial institutions where you can apply for credit. You explore the variety of credit available at each institution. All this information helps you determine where to go and what kind of credit to request for your financing need.

Where Do I Turn? If you’ve been reading the chapters of this book in order, you’ve already established your credit and reviewed your credit history. Now you’re ready to choose the financial institution that provides the best credit arrangement and interest rate for you. The decision depends largely on your own personal financial situation. Say, for example, that you want to finance a new car. You may be able to borrow against your securities at your

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CliffsNotes Getting a Loan brokerage house, or borrow against the cash value in your whole life insurance policy. Financing your new car doesn’t have to mean an auto installment loan. You can tap other assets or seek credit at different financial institutions. All these institutions are in business to make money. Lending money at a higher interest rate than their own cost of money (what the financial institutions pay for the money they lend you) is one of their main sources of profit.

Commercial banks Commercial banks offer personal installment loans, lines of credit, and term loans — both on an unsecured or secured basis. They also provide such financing as mortgages, home equity loans, debt consolidation loans, auto and boat loans, guaranteed student loans, and general home improvement loans. Looking for a bank credit card such as Visa and MasterCard? You’ll find them here. Commercial banks tend to be more selective, approving loans only to individuals with established credit and stable employment and income. This selectiveness, however, decreases their risk of default and thereby lets the banks offer competitive interest rates. Being a bank customer with well-maintained checking and savings accounts helps you get financing from a commercial bank.

Savings and loan associations Previous laws limited the types of credit available at savings and loan associations (S&Ls). As times and laws changed, S&Ls started competing with other financial institutions. Federal law allows S&Ls to extend personal and business loans, but the variety and total number of services available are different from state to state.

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Chapter 3: Where to Get a Loan

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Consumer finance companies If you have no or poor credit background, a consumer finance company may be an option. Unlike banks and savings and loan associations, these finance companies borrow money from other sources and then lend that money out to the consumer. The spread, or difference between the interest rate that the finance company pays to borrow the money and the interest rate the company charges you, needs to be large enough for the finance company to profit, so the interest rate that finance companies charge is much higher than the rate that a bank or S&L charges. Consumer finance companies also tend to approve smaller loans than other institutions. If you have little or poor credit history or are borrowing without collateral (security pledged for the payment of a loan), you pay a very high interest rate at a finance company. The company is taking on a greater risk with your loan and needs to build in provisions for collection costs if you default on the loan. If you can pledge collateral for the term of the loan, negotiate for a lower rate. Before applying with a finance company, do your homework. Try to find something of yours that you can put up for collateral, and check your credit report for positive accumulated credit. If either of these options is available, apply for your loan at a bank or a savings and loan and discuss different options with them. If you have a relative or friend who would cosign or pledge collateral for you, try that avenue before committing to the high interest rates of a finance company.

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Credit unions Credit unions, also called cooperative associations, are affiliated with your place of employment. Large corporations, government agencies, and school districts are examples of institutions that have organized credit unions as a benefit for their employees. Employees who qualify as members must open a savings account with a deposit to confirm their membership. Smaller credit unions may limit their loans to small personal and auto loans, while larger credit unions handle personal, auto, debt consolidation and home equity loans, and residential mortgages. Members receive lower interest rates on their loans because the employer subsidizes many of the costs. On occasion, members volunteer at some credit unions to help offset costs. If you default on your payment, the credit union deducts the amount from your paycheck — a way to keep collection costs at a minimum. Credit unions also offer employees other beneficial services, such as a buyers program, where the credit union assists you in finding the dealer’s cost of a new car to help you negotiate a good deal.

Life insurance companies Life insurance companies are a source of available credit that people sometimes overlook. The insurance companies permit policyholders to borrow against the accumulated cash value of their whole life insurance policy. The insurance company defines the cash value of your policy as the amount that you would receive if you decided to cash in your policy early. Borrowing against your cash value is borrowing against your own money.

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31

This form of credit brings sizable advantages: ■

The interest rate charged on the loan is lower than other financial institutions.

■

The repayment schedule is very flexible. You can pay just the interest or the principal and interest, as specified in the policy.

The amount you haven’t repaid is deducted from the policy’s death benefit when you die. You can’t borrow against a term life insurance policy because it has no cash value.

Brokerage firms If you have securities on deposit in a margin account at a brokerage firm, you can borrow against them, given certain guidelines. The total amount you can borrow is dependent upon the market value of your stock and the percentage amount of this market value that the brokerage firm allows — usually 70 percent. As with life insurance companies, the terms are flexible. However, if the market value of your stock declines, you may be asked to repay some or the entire loan or to pledge other collateral. Before borrowing against your margin account, contact your broker or money manager to get all the specifics. Table 3-1 summarizes the sources of credit.

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CliffsNotes Getting a Loan Table 3-1: Comparing Financial Institutions Financial Institution Commercial banks

Type of Credit

Features

Personal/ installment loans

Requires good credit.

Auto/boat/ education loans

Collateral often required.

Home equity/ Good interest rates for improvement loans bank customers. Credit card Single payment loan Line of credit Mortgage Savings & loan Personal/ association installment loan

Requires good credit.

Home equity/ Collateral often required. improvement loan Auto/education loan

Interest rates usually lower than commercial banks.

Line of credit Mortgage Consumer finance company.

Personal/ installment loan

Low credit standards; easy to get credit. High interest rates.

Auto loan

Smaller sized loans.

Home equity loan

Collateral/cosigner required.

Credit unions. Personal/ installment loan Auto/education loan

Members only. Lower interest rates.

Home equity/ Smaller sized loans. improvement loan Credit card

Collateral not always required.

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Chapter 3: Where to Get a Loan Financial Institution

Type of Credit

33

Features

Life insurance Any purpose loan company

Lower interest rates. Loan is against policy’s cash value. No obligation to pay off. No credit/fees necessary. Easy to set up.

Brokerage firm Any purpose loan

Easy to request and access. Loan is against securities held in account. Repay when you want. Margin account required. Low but fluctuating rates.

Types of Consumer Credit Now take a look at the many different types of consumer loans that are available.

Installment loans Installment loans are arranged so that you repay the principal (the original amount borrowed) and interest in equal (usually monthly) payments. Installment loans are also called closed-end credit because they have a fixed rate, a monthly payment, and a due date. Each month you pay a fixed installment (payment) made up of monthly interest and a portion of the principal. Auto and personal loans are common installment loans. They may be unsecured or secured with an auto title, savings account, certificate of deposit, or securities. Be sure to ask about prepayment. Will you save any interest by paying off the loan early? Are penalty charges assessed if you pay it off early?

Single-payment loans Single-payment loans allow you to borrow a specific amount of money for a fixed period. Instead of making monthly payments, you pay off the loan in one lump sum at the end of

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CliffsNotes Getting a Loan the term. The interest rate can be fixed or can float, tied to the prime rate of the bank. You can pay the interest in payments during the loan period or along with the principal at the due date. For example, say you borrow $10,000 for one year at an interest rate of 9 percent. Your interest at the end of one year is $900, along with the principal payment of $10,000, for a total of $10,900 to pay off your loan. If you chose to pay off the entire loan in half the time, you also reduce your interest by half (to $450), making the total to pay off the loan after six months $10,450. Single-payment loans, also known as term loans, provide greater flexibility for prepayment because you save money on interest by paying the loan off early.

Open-end credit or a personal line of credit Open-end credit, more popularly known as a personal line of credit, offers you flexibility in accessing borrowed funds. A personal line of credit allows you to borrow money at your convenience up to the maximum limit determined by the financial institution. Sometimes the line of credit is set up as a separate checking account or is tied to your existing checking account as overdraft protection. You usually pay interest on the amount borrowed each month. A personal line of credit is a very flexible source of credit, permitting you to borrow at your convenience without having to reapply each time for credit. Open-end credit is also very recognizable through charge cards and bank credit cards. With these cards, you’re initially approved for an unsecured line of credit of a fixed amount. Every time you make a purchase, you draw on that line of credit. Each month, you get a statement of your purchases.

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35

If you pay the full amount by the due date, you don’t pay any interest. If you pay only a portion of the balance on your statement, the creditor charges the predetermined interest rate against the remaining balance until you pay it off in full. Big stores offer charge cards to promote sales. They act like a bank to grant consumer credit to their customers in hopes of generating more sales through the ease of charge card purchases. Another very popular source of open-end credit is the bank credit card: Visa or MasterCard. You may receive applications for bank credit cards in the mail nearly every day. Each one has a new promotion: a lower interest rate, bonus airline miles, free gasoline, or gift premiums. All sound enticing and oh-so-easy to get. Ending up with a wallet full of credit cards may be easy, but your goal is to use them wisely. Don’t turn credit use into credit abuse.

Home equity loans A home equity loan is based on the equity (market value of your home minus all outstanding loans against it) in your home and can be arranged as a line of credit or as an installment loan. The lending institution places a second mortgage on your home as collateral. You borrow a percentage of the equity you have built up in your home. If you take out the home equity loan as an installment loan, you receive the total amount borrowed up front and repay the loan in monthly installments. If you take out the loan as a line of credit, you draw on the funds as needed by writing a check; the lender charges interest only on the amount used. Monthly payments of interest (or interest and principal) are due. The entire amount owed, principal and interest, is due at the maturity date stated in the loan agreement.

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CliffsNotes Getting a Loan A home equity loan is a very flexible lending arrangement. The biggest advantage of a home equity loan is the taxdeductible nature of the interest that you pay. See Chapter 6 for more detailed home equity information.

Choosing a Loan Type and Institution Which loan and which institution is best for your situation? Make some calls, find out some information, and fill out Table 3-2 to compare your options.

Purpose

Rate % % % % % %

Amount $ $ $ $ $ $

Loan Survey

mo.

mo.

mo.

mo.

Institution

Collateral

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mo.

mo.

Term

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Table 3-2:

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CHAPTER 4

APPLYING FOR RETAIL FINANCING I N T H I S C HAPT E R ■

Exploring financing through retailers and contractors

■

Understanding the terms of the financing contract

■

Taking advantage of retail financing

This chapter deals with retail financing arrangements, in which the retailer helps you find credit to pay for your purchase. You discover what to look for in the fine print of the financing contract: the interest rate, terms of the contract, reasons for repossession, and so on. You see the advantages and disadvantages of this type of financing and find out why people use it.

Understanding Retail Financing Many retailers and home improvement contractors arrange with a consumer finance company (see Chapter 3) to offer their customers financing through an installment loan or a credit card account. In either case, the amount financed is usually a fixed amount (the amount of the purchase), not an open line of credit. The installment or credit card contract states the interest rate and the term of the loan. The interest rate is usually higher than most consumer loans to offset the risk that the finance company is taking. In most cases, the lender places a lien (a legal right to hold property until the debt is paid) on the item you are financing.

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39

Filling Out the Financing Contract Applying for retail financing is quick and easy — the retailer provides you with a financing contract. You complete a credit application similar to that of a credit card. The retailer performs a credit check, sometimes right there on the spot. Your retail financing approval can follow as fast as the credit check. Quite often, credit requirements for retail financing are not as stringent as the requirements for an installment loan. Therefore, credit decisions can be made more quickly. Note the name of the consumer finance company that manages the credit. This is the institution that is financing and placing a lien on your purchase. By simply signing the contractor bid and/or filling out the credit contract, you accept two agreements: ■

The price of the item you are purchasing or the work to be done.

■

All the terms of the installment/credit contract, including acceptance of the high interest rate, monthly payments, and lien against the item. You acknowledge and accept the fact that the item can be repossessed if you default on the loan.

Retail finance companies are known to tolerate very few missed payments before repossession procedures take place. Following up with you to get you to pay is not cost-effective for the consumer finance company handling your retailfinancing contract. The company may quickly assign your account to a collection agency — thereby, reporting a negative rating to the credit bureau.

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Making Retail Financing Work for You Retail financing is expensive. Interest rates can fall in the 19 to 25 percent range. If you are delinquent on your loan (when you’re late in making your payments or have missed making payments), the interest rate can jump to 25 percent or more. In some cases, the contract provides no grace period at all (the time frame after the date of purchase and before the payment due date when no interest is charged), and interest begins to accrue on the outstanding balance the day you sign the contract. Even if you repay the loan on a timely basis, the interest clock keeps ticking. To add salt to the wound, repossession looms over your head. Not a pretty picture, is it? Late payments or defaulting on your retail finance contract can result in repossession, costly fees, and a negative credit rating. However, you can make a retail financing package work for you rather than against you. Here’s how: 1. Work to establish a fine credit background to qualify for

and get a bank credit card. 2. When you’re ready to make a large purchase, find a

financing contract that offers the first 90 days (or more) interest-free. 3. If you can, pay off the retail financing contract within

the first 90 days. If you can’t, go to Step 4. 4. Just before the 90-day period expires, pay off the retail

financing contract with a check from your credit card account.

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Chapter 4: Applying for Retail Financing Occasionally, your credit card bank sends you these handy checks in the mail to encourage you to use your credit card account. Often, you get a special, low interest rate, perhaps 4 to 5 percent, for using these checks to pay off balances on other accounts, a procedure called a balance transfer. (See Chapter 9 for more information on balance transfers.) By following these steps, you can end up with 90 days of no interest and maybe another 90 to 180 days of low interest on the balance transfer. You can see the difference between this method and the 19 to 25 percent interest rate regularly charged for using the credit card in Table 4-1, which compares buying a $1,000 item using this method with buying the item on your credit card. In each case, you pay $200 (or a little more) each month.

41

Amount paid

Interest

Beginning balance

Interest rate

Amount paid

Interest

$218.25

$18.25

$1,000

21.9%

Month 1

$200

$0

$1,000

0%

Month 1

$214.60

$14.60

$800

21.9%

Month 2

$200

$0

$800

0%

Month 2

$210.95

$10.95

$600

21.9%

Month 3

$200

$0

$600

0%

Month 3

$207.30

$7.30

$400

21.9%

Month 4

$201.97

$1.97

$400

5.9%

Month 4

Making Good Credit Work for You

Beginning balance

Interest rate

Table 4-1:

$203.65

$3.65

$200

21.9%

Month 5

$200.98

$0.98

$200

5.9%

Month 5

$0

$0

$0

21.9%

Month 6

$0

$0

$0

5.9%

Month 6

$1,054.75

$54.75

Total

$1,002.95

$2.95

Total

42 CliffsNotes Getting a Loan

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This procedure requires attention to details and the time frame, but it can make good credit work for you. Paying off and transferring the amount financed before the interest-free period expires is extremely important. Otherwise, the transaction isn’t economical. If your timing isn’t right, you get socked with the high interest rates of the financing contract and/or the credit card account. Shop around for lower-interest-rate retail financing contracts. If the financing available is expensive, consider it part of the cost of the item you’re purchasing. Another store or contractor may charge a little more for the same good or service but have a more attractive retail-financing package.

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CHAPTER 5

APPLYING FOR A MORTGAGE I N T H I S C HAPT E R ■

Exploring different features of a mortgage

■

Determining an affordable mortgage and monthly payment

■

Learning the composition of monthly mortgage payments and closing costs

A dramatic increase in consumers’ desire to purchase housing has created a demand for a greater variety of home financing arrangements. In this chapter, you learn about different types of mortgages so that you can choose the lending arrangement best suited for you. You calculate the monthly mortgage payment you can afford and explore the components of a mortgage payment and closing costs.

Which Mortgage Plan Is Right for You? As you read the descriptions of the various financing alternatives, you need to keep some things in mind: ■

How long you plan to live in your new home

■

How much you can afford on a monthly house payment after paying all your other bills

■

Whether you prefer the stability of a fixed-rate payment schedule or the flexibility of an adjustable-rate schedule

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Chapter 5: Applying for a Mortgage

45

The interest rate, length of loan, amount of monthly payment, and final closing fees (see later in this chapter) vary depending on the mortgage you choose.

Fixed-rate mortgages The interest rate and monthly payments stay the same for the length of the mortgage with a fixed-rate loan, often called a conventional mortgage. Fixed-rate loans usually have terms of 15, 20, 25, or 30 years. Early on, most of your monthly payment goes toward the interest due; in later years, most of your payment pays the principal. For example, say that your $90,000, 30-year mortgage at an 8 percent interest rate requires a monthly payment of $660. In the first month, the lender applies $600 of that payment to interest and $60 to principal. The second month, the lender applies $599.59 to interest and $60.41 to principal. After two months, you’ve paid $1,199.59 interest and $120.41 in principal. Your monthly payments are lower with a 30-year term than over 15 years. If you can afford a larger monthly payment, a 15-year mortgage is advantageous because you pay less interest and pay off your principal faster. The 15-year fixed-rate mortgage allows you to build up equity (the market value of your home minus all outstanding loans against it) faster — a real advantage if you plan to move in a few years.

Adjustable-rate mortgage (ARM) Another conventional loan is an adjustable-rate mortgage (ARM). An ARM features a changeable interest rate tied to another rate, such as the U.S. Treasury Bill rate. In other words, the interest rate isn’t under the absolute control of the individual lending institution.

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CliffsNotes Getting a Loan The loan agreement specifies how often the rate can change: annually (once a year) or semi-annually (twice a year). Your monthly payment may increase or decrease at those times. Within the loan agreement are interest rate limits, called caps. An Adjustment to Rate cap limits the movement of the interest rate annually or at each changing period. A Life of the Loan cap limits the maximum amount that the interest rate can change over the term of the loan. For example, an ARM may have a 1 percent annual cap and a 5 percent Life of the Loan cap, meaning that the interest rate can’t increase more than 1 percent each year and can’t increase more than 5 percent over the life of the loan. At the outset, the ARM loan can have a low, attractive rate, but it can also increase later. When deciding between a fixedor adjustable-rate mortgage, ask yourself whether your budget can adjust to a rate increase over the life of your mortgage.

FHA and VA insured loans If you can’t come up with the required down payment for a conventional mortgage, the Federal Housing Administration insures mortgages for up to 97 percent of the appraised value (the certified market assessment of your home’s value). The biggest advantage of an FHA mortgage is the small down payment — usually 3 to 5 percent. The FHA mortgage rate is adjustable. You can find FHA mortgages at selected participating financial institutions. FHA loans have the following limitations: ■

The borrower must have an established credit background.

■

The borrower must pay an insurance fee to the FHA to guard against default on the payments.

■

The amount to be borrowed must be within the FHA limit and geographic area.

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47

The Veterans Administration (VA) also guarantees home loans to lenders. The VA requires a certified appraisal of the property and a down payment from the borrower, if the sale price of the home exceeds the appraised value. In addition, the VA places qualifications on the construction of the home and limits on the amount that you can borrow. To be eligible for a VA insured home loan, you have to be a veteran who has served in the armed forces for a specified time period and received an honorable discharge. If you are the spouse of a veteran who died during military service and have not remarried, you are also eligible. To see whether you qualify, send in a copy of your DD-214 (your discharge document) to the Department of Veterans Affairs or call 800-827-1000.

Seller financing Seller financing is most common during times of high inflation and unemployment, when the going interest rates. on mortgages make house payments too high for many people to afford. In a seller financing arrangement, the seller acts as the lender and arranges the financing for the buyer, usually in one of two ways: ■

The buyer assumes (takes over) the seller’s mortgage and begins making the seller’s regular mortgage payments on the property. The original mortgage is usually at a lower interest rate than is available at the time of the sale. In most cases, the seller transfers the title to the new owner and draws up a mortgage document for the buyer. The seller becomes the mortgage holder, just as a bank would be, and usually requires a down payment. Many lenders don’t approve of having another buyer assume the mortgage and have a due on sale clause, giving the lender the authority to demand payment in full if the home changes ownership.

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CliffsNotes Getting a Loan If you find the mortgage has a due on sale clause and is therefore not assumable, don’t offer financing as a seller or enter into such a transaction as a buyer. ■

The seller actually provides the financing for the buyer himself. Typically, the buyer makes a down payment of 10 percent of the purchase price. The seller extends a second mortgage for 10 percent of the purchase price for a short period of time, sometimes five years. In that time, the buyer makes payments to the seller, accumulates some equity in the house, and possibly saves some money for a down payment toward a conventional mortgage. The buyer is then in a better position to seek conventional mortgage financing for the final 80 percent.

Considering Payments, Costs, and Fees Before devoting months to house hunting, learn the components of a monthly mortgage payment and take time to figure the maximum monthly mortgage payment you can afford. Explore the application process; you need to know all the costs assessed for application and processing fees and when payment is due for those expenses. Finally, review the many costs that make up closing costs.

Figuring the monthly mortgage payment You should be clearly aware of what composes a monthly mortgage payment. In some cases, the payment is primarily principal and interest. However, many lending institutions include other costs within the monthly payment to lower their risk and to help you manage your budget. A monthly mortgage payment can include:

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■

Principal: The amount of money you borrowed.

■

Interest: The money you pay to borrow the principal. Interest is expressed as a percentage of the principal.

■

Property taxes: Real estate taxes paid to your local government, village, and so on.

■

Flood insurance: You are required to purchase flood insurance if the lender receives notification that the house is located in a Special Flood Hazard Area. The National Flood Insurance Reform Act of 1994 requires the borrower to pay for a certified flood determination.

■

Homeowners insurance: Insurance that protects you and the lender from loss of building and furnishings from hazards, such as fire.

■

Mortgage insurance: Protects the lender from some financial loss if the borrower defaults (falls behind in payments or no longer can repay). Many lenders don’t require mortgage insurance if your down payment is at least 20 percent of the price of the house. Be sure to ask when you apply whether this insurance is required.

■

Escrow account: A special bank account set up in your name to collect money from your monthly payment to pay property taxes, homeowners insurance, and, if needed, mortgage and flood insurance.

Take a moment to examine Table 5-1. Note the increase in monthly payment (principal and interest only) as the interest rate and amount of principal borrowed increases.

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CliffsNotes Getting a Loan Table 5-1: Interest Rate and Monthly Payments Loan amount

Interest Rates 7%

8%

9%

10%

$60,000

$399

$440

$483

$527

$80,000

$532

$587

$644

$702

$100,000

$665

$734

$805

$878

$120,000

$798

$880

$966

$1,053

$140,000

$931

$1,027

$1,126

$1,229

$160,000

$1,064

$1,174

$1,287

$1,404

$180,000

$1,198

$1,321

$1,448

$1,580

How much can you afford? Don’t let the lengthy mortgage application intimidate you. The lender is simply seeking detailed financial information about you. Be prepared to give specific information regarding employment, income, residence, savings accounts and stock, outstanding debts, payment history, and any clarification of your past credit history. Before you apply for a mortgage, complete the Calculating Your Affordable Monthly Payment worksheet to compute an affordable monthly payment. To complete the worksheet, follow these steps: 1. Multiply your total monthly income by 0.28 and write

the result on line A. 2. Multiply your total monthly income by 0.36 and write

the result on line B. 3. Subtract your total monthly expenses (line C) from line

B and write the result on line D. 4. Take the lesser amount of A or D and fill it in on line E.

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Calculating Your Affordable Monthly Payment Total monthly income _________ × 0.28 = _________ (A) Total monthly income _________ × 0.36 = _________ (B) Minus total monthly expenses

_________ (C)

Equals

_________ (D)

Lesser amount, A or D

_________ (E)

This figure represents the amount you can afford monthly for mortgage, home insurance, and property taxes. Completing this calculation is the first step in determining how much you can afford. Now take a moment to complete the Calculating the Price of a Home You Can Afford worksheet. Calculating the Price of a Home You Can Afford 1. On line A, fill in the amount of available monthly

income from line E of the Calculating Your Affordable Monthly Payment worksheet. ____________ (A) 2. Compute the monthly real estate tax and home insur-

ance payment and write this amount on line B. You can get approximations of these amounts from your real estate and insurance agents. ____________ (B) 3. Subtract line B from line A to find out how much of

your monthly income you need for the monthly principal and interest only. Write this amount on line C. ____________ (C) 4. To find your estimated mortgage amount, multiply line

C by the mortgage factor associated with the interest rate of your mortgage, listed in Table 5-2, and write the result on line D:. ____________ (D)

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CliffsNotes Getting a Loan 5. To find your minimum down payment, multiply your

mortgage amount (line D) by .05 and write the result on line E. ____________ (E) You multiply line D by 5 percent because most lenders require a minimum 5 percent down payment. If the down payment is more, the amount you multiply by must match that percentage. You have now calculated your estimated monthly income available for a mortgage, your total affordable mortgage, and your minimum down payment. 6. Add lines D and E to compute your proposed house

price.

____________

Table 5-2: Mortgage Factors Interest Rate.

Factor

7%

150.30

8%

136.30

9%

124.30

10%

113.95

11%

105.00

Closing costs The closing of your house represents the transfer of the title of the property from the seller to the buyer. Take note of the individual costs listed here that are due at closing: ■

Attorney fees: To review documentation

■

Title search and insurance: To determine whether the title is clear of any liens (see Chapter 4) and to obtain title insurance (a contract by which the insurer, usually a title insurance company, agrees to pay the insured, the buyer, up to a specific amount for any loss caused by defects of title to real estate)

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■

Application fee: To evaluate your application

■

Appraisal fee: To obtain a certified appraised value of the house

■

Loan origination fee: A percentage of the loan to pay for processing the loan

■

Prepaid escrows: An advance payment of approximately one year of real estate taxes and homeowners insurance

■

Recording and transfer fee: To record the purchase of your home with your local government

You should receive a written estimate of the closing costs when you first apply for a mortgage.

Buy-downs and buy-ups A buy-down is a method of temporarily lowering the loan interest rate for a specific period of time. You can use a buydown in almost any kind of mortgage, fixed or adjustable. You make a payment to the lender at closing to subsidize payments; this payment lowers the monthly payments for a specific period of time. The amount of the buy-down equals the difference between the monthly payment at the stated interest rate and the lower monthly payments over the term. A buy-up is almost the direct opposite of a buy-down. It’s a way of lowering the loan origination fee paid at the time of closing by increasing the monthly payment. Although your points at closing are lower, the monthly payments are higher for a set time. The amount of the buy-up equals the difference between the amount of points due at closing and the new, higher monthly payments for the specific period of time.

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CHAPTER 6

GETTING A LOAN FROM YOUR HOUSE I N T H I S C HAPT E R ■

Evaluating the cost-effectiveness of refinancing your mortgage

■

Reviewing the features and advantages of a home equity loan

■

Determining the best home equity arrangement for you

Your home is probably your most valuable asset. If you need to reduce your monthly debt or find a chunk of cash to make home improvements or send your child to college, you may want to consider refinancing the mortgage on your house or taking out a home equity loan. This chapter takes a look at both of those options.

Refinancing Your Mortgage Mortgage interest rates rise and fall over time, and low rates present you with opportunities to refinance your existing mortgage to lower your monthly payments. Or maybe you want to increase the mortgage amount so you can add an extra bedroom. Before you jump in feet first, figure out whether refinancing is cost-effective for you. Refinancing is probably cost-effective if ■

The new rate is 2 to 3 percent lower than your current rate

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55

You intend to remain in that home long enough to get back the costs of refinancing

Refinancing means applying for and taking out a new loan, which means documents to prepare, appraisals to be done, and many other tasks that cost money. These costs are charged to you, along with points (a percentage of the amount being borrowed). All these fees can add up to several thousand dollars. To help you decide whether refinancing is costeffective for you, take a moment to answer the questions in the Refinancing Worksheet. Refinancing Worksheet 1. What are the costs associated with taking out the new

loan (points, appraisal, documentation preparation fee, and so on)? –––––––––––––––––––––––––––––––––––––––––– –––––––––––––––––––––––––––––––––––––––––– 2. How long do you plan to live in your current home? Will

it be long enough to pay for the additional costs? –––––––––––––––––––––––––––––––––––––––––– –––––––––––––––––––––––––––––––––––––––––– 3. Will the new interest rate offset your income tax situa-

tion for the better or the worse? (Less interest means a lower tax deduction.) –––––––––––––––––––––––––––––––––––––––––– ––––––––––––––––––––––––––––––––––––––––––

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CliffsNotes Getting a Loan 4. Does your current mortgage contain any benefits (such as

flexible rates or an assumable mortgage clause), that you would sacrifice if you refinance with another institution? –––––––––––––––––––––––––––––––––––––––––– –––––––––––––––––––––––––––––––––––––––––– 5. Does it make better economic sense to buy a new, larger

house or to increase the amount refinanced to add that extra bedroom or enlarge the kitchen? –––––––––––––––––––––––––––––––––––––––––– –––––––––––––––––––––––––––––––––––––––––– 6. Would a home equity loan be a less costly (fewer up front

fees) and a more flexible means of generating cash than refinancing (less paperwork)? –––––––––––––––––––––––––––––––––––––––––– –––––––––––––––––––––––––––––––––––––––––– If you want to lower your interest rate, lower your monthly payment, extend or reduce the term of the mortgage, or increase the amount borrowed to pay off high-interest debt, refinancing is a sound decision. If you want to refinance your home to get extra cash with which to buy a luxury car or take frequent vacations, you may be placing yourself at the start of a dangerous downward spiral of debt. Work the numbers in the Refinance Cost-Effectiveness Worksheet to see whether refinancing is cost-effective for you. Before you start filling out the worksheet, consider how many years you will continue to live in your current home. When you multiply your monthly payments, both current and proposed, use that length of time to figure the total monthly payments. For example, if you plan to live in your current

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home for another five years, multiply the monthly payment (both current and proposed) by 60 months. This method is more realistic in computing your real savings. Refinance Cost-Effectiveness Worksheet 1. List your current total monthly payments (monthly pay-

ment amount × number of months you will reside in this house). ______

2. List your proposed total monthly payments (new lower

payment × number of months you will reside in this house). ______

3. Subtract the total proposed payments from the total cur-

rent payments to determine the difference.

______

4. List all the costs related to the refinance (closing costs,

points, prepayment penalty, and additional income tax because of your decreased mortgage interest tax deduction). ______ 5. Subtract the total cost from the difference to determine

your overall savings.

______

Now you are able to make a more educated decision on whether to refinance or to seek a home equity loan (see the next section).

Taking Out a Home Equity Loan Home equity loans allow homeowners to borrow against the accumulated equity (the market value of the home minus outstanding debt) in their homes. A home equity loan can be set up as a fixed-term installment loan or as a revolving line of credit (an approved amount of money made available for you to draw upon in varying increments as needed). In both cases, you secure the loan by a second mortgage.

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CliffsNotes Getting a Loan This type of loan has become more popular as real estate values have gone up. A home equity loan is a convenient form of credit, combining the flexibility of a personal line of credit with the collateral of a secured loan. The interest you pay on a home equity loan is tax-deductible, an attractive feature not found in other consumer installment loans or lines of credit. The amount of equity you have in your home helps determine how much you can borrow on a home equity loan. Your income also helps determine how much credit is extended to you. The application process is more extensive and requires more information than a small consumer loan. All major factors are evaluated, especially your credit history and any outstanding debts.

Reasons to borrow The largest financial asset most people have is the equity in their home. A home equity loan lets you take advantage of this asset easily. When you need to make a large purchase, you can just write a check on the home equity line — easy and simple. For homeowners with sizable equity in their homes, a home equity loan is one of the best sources of credit for large purchases. Many people use this type of credit to finance ■

A new car

■

Home improvement

■

Higher education

■

Debt consolidation

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Determining your equity You compute the equity you have in your home by taking the market value (appraised value) of your home and subtracting all outstanding loans against it (such as your mortgage). When figuring the maximum amount you can borrow on a home equity loan, the lender usually takes 75 percent of the market value, minus the mortgage and any other outstanding debts against the home. For example, say that your home is worth $175,000, market value, and your mortgage balance is $75,000. Figure 6-1 shows the computation. Figure 6-1:

Figuring your equity.

75% of $175,000 = $131,250 $131,250 – $75,000 = $56,250 (75% of market) – (mortgage value) = (amount of credit available)

In this example, you may be able to borrow as much as $56,250 against a second mortgage on your home.

Searching for the best offer The market for home equity loans is competitive. Many financial institutions offer attractive variable rates and often waive service and registration fees. Because the line of credit is secured by a second mortgage, the interest rate is usually less than for other types of credit lines. Before you sign a home equity loan, shop around for the best deal for you. Use the Home Equity/Lending Institution worksheet to record your answers about specific lending institutions.

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CliffsNotes Getting a Loan Home Equity / Lending Institution Survey

Lending Institution 1

2

3

What is the initial interest rate?

______ ______ ______

If the rate is a special offer, when will it change?

______ ______ ______

How often does the rate change?

______ ______ ______

What percentage of home market value is lent out?

______ ______ ______

How much is the annual fee?

______ ______ ______

How much is the closing fee? ______ ______ ______ How much is the appraisal fee? ______ ______ ______ Are there points? How many? ______ ______ ______ Can the line of credit be increased if equity increases?

______ ______ ______

Can the lender demand payment?

______ ______ ______

How long is the loan contract? ______ ______ ______ What is the minimum monthly payment?

______ ______ ______

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61

A home equity loan is a very flexible, accessible form of credit, but it’s very easy to jeopardize your home if you abuse it. Borrowing against your home equity for small purchases can lead to spiraling debt. Manage your home equity line just like any other debt — pay back the loan principal and interest over a set period of time.

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CHAPTER 7

APPLYING FOR AN AUTO LOAN I N T H I S C HAPT E R ■

Determining your debt-to-income ratio

■

Learning about the features and costs of traditional auto installment loan financing

The rising price tags of cars today have spawned loans with longer terms and alternative financing. In this chapter, you explore the costs and features of a typical auto installment loan and grasp a better understanding of the components of the loan.

Finding Out What You Can Afford For now, assume that you have picked out the new car that you want to buy and have decided to finance your car by means of a typical installment loan. The lender looks at many factors before approving your auto loan, including: ■

Your credit rating and payment history

■

The cost of the car

■

Your down payment

■

The amount to be financed

Auto loans are considered secured loans (the title acts as the collateral security — see Chapter 2), so the lender wants to ensure that the outstanding balance of the loan is never more than the market value of the car. Because the market value of

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a new car drops dramatically when you drive it off the showroom floor, most lenders set a financing limit of 75 to 80 percent of the value of the car. Review your expenses and then confirm the amount that you can afford for a monthly payment by figuring your debt-toincome ratio (see Chapter 1). If the ratio is in the 36 to 42 percent range, getting your loan approved is likely. If the percentage is over 42 percent, loan approval is less likely. This quick check helps you choose which car you can realistically afford every month. If the payments for the car you’ve chosen prove to be more than you can afford, choose a lowerpriced car. The higher the price of the car, the larger the amount financed, and, in turn, the higher the monthly payments.

Features of an Auto Loan Now look at the important factors of an auto installment loan. ■

Length of the loan: Installment loans usually run 36, 48, 60, or 72 months. The longer the term, the more the total interest you pay over the course of the loan. The benefit to a longer-length loan is the smaller monthly payments.

■

Interest rate: Traditional installment loan interest rates don’t change as often as business loan rates do. So shopping around can pay off. You want to know the annual percentage rate (APR) of the loan, which is the cost of the loan stated over a 12-month period. Keep in mind that lenders quote lower interest rates for new cars and higher rates for used car.

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CliffsNotes Getting a Loan One way of figuring interest for an auto installment loan is simple interest computation. In this method, you pay interest only on the remaining (declining) balance of the loan. If you plan to pay off the auto loan early, this method is the better deal for you. In comparing two loan arrangements for the same length of time, choose the loan with the lower APR. ■

Total finance cost: The total finance cost is your bottom line cost — your total principal, interest, and other charges (such as credit life insurance) over the life of the loan. Use this figure when comparing loans.

■

Monthly due date: In many cases, you can request a specific date of the month when your payment is due.

■

Charges for prepayments and late payments: Before you enter a loan agreement with a financial institution, find out what its charges are for prepayment and late payments. Does the institution offer a grace period before it assesses a late charge? Can you prepay the loan in its entirety without having to pay also a service charge or a handling fee?

■

Life and disability insurance: This insurance pays off your loan if you die or become disabled during the loan period. Some lenders require you to carry and pay for credit life and disability insurance for the duration of the loan, but if not, think twice before accepting it. The insurance payments added to your monthly payments may also accrue interest, thereby increasing your total finance cost.

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65

Lien holder: When you borrow money to buy a car, the lender places a lien on the title of the car. A lien assures the financial institution that loaned you the money that it can repossess the car if you default on the loan. When you sign the loan papers, confirm that the lender is only placing one lien on the car title.

Sources for Auto Loan Financing Chapter 3 tells about the various institutions that offer auto financing. Another source of credit lies with dealerships, which offer attractive interest rate packages on top of less stringent credit requirements. They act as the bank, lending you the money to buy the car, and as a collection agent for your monthly payments.

Comparing Loans Take a moment and examine Table 7-1. Notice that as the length of the loan increases, the amount of finance charges (interest) and total loan amount increase as well. However, the monthly payment decreases, making the payment more affordable. Table 7-1:

Loan Comparison for $10,000 at 11%

Length of loan

2 years

3 years

4 years

5 years

Monthly payment

$ 466.07

$327.39

$258.45

$217.42

Total due

$11,185.68 $11,786.04 $12,405.60 $13,045.20

Total interest

$1,185.68

$1,786.04

$2,405.60

$3,045.20

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CHAPTER 8

APPLYING FOR AN EDUCATIONAL LOAN I N T H I S C HAPT E R ■

Exploring the processing steps of the FAFSA

■

Learning the provisions of federal student loans

■

Examining repayment conditions and alternatives

■

Investigating other financing options for parents

Education is an investment in your or your child’s future, but the costs of post-secondary education may shock you. This chapter focuses on educational loans. You uncover the components and provisions of the Free Application for Federal Student Aid (FAFSA), and examine federal loans for both students and parents. You review the repayment process and the alternatives available to students who can’t repay their loans. The loans discussed in this chapter apply to students attending the following federally approved schools: colleges, universities, community colleges, and trade, technical, or vocational schools. Individual states may have their own unique lending programs; ask your state’s department of education for more information.

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What’s a FAFSA? To finance advanced education, your first step is to complete the Free Application for Federal Student Aid as soon as possible after January 1 of the year you will begin your studies. The FAFSA comes with step by step directions. After you complete the FAFSA, either online or in hardcopy, send it to a processing center where your eligibility for financial aid is determined. You can find the FAFSA online at www.fafsa.ed.gov. Also check out www.ed.gov (and find more great Web sites in the Resource Center at the back of this book). The processor uses the financial information you provide to calculate the amount of money the government expects your family to contribute toward your education, called the Expected Family Contribution (EFC). Some two or three weeks later, you receive a Student Aid Report (SAR). The SAR confirms your EFC and all your financial information. The processor also sends this same information to the schools you designated on your application. Always list the most expensive in-state school choice first on your FAFSA, followed by other private and public schools. Make sure you fill out your FAFSA accurately and promptly, as soon after January 1 as possible, to give yourself enough time to correct any errors or assumptions made during processing. Because the information on your FAFSA is based on your current year’s financial statement, you can’t send your FAFSA before January 1 of the next year. If you do so, the processor returns the form to you unprocessed.

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CliffsNotes Getting a Loan After you receive the SAR, make any corrections or clarifications and resubmit it for processing. After you confirm the SAR as correct, the processor sends an Institutional Student Information Record (ISIR) to your requested schools. The ISIR states your EFC. If your EFC is less than the cost of education at the school, the government recognizes you as needing financial aid and, therefore, you are eligible for needbased financial aid. If the EFC is too high — that is, the EFC is higher than the cost of education — the government does not consider you eligible for financial aid, but you can still qualify for a non-need-based loan. If the EFC proves financial need, the financial aid administrators at your requested schools start developing a financial aid package for you. The aid package may consist of federal, state, and institutional grants (those that the school itself awards) and federal and state student loan programs. If you apply to a private school, you may need to complete the PROFILE — an additional financial aid form from the school itself — so check with the admissions office of the school. You can complete the PROFILE application before January 1 with financial information based on the current year. Some schools use this form to target scholarship as well as financial aid candidates. Federal loans come in three types — Stafford Loans, PLUS Loans, and Perkins Loans.

Stafford Loans The Federal Stafford Loan Program offers low-interest loans to U.S. citizens or resident aliens who are undergraduate or graduate students. The program divides into two categories:

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■

If the government considers you in need of financial aid, you can qualify for a subsidized loan. With a subsidized loan, the government pays the loan interest while you’re in school or if you request a payment deferment (a longterm postponement of repayment; refer to the “Forbearance and deferment” section later in this chapter).

■

If the government considers you to not be in need of financial need, you can get an unsubsidized loan, and the interest accrues while you’re in school and during any deferment.

Depending on the financial situation, you may receive a financial aid package combining both types of loans. Some schools offer Federal Direct Loans instead of or in addition to Federal Stafford Loans. The only difference between the two programs is that with Direct Loans, the federal government lends the money, while with the Stafford Loans, banks, savings and loans, credit unions, and private organizations lend the necessary funds. The provisions of the two programs are virtually the same.

Student eligibility To be eligible for a Stafford Loan, you must qualify in each of these categories: ■

U.S. citizen, national, or eligible non-citizen (with Alien Registration Receipt Card, Form I-151, I-551, or Form I-94)

■

At least a half-time student in a degree or certificategranting course of study

■

Be registered with the Selective Service, if applicable

■

Show academic progress based on criteria established by the school

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Not be in default of any federal student loan

In addition, to be eligible for independent undergraduate borrowing, a student must meet one of the following conditions: ■

Be at least 24 years old by Dec. 31 of the loan year

■

Be an orphan or ward of the court

■

Be a veteran of the Armed Services

■

Be married or have legal dependents

■

Be judged independent by financial aid officer

Loan amount provisions The amounts that you can borrow through the Stafford Loan program are limited annually. These limits can come from subsidized or unsubsidized loans or a combination of the two — as long as the borrowed amount doesn’t exceed the following annual limits: ■

Dependent undergraduates: Freshmen, $2,625 per year; sophomores, $3,500 per year; juniors, seniors, and fifth-year students, $5,500 per year. The maximum a dependent undergraduate can borrow is $23,000.

■

Independent undergraduates: Freshmen, $6,625 per year (of which at least $4,000 is from an unsubsidized loan); sophomores, $7,500 per year (of which at least $4,000 is from an unsubsidized loan); juniors, seniors, and fifth-year students, $10,500 per year (of which at least $5,000 is from an unsubsidized loan). The maximum an independent undergraduate can borrow is $46,000.

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Graduate students: No classification is given for grade/year. The annual limit for a graduate student is $18,500 (of which at least $10,000 must come from an unsubsidized loan). The overall maximum is $138,500 (of which $65,500 can be in subsidized loans and $73,000 in unsubsidized loans). This $138,500 limit includes all Stafford loans taken out during the student’s undergraduate and graduate life.

Interest rate The interest rate of a Stafford or Direct loan is 1.7 percent over the 91-day U.S. Treasury Bill rate (which changes annually and has a maximum interest rate of 8.25 percent) for inschool time, deferment, and grace periods. For the repayment period, the rate is 2.3 percent over the 91-day U.S. Treasury Bill rate. For unsubsidized loans, interest accrues while you’re in school and adds to the amount you owe. With subsidized loans, the government pays the interest while you’re in school and for the six months following graduation.

Lenders Banks, savings and loans, private lenders and organizations (such as the College Board), insurance companies, credit unions, and colleges and universities act as lenders for the Stafford Loan Program. For the Federal Direct Loan, the federal government is the lender.

Fees A 3 percent (of the amount borrowed) origination fee goes directly to the government, and a 1 percent (of the amount borrowed) insurance fee goes to the guarantor — usually an insurance company that insures against payment default. In an effort to get your business, a lender may pay some or all of these fees on your behalf.

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CliffsNotes Getting a Loan Because the government insures the Stafford and Direct Loans against default, more financial institutions participate in this program. Shop for a good deal on origination and insurance fees.

Application process Every financial aid applicant must complete the FAFSA. In addition, students awarded a Federal Stafford or Direct Loan must complete a separate loan application. Even if you don’t qualify for a need-based subsidized Stafford Loan but you will take out an unsubsidized loan, you still need to file a FAFSA.

Repayment The repayment plan for a Stafford Loan depends on the type of loan: ■

For subsidized loans, principal and interest loan repayment begins after the six-month grace period following graduation or authorized deferments.

■

For unsubsidized loans, interest payments start after you receive the first loan. However, you can elect to have the interest accrue instead of having to make payments while you are in school. Principal and interest repayment starts after the six-month grace period following graduation or authorized deferments.

Table 8-1 shows you the monthly payment and total amount due for three different loan values at the maximum of 8.25 percent.

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Table 8-1: Stafford Loan Repayment Loan Amount Number of Months

Monthly Payment

Total Amount Paid

$2,625

60

$53.54

$3,212.40

$23,000

120

$282.11

$33,853.20

$65,500

120

$803.37

$96,404.40

Generally, you repay the loan within five to ten years. However, you may petition for an additional three to five years to repay the loan. The minimum amount you can repay each year is $600.

PLUS Loans The PLUS Loan provides long-term educational loans to the parents of dependent undergraduate students. The parent, not the student, is the borrower and is responsible for repaying the loan.

Eligibility Student eligibility is identical to the Federal Stafford or Direct Loan Programs. Because the PLUS Loan is dependent on the parent’s creditworthiness, the borrower must meet the following conditions: ■

Parent must be the student’s natural or adoptive parent or legal guardian

■

Student and parent must be U.S. citizens, nationals, or eligible non-citizens (as explained in the Federal Stafford or Direct Loan Programs section)

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Loan amount provisions PLUS Loans aren’t need-based, so parents can borrow an annual maximum amount of the total school cost minus the amount of other financial aid you get. Lenders are more apt to solicit larger loans (over $5,000) to recoup their administrative costs. Of course, the parent must be credit-worthy to be approved (see Chapter 1).

Interest rate The interest rate is 3.1 percent over the 91-day U.S. Treasury Bill rate, with a 9 percent maximum. Interest starts to accrue as soon as you get the money.

Lenders and fees These costs are the same as for the Federal Stafford or Direct Loan Programs. See the section on Stafford Loans earlier in this chapter.

Application process A borrower’s certificate, signed by the borrowing parent, states that the money is used only to pay for the cost of their child’s schooling, along with a Federal PLUS Loan Application. Because PLUS Loan approval is based on the parent’s credit history and isn’t need-based, a FAFSA isn’t required.

Repayment The full amount of the loan, principal, and interest must be repaid within five to ten years. The first payment is due 60 days after you get the last installment of the loan. The minimum amount you can repay each year is $600. Table 8-2 lists the monthly payments required for three loans, all calculated at the 9 percent maximum.

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Table 8-2: Federal PLUS Loan Repayment Loan Amount

Number of Months

Monthly Payment

Total Amount Paid

$5,000

120

$63.34

$7,600.80

$30,000

120

$380.03

$45,603.60

$50,000

120

$633.38

$76,005.60

Perkins Loans The Federal Perkins Loan Program is based upon financial need and is available to both undergraduate and graduate students. The government allocates funds for these loans directly to the schools. Consequently, only the schools, not financial institutions, choose the students and determine the loan amounts.

Loan amount provisions The government bases the amount you can borrow through the PLUS Loan on your classification as an undergraduate or graduate student. ■

Undergraduate students: $3,000 per year; $15,000 maximum

■

Graduate students: $5,000 per year; $30,000 maximum, minus any previous undergraduate Perkins Loan money

Expanded lending option (ELO) If a student enrolls at a school that has a low default history, the student may qualify and receive more than the regular annual maximum under the expanded lending option. Undergraduates can borrow up to $4,000 per year with a $20,000 maximum. Graduate students can borrow up to

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CliffsNotes Getting a Loan $6,000 per year with a $40,000 maximum, minus any previous undergraduate Perkins Loan money.

Interest rate The interest rate is 5 percent, which is deferred while the student is attending school and during grace and deferment periods.

Application process Initially, the student completes a FAFSA (and PROFILE, if appropriate) so that the school can determine financial need. The financial aid administrator of the school selects recipients and authorizes specific loan amounts.

Repayment Payment starts nine months after the student completes school and can continue over a 10-year maximum. A grace period of nine months (after the student is considered a halftime student) or six months (after the every authorized deferment) is allowed. The minimum annual repayment is $480. Table 8-3 lists the monthly payment due for various loan amounts, all computed at 5 percent. Table 8-3: Perkins Loan Repayment Loan Amount

Number of Months

Monthly Payment

Total Amount Paid

$4,000

120

$42.43

$5,091.60

$15,000

120

$159.10

$19,092.00

$30,000

120

$318.20

$38,184.00

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Repayment Time Congratulations! You’ve graduated. It’s time to review those student loan documents and prepare your budget to repay your debt. Defaulting on your loan payments can result in your going to court, your wages being garnished, or your income tax refund being taken, and can adversely affect your credit history for years. If you are consistently unable to repay your student loan, tell the lender about the situation. Alternative payment plans are available.

Forbearance and deferment Some lenders grant forbearance (not enforcing the payment of a debt after it is due) to the borrowing student if unexpected situations arise the make the student unable to repay according to the loan agreement. Unemployment, underemployment (when your student loans exceed 20 percent of your annual gross income), poor health, or personal problems are reasons to request forbearance. Lenders may also grant forbearance if the borrower is working in a medical/dental internship or residency program or is serving in the military. In a forbearance situation, the borrower may be given an extended time to make payments, may be allowed to miss a few months, or may request reduced payments. However, interest continues to accrue. Deferments are more long-term postponements in the repayment schedule than forbearances and, consequently, have requirements that are more stringent. The borrower must be at least a half-time student at an approved school. You may receive a deferment of up to three years if one of the following situations apply:

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You are working full-time at minimum wage or less and can’t meet the debt obligations.

■

You are currently unemployed but can prove an active job search.

■

You are in a graduate fellowship program or rehabilitation training program for the disabled.

Graduated and income-sensitive repayment alternatives If you don’t qualify for forbearance or deferment provisions, other workable alternatives are available: ■

The graduated repayment program allows you to start repaying in smaller installments, gradually increasing in amount as your income increases. You still must pay off the loan within ten years.

■

In the income sensitive repayment program, you establish a flexible repayment plan with the lender (financial institutions only) — usually 4 to 25 percent of your monthly income. Again, you should repay the loan within ten years.

Loan consolidation Student loan consolidation is similar to consumer debt consolidation in that you pool all your student loans into one monthly payment and extend the terms of repayment, resulting in a smaller and more affordable monthly payment. Consolidation is a common solution for borrowing students who have accumulated a large debt after graduation and whose income, at first, may not be sufficient to cover their living expenses and student loan payments.

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All the federal loans described in this chapter are eligible for federal loan consolidation. The same forbearance and deferment provisions apply as described earlier in the chapter. If you consolidate a subsidized loan, the interest subsidy benefit remains if you request deferment.

Alternative lending for parents If you need supplemental financing, parents have some other options for borrowing money to pay for their child’s education: ■

Home equity loans (see Chapter 6)

■

Stock margin loans (see Chapter 3)

■

401(k), 403(b), or profit sharing loans (refer to your employer or plan provider for regulations and restrictions)

■

Commercial education loans through commercial banks (although the interest rate may not be as attractive as the other options listed)

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CHAPTER 9

BORROWING THROUGH A CREDIT CARD I N T H I S C HAPT E R ■

Exploring the features of merchant cards, bank credit cards, and travel and entertainment cards

■

Reviewing the definitions of card costs

■

Learning the process and costs of credit card cash advances

■

Evaluating credit cards to find the best deal

This chapter reviews the features of store charge cards, bank credit cards, and travel and entertainment cards. You discover the meaning of such important facets of credit cards as the annual percentage rate (APR), grace period, and the numerous costs associated with credit lines. You also explore the process and costs of a credit card cash advance — your quick and easy loan. Finally, you evaluate what kinds of cards fulfill your needs at the best price.

Choosing the Right Kind of Card for You Credit cards, another form of borrowing, come in the forms of merchant cards, bank credit cards, secured credit cards, and travel and entertainment (T&E) cards. Cards can vary widely in the interest rate charged, how the lender figures the interest rate, annual fee assessed, grace period extended, and payment required.

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Merchant cards Department, discount, specialty stores, and oil and gas companies issue merchant cards. These cards are relatively easy to obtain, with less strict credit qualifications. Store and gas cards usually have a low credit limit, $500 for starters, and no annual fee. Gas company cards are probably the easiest credit cards to qualify for — a great way to establish your credit. Review Chapter 2 for more tips on establishing and building your credit background. Convenience is the biggest advantage of store charge cards. ■

You can shop without a wallet full of cash or a checking account full of money.

■

You can charge your purchases today and pay for them later (in 30 days or so) when your credit card bill arrives.

■

Charge card customers have better luck settling service or merchandise disputes with the store because the store wants to keep your consistent business.

■

Stores frequently provide preferred treatment to their cardholding-customers by inviting them to pre-sale events, offering no payment for 90 days without interest due, and special event catalogues.

The biggest disadvantage with merchant cards is the high interest rate charged on unpaid balances, usually 18 percent and up. Merchant charge cards provide shopping convenience for you but generate interest profits for the store. Make sure you remain a “30 day-er” and pay your balance in full each month.

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Bank credit cards MasterCard and Visa are the two most commonly held and internationally accepted bank credit cards. To obtain one of these cards, you need to apply at a financial institution that is a member of the Visa or MasterCard organizations. You must have an established credit background, as well as a stable income and residence, to receive approval for credit cards. As with store charge cards, you can postpone the payment of your purchases on a bank credit card for approximately 30 days. You owe no interest if you pay for your purchases by the due date. You can also get a cash advance, or a loan, from your bank credit card line. See “Getting a Cash Advance” later in this chapter to find out more. The card-issuing financial institutions have legal limits, set by each state, on the interest rates and annual fees they can charge. The annual fee can range from nothing to $65 or more. If your credit card-issuing bank is located in Delaware or South Dakota, watch out for the potentially high annual fee. Those states do not have consumer-friendly laws regarding credit accounts. An institution may offer an initial interest rate of 6.9 percent, for example, to entice new customers to apply and then later increase the interest rate to, say, 21 percent. If you choose to make a partial monthly payment, that 21 percent interest can add up on the outstanding balance rather quickly. Researching the fine print of interest rates and annual fees pays off. Even with a low balance, interest still adds up over the years. Table 9-1 shows the interest charged if you repay $1,000 in equal monthly installments for one year ($1,000 ÷ 12

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months), two years ($1,000 ÷ 24 months), or three years ($1,000 ÷ 36 months). The longer you take to pay off the $1,000, the more interest you pay. Table 9-1: Unpaid Balance on $1,000 Paid in Equal Installments Annual Percentage Rate (APR)

First Year Interest

Second Year Interest

Third Year Interest

12%

$66.08

$129.68

$195.56

18%

$100.04

$198.08

$301.40

21%

$117.32

$233.12

$356.12

The Discover credit card is gaining popularity but is not as widely accepted as Visa and MasterCard. Discover has a reputation of charging interest rates higher than its competitors. The Discover Card offers a cash-back benefit dependent upon the amount you charge — you earn 0.25 percent on the first $1,000, 0.50 percent on the second $2,000, and up to 1 percent on balances over $3,000. Premium cards, such as Visa and MasterCard’s gold and platinum series, may offer additional benefits. In turn, you may pay a higher annual fee and interest rate to receive the higher credit limit, prestige, and “built-in” benefits. You benefit more financially by requesting an increase in your credit limit on your regular Visa or MasterCard than by paying the higher fees and interest rates on gold and platinum cards.

Secured credit cards A secured Visa or MasterCard is the optimum solution for you if you have a poor credit history or no credit established. Your savings account secures this kind of credit card. For

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CliffsNotes Getting a Loan example, XYZ Bank places a hold on your $1,000 savings account and, in turn, issues you a Visa or MasterCard with a credit limit of $1,000 or less. You still earn interest on your savings balance, but you aren’t allowed to withdraw it while the credit card account is open. Shop around for banks that provide secured credit cards — not many do. Before you sign on the dotted line, confirm the following: ■

Credit card interest rate

■

Savings account interest earned

■

Credit card annual fee

■

Percentage of savings balance available for credit card use

Find out how long you need to maintain a secured credit card before you can apply for an unsecured Visa or MasterCard.

Travel and entertainment cards The three travel and entertainment cards — otherwise known in this text as T&E cards — are issued by American Express, Carte Blanche, and Diners Club. In the past, people used these cards for restaurant, travel, and hotel costs to track business expenses. Today, stores accept these cards for regular purchases. However, not as many places accept T&E cards as Visa and MasterCard. Customer annual fees are also higher than bank credit cards. The T&E cards also differ from bank credit cards in their payment demands, requiring full payment within 30 days of receipt of your billing statement. However, you have a longer period of time to pay your bill before interest starts to accrue than with Visa or MasterCard. — a big advantage for people who manage their cash flow rather closely.

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Another T&E advantage lies in customer service. If a cardholder needs a replacement card, customers note a faster turnaround time dealing with T&E customer service departments than bank credit card customer service. In addition, copies of your charge receipts are included in your monthly statement to help you verify expenses and reconcile your account. Requesting a cash advance on your T&E card may be difficult and expensive. Some cards don’t permit cash advances; others charge a high service fee.

Understanding and Evaluating Card Costs If you’re applying for a store charge card, a savings secured card, a bank credit card, or a T&E card, you need to know the facts of costs before agreeing to the credit contract.

Interest rate The credit card company calculates interest as a percentage of the amount financed, usually stated in terms of the annual percentage rate (APR). The APR is the total cost of borrowing money, stated on an annual basis. You can find the APR on the credit application or the monthly statement. Federal legislation requires that creditors disclose all fees and vital information on the monthly charge card bill. This information includes the APR, daily periodic interest rate, grace period, annual fee, minimum finance charge, and method of interest computation.

Methods of interest computation Lenders calculate finance charges on the credit balance by one of three methods:

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The adjusted balance method computes the charges using the credit card balance after subtracting all payments made during the billing period. The adjusted balance method is usually the least costly method.

■

The previous balance method does not make any allowance for payments made to your credit card account during that billing period. This method figures the finance charge on the total balance. If your unpaid balance is high, your finance charge is high, no matter how many payments you have made.

■

The average daily balance method totals the balances for each day during the billing cycle and then divides the total of your daily balances by the number of days in your billing cycle. This method considers all new purchases and therefore, increases your daily outstanding unpaid balance.

Annual fee The credit card company charges the annual fee every year to cover the cost of maintaining your account. Credit card maintenance costs include the computer inputting of your charges, mailing of monthly statements, and providing customer service representatives to answer your questions. Introductory offers for new credit cards sometimes waive this fee for the first year. If you’re a “30 day-er” and pay off your credit card bill in full every month, shop for the credit card that waives the annual fee but may charge a higher interest rate. As long as you pay in full each month, you won’t pay either an annual fee or interest.

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Miscellaneous fees Miscellaneous fees are additional charges against your credit account in the form of late fees, cash advance fees, returned check charges, and over-credit-limit fees.

Grace period The grace period of your billing cycle is the length of time (usually 25 to 30 days) from the date of purchase to the date you pay your bill in full without accruing interest on the outstanding balance.

Minimum payment The minimum payment is the least amount of money that the bank expects you to repay monthly. It is usually a percentage of the total balance that you must pay by the billing cycle due date.

Balance transfers Balance transfers, in which you transfer the balance on one credit card to another, offer an attractively low interest rate. But before transferring, read all the fine print. Only the balances being transferred may be subject to the low interest rate, not cash advances or new purchases. Also, be aware that after the promotional period ends, your total balance on that card reverts to the higher rate. Be prepared to pay it off completely within the promotional period. You can take advantage of balance transfer promotions if you monitor them carefully. The advertised low interest rate can reduce your finance costs on your other credit lines. So by transferring the balances to one card, you benefit.

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CliffsNotes Getting a Loan After transferring your credit card balances to one card, put the credit cards away and do not use them. The reason for balance transferring is debt consolidation, not an opportunity to use more credit and become further in debt. Additional purchases or cash advances greatly increase your outstanding balance. Try to completely pay off the balance before the promotional time period ends, because after that time period, the interest rate probably goes back up. Use Table 9-2 to assess the advantages of transferring your balances. Table 9-2: Balance Transfer Assessment Current Balance

Transferred Balance

New Purchases

APR Grace Period Transaction Fee Method of Interest Computation

Getting a Cash Advance A cash advance is like getting a loan from your credit card. Bank credit cards advertise this form of a quick loan that you can conveniently carry out through an automated teller machine (ATM). How much easier can getting a loan be? Simply punch a few buttons on an ATM, and wait for the cash. Just remember that the interest clock starts ticking the same time you punch those ATM buttons.

When does interest accrue? With a cash advance, interest starts accruing on the date you receive the money — the day you request and receive the

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advance. When you charge a purchase on your credit card, you have a grace period of approximately 25 to 30 days. During the grace period, you may pay the outstanding balance in full without incurring any interest. Most T&E cards don’t offer cash advances, primarily because you can’t take advantage of interest-free repayments with a cash advance. Remember the additional time granted after you make a purchase and before you have to make a payment when interest does not accrue for T&E cards? The benefit of this grace period is the difference between a purchase and a cash advance on a credit card.

Are service fees assessed? If you receive your credit card cash advance at a bank not affiliated with your credit card, you aren’t charged for the actual service of granting a cash advance. However, many card-issuing banks now charge cash advance service charges. The bank issuing the credit card (not necessarily the bank providing the cash advance) may assess a fee of 2 to 5 percent of the cash advance amount. You see this fee listed on your monthly statement. Use the cash advance feature of your credit card for emergency purposes only. Because a cash advance is an expensive “loan,” pay it off as quickly as possible.

Searching for the Best Credit Card Deal Let your fingers do the walking when you’re searching for a good credit card deal. Call around to local financial institutions. Take a closer look at the card applications you receive in the mail. Read the fine print regarding interest rate, annual fee, cash advance fee, grace period, fringe benefits (such as mileage points and travel insurance), and how the lender

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CliffsNotes Getting a Loan computes interest on outstanding balances. Review personal financial magazines in the library. Use the Charge, Credit, and T&E Card Survey worksheet to record your findings. Carefully compare costs for your present and future needs for charge, credit, and T&E cards. You may need to have one or more of each, as each category of card serves different purposes. Charge, Credit, and T&E Card Survey Features

Names of Card and Financial Institution ______

______

______ ______

APR

______

______

______ ______

Annual fee

______

______

______ ______

Late fee

______

______

______ ______

Cash advance fee

______

______

______ ______

Grace period ______

______

______ ______

Fringe benefits

______

______

______ ______

Method of interest computation ______

______

______ ______

Purpose for the card ______

______

______ ______

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CHAPTER 10

KNOW YOUR RIGHTS I N T H I S C HAPT E R ■

Exploring why women need to establish their own credit identities

■

Learning how a woman can establish and transfer credit to her own name after marriage, divorce, or the death of her spouse

■

Examining the legal rights that protect women and senior citizens and help them establish their own credit

■

Exploring how senior citizens can establish credit

■

Discovering ways for young adults to establish credit and prepare for future credit needs

This chapter addresses the obstacles encountered by women, senior citizens, and young adults when establishing their credit identities. It gives suggestions on how to overcome these hurdles and build a credit background. This chapter also explains the Equal Credit Opportunity Act, with an emphasis on how specific aspects of the Act protect people from being denied credit. A great resource for information about credit law is www.lawstreet.com. Follow the link from the main page to the Law Guide, to Consumer Law, and then to Credit Law. Figure 10-1 shows some of the topics on the Credit Law page; many more are available. For more useful Web sites, see the Resource Center at the back of this book.

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CliffsNotes Getting a Loan The Credit Law page of Lawstreet.com.

Source: www.lawstreet.com. Reprinted by permission. All rights reserved.

Figure 10-1:

Credit and Women Before Congress passed the Equal Credit Opportunity Act in 1974, women struggled to obtain credit in their own names. Whether they had jobs or not, married women had to apply for credit in their husband’s name, using their husband’s income in the credit decision-making process. Single women had a more difficult time obtaining credit than single men did. Establishing credit was nearly impossible with or without a job. The government passed the Equal Credit Opportunity Act to stop this discrimination against women. The Act states that a woman can’t be denied credit solely because of her sex or marital status. Today, however, women (single, married, divorced, or widowed) need to establish credit in their own names. More women now work outside the home, retain their

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maiden names, and/or head single-parent households. No longer can a married woman rely on her husband’s credit. In emergency situations, such as the sudden death of a spouse, and even in the regular day-to-day routine, a woman needs to be prepared to hold and manage finances in her own name. Even when you have a joint credit account, having your own credit identity — credit established solely in your name — is imperative.

Establishing and transferring credit Requesting and examining your credit report before applying for a loan (see Chapter 1) is especially important when a woman is establishing or applying for credit on her own. If your individual credit report doesn’t list the credit accounts that you own jointly with your husband, you need to contact the creditors and request that they list these accounts. The creditors should list the joint credit and payment history in both names. If you marry and change your name, you are responsible for contacting all your creditors to inform them of your name change. The credit previously held in your maiden name needs to be transferred to your married name. Before the sudden death of a spouse leaves you in emotional and financial confusion, you should establish your own credit while your joint credit is active. Without your own credit identity, you may find yourself unable to get a job or insurance if you are widowed. Creditors may cancel credit accounts when they find out about your husband’s death. If you haven’t already established or transferred the joint credit history to your name, you may find rebuilding your credit difficult.

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CliffsNotes Getting a Loan If you get divorced, be sure to contact all your creditors. Tell them about your change in marital status and confirm the outstanding debts that are solely in your name and those that are in your former husband’s name. Contact your creditors in writing, mailing the letters certified mail with a returned receipt requested. Keep a file of these letters and all correspondence related to them as a precautionary measure. If joint credit accounts remain open and active, you are still liable for them, even if your former husband used the credit. After you transfer your credit information or change your name, you should request another credit report to verify that your creditors have correctly updated their information.

A woman’s legal rights As you establish your own credit identity, you need to be aware of certain safeguards that protect your rights along the way: ■

You can use your maiden name, married name, or a combination thereof.

■

You don’t have to use Mrs., Ms., or Miss.

■

A creditor can’t ask you about your husband, his job, or his income.

■

A creditor must consider all your income sources, including alimony and child support, if you choose to disclose them.

■

A creditor may not ask you about your birth control practices or your plans for having children.

■

A creditor may not refuse you credit based on your age, sex, marital status, race, color, or religion.

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Credit and Seniors Establishing and maintaining credit is as important — and as difficult — for senior citizens as it is for women (see the preceding section). Today’s seniors were raised in a cash-paying society, in which you didn’t buy things until you had saved up the money for them, and they often continue that practice rather than financing items. Their only experience with long-term credit may be the mortgage on their house.

Establishing credit Establishing credit is admittedly difficult when you have paid cash for most major purchases. Many lenders turn down such seniors for credit because they lack sufficient credit history. You can establish a credit history by following the steps outlined in Chapter 2. If you paid off a mortgage or any other loan 15 or 20 years ago, your credit report may no longer reflect this information; show proof of the paid loan to the loan administrator. Doing so helps in the credit approval process and ensures that your credit report reflects the paid mortgage for the next time. AARP, the American Association of Retired Persons, promotes its own Visa credit card specifically for its senior citizen members. Call 800-283-3310 for new account information.

A senior’s legal rights The same Equal Credit Opportunity Act safeguards that protect women (see “Credit and Women,” earlier in this chapter) also pertain to seniors.

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Creditors can’t discriminate against you because of your age, sex, marital status, race, color, or religion.

■

A creditor must look at all types of income — retirement benefits, pension, social security, interest, dividends, and any income from full or part-time work.

■

A creditor can’t force you to close a credit account or reapply for credit just because you are retired or have reached a certain age.

■

A creditor can’t reject your credit application because you are too old for credit life insurance.

Always list all your assets on the credit application — savings, certificates of deposit, stock, mutual funds, real estate, and so forth — so that the loan administrator gets a better picture of your savings and spending habits.

Credit and Young Adults In the past, young adults also found establishing credit difficult. But since the passage of the Equal Credit Opportunity Act and the explosion of the credit card industry, creditors now view young adults in a more positive light. Young adults who are full-time college students are considered a good credit risk even though they don’t meet the employment and income criteria (as long as the student doesn’t have a previous poor credit background). The credit card industry targets college students in particular because of their future earning and spending potential. Paying for college fees, books, and daily living expenses via credit card is a profitable venture for creditors because so many college students make only partial payments each month and let the interest accrue on their accounts until they get out of school.

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The opportunity for credit for college students is a doubleedged sword. While your college years can be an excellent time to establish credit for your future, having credit cards during those years can also lead to irresponsible spending, resulting in a poor credit background. Young adults who work full-time and don’t attend college may find a few obstacles in their search for credit, but credit opportunities are available. Follow the suggestions in Chapter 2 to establish financial responsibility and build a strong credit background. As you establish your credit, order your credit reports annually to ensure that it records all pertinent information is in your name.

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CHAPTER 11

MANAGING YOUR CREDIT WISELY I N T H I S C HAPT E R ■

Examining your current assets and outstanding debts

■

Prioritizing your debts and monthly living expenses

■

Negotiating with creditors

■

Reviewing your rights under the Fair Debt Collection Practices Act

■

Seeking help with the Consumer Credit Counseling Service

■

Restructuring your debt with a debt consolidation loan

■

Understanding the process and consequences of repossession and bankruptcy

In this chapter, you reflect on your use of credit and your payment habits and learn about the signs of potential credit problems. You review the steps of establishing a plan to repay your debt and discover the importance of communication and negotiation with your creditors. You check out different ways to earn extra cash, consolidate your debts, and “buy” more time for repayment. If you are unable to set up your own plan, you explore the benefits of seeking counseling with the Consumer Credit Counseling Service. As a final measure, you review the meaning and process of filing for repossession and bankruptcy.

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Chapter 11: Managing Your Credit Wisely

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Finding Yourself in Trouble At some point, you may find yourself in credit trouble. Perhaps you suddenly lose your job or are unable to work for a while because of an injury. Or maybe you find yourself taking a cash advance on one credit card in order to make the minimum payment on another. Perhaps you just realize one day that your monthly payments on various loans and credit cards surpass your monthly income. Sometimes the problem isn’t so obvious. You may try to fool yourself into thinking that your habit of “taking from Peter to pay Paul” is only temporary, but such behavior can lead to serious debt problems if you don’t address the situation immediately. Table 11-1 lists some questions to help you assess your spending habits. Take your time as you fill it out, and give some thought to your answers so that the worksheet can help you help yourself. Table 11-1: Survey of Spending Habits Question Do you use one credit card to make payments on another card? Do you pay the monthly minimum payment more often than the complete amount due? Are you behind on your rent/mortgage payments? Do you overdraw your checking account? Do you go over your credit limit on your store charge and credit cards? Have your health, auto, or life insurance policies been cancelled? Have you received notice of utilities or credit cards being cancelled? Have you stopped adding to your savings account?

Your Answer

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CliffsNotes Getting a Loan If you answer “yes” to more than three questions, cut up the credit cards! This chapter helps you make a plan to control your debt.

What Do I Do Now? Just as you set goals when you first established your credit, you need to set goals to reduce your debt. The following sections outline the steps you should follow to continue to pay your creditors and maintain your good credit background. You need to approach these steps intelligently and diligently. By doing so, you can accomplish your goal of debt repayment with as little damage to your credit background as possible.

Examine your debts Your first job is to review all your debts and list all your credit accounts. Fill out Table 11-2 by writing down the current outstanding balances for each credit account. List all credit accounts, even those with zero balances. Gather your most recent monthly billing statements or call your creditors to get current balances. Table 11-2: Current Debts Name of Creditor

Current Balance

Monthly Payment

Payment Due Date

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Next, list all your assets in Table 11-3. Inventory your material possessions. What are some valuable items that you can sell to earn some money? Stereo equipment, collectibles, jewelry, antiques? Table 11-3: Current Assets Sources of of Income

Monthly Amount $

Material Possessions Income to Sell Value $

Income Commissions Dividend/ Interest Other

Now you have a better picture of where you stand financially. Look carefully at your financial assets (savings, stock, and certificates of deposit). Keep some funds in your savings account for an emergency. Evaluate the projected value of your stock. Do some stocks have more earning potential than others do? Consider both the financial and sentimental value of your material possessions before selling them to reduce your debt. As you can see, evaluating all your assets is a thoughtful process.

Communicate with your creditors Next, you should contact your creditors and notify them of your situation — a task that isn’t as frightening as it may seem. Loan administrators want to help you help yourself so that you can continue to pay and the financial institution can continue to profit. Discuss with your creditors some arrangements for the next few months to buy some time to establish your reducing plan. Maybe your $100 payment can become $50 for the next three months.

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Be calm and honest in your discussions with your creditors. Creditors like their clients to keep them informed.

Prioritize your debts If you’re strapped for cash, you need to prioritize your debts and expenses as what is necessary for day to day survival and what is secondary. For example, daily living expenses such as rent/mortgage, utilities, and food are necessary expenses. Payments on charge and credit cards, auto loans, and medical bills are secondary because you can arrange partial payment. Only you can judge the importance of some expenses. Fill in Table 11-4 with your monthly expenses and outstanding debts and their amounts from Table 11-2. Indicate each expense as necessary or secondary by a check mark. Table 11-4: Prioritize Your Monthly Expenses Debt/Expense Creditor Name:

Rent/Mortgage Food Utilities Transportation Insurance Medical/Dental Taxes Personal Items Other

Necessary Secondary Monthly Amount

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Negotiate with your creditors After you prioritize your debts and expenses, contact your creditors in writing (mail the letter certified with return receipt requested) to explain your situation and your request to reschedule payments. Someone will contact you to discuss your adjusted payment schedule. Now is your opportunity to negotiate a workable solution. Contacting your creditors in writing is best so that you have a record of the contact made with the creditor. Set up a file folder for each creditor and keep copies of all correspondence and notes of all telephone conversations in these files. Be prepared to say exactly how much you can afford to pay each creditor (depending on the prioritization of the debt) before talking to your creditors. Having a figure already worked out shows that you have seriously thought about the matter and are acting in good faith. Confirm the bottom-line amount of money the creditor will accept to meet the monthly payment and total debt. Request an extension of your credit agreement. Your meeting with your creditor is an opportunity for you to negotiate a settlement favorable for you. The creditor is interested in settling the debt with whatever you can pay. If the creditor tries to waver from your proposed lower amount and requests more, stick to your guns. This new lower payment is workable for you, and the creditor already agreed to it. Be diligent in your timely payments. A late payment may cause the creditor to revoke the rescheduled payment agreement.

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Deal with collection agencies Collection agencies are notorious for their questionable manner in collecting debts. The Fair Debt Collection Practices Act protects consumers against these unfair collection agency practices: ■

Any type of communication with anyone except yourself or your attorney. The collector may not contact your boss, relatives, friends, or anyone else in getting your debt paid.

■

Telephone calls at unusual and inconvenient times of the day. A bill collector can call only between 8 a.m. and 9 p.m.

■

Abusive language and behavior. A bill collector may not threaten or harass you verbally or in writing.

■

Untrue threats of lawsuits. A bill collector may not pose as a lawyer or government official or threaten you with any unfounded lawsuit.

■

Phony service charges. A bill collector may not charge you for collection services. The creditor who has employed the collector incurs these charges.

■

Reversals of telephone charges. A bill collector may not reverse the charges back to you for telephone charges incurred while trying to contact you.

■

Requests for a post-dated check. A bill collector may not ask or force you to write a post-dated check.

Don’t let your situation get as far as a collection agency. Act promptly to resolve your credit situation.

Seek help with the Consumer Credit Counseling Service

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The Consumer Credit Counseling Service (CCCS) is a professional debt counseling service that helps people in financial trouble. If you can’t establish a revised repayment plan for yourself, call the CCCS at 800-388-2227 for an appointment The first appointment with the CCCS is free. Come to the meeting armed with the information from Tables 11-2, 11-3, and 11-4. The counseling service devises a credit-restructuring plan according to this information. If you choose to use the counseling service’s plan, the CCCS charges a minimal monthly fee. The fee ranges from $5 to $30 a month, depending on your annual income. This non-profit service is a proven and professional solution to repaying your debt. The advantages to using the CCCS are many: ■

The service contacts your creditors and arranges specific repayment amounts.

■

Creditors often waive interest on the outstanding debt if you are part of the Debt Management Program run by the CCCS.

■

Repayment is easy. You send one designated amount of money to the CCCS each month, and the service forwards the restructured payments to your creditors.

Be careful of independent “credit repair clinics.” These forprofit companies charge sizable fees and deliver little help.

Restructure your debt One way of restructuring your debt is to buy more time. You can do this on your charge and credit cards by paying the minimum amount due each month. Of course, interest continues to accrue on the outstanding balance, but you keep

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CliffsNotes Getting a Loan current in the eyes of the creditor. Another way to buy more time is to consolidate all your debts into one loan. You get a loan — due over a longer period of time with lower payments and a lower interest rate — and use the proceeds of that loan to pay off your smaller, higherinterest debts. Hopefully, this restructured loan is manageable and budget-friendly. After you restructure all your debts into one loan, be careful not to fall back into your old spending habits. Don’t use your credit or charge cards — cut them up or hide them. The best debt consolidation deal may be a home equity loan. Because a second mortgage secures the consolidation loan, the interest rate is less than an unsecured debt consolidation loan, and the interest may be tax-deductible (refer to Chapter 6).

Reduce your expenses An important part of debt management is to reduce your expenses. In Chapter 1, you evaluate your needs and wants. If you’re having debt problems, forget the wants and concentrate on the needs. By reducing your expenses, you free up more money to meet your monthly debt payments. Look at the necessary expenses and payments from Table 11-4. Those are the costs that have priority and that you pay first.

Seek supplemental income Take inventory of your assets. What can you part with? Have a yard or garage sale to raise extra cash to reduce your debt. Or apply for a part-time job. Consider the job temporary work until you can manage your debt better.

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If you get a part-time job, put the extra money in a savings account. You’re working two jobs to reduce debt, not to increase it.

As a Last Resort If all attempts at reducing your debt have failed, you may need to sell your assets to pay off your debt. This liquidation can take the form of repossession or bankruptcy, the last resort.

Repossession A secured loan is one with collateral guaranteeing repayment of the loan if the borrower defaults. The creditor then has the right to take, or repossess, the collateral and sell it to repay the loan. Examples of collateral that are subject to repossession include vehicles (including boats), major appliances, furniture, jewelry, and collectibles. The creditor can repossess the collateral if you default on the loan. After only one missed payment, the creditor can legally notify you of repossession. Check your loan contract for the fine print detailing when repossession takes place. The time period for missed payments can vary from one financial institution to the next. In most cases, the creditor contacts you seeking an explanation of the missed payment in hopes of avoiding repossession and helping you get back on track. Creditors can’t use force to repossess your car unless they’ve presented a court order to you. After your car is repossessed, you have 60 to 90 days (specified by your creditor) to make payments and make the loan current, or paid up. If this isn’t possible, the creditor prepares to sell the car at auction to pay off the loan. Before the sale

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CliffsNotes Getting a Loan takes place, the creditor must present you with a ten-day written notice of intent to sell the car. This notice states your right to buy the car at auction and specifies the amount of money needed to do so. If you can purchase the car, be aware that you are obligated to pay an amount equal to the outstanding debt plus the creditor’s service charges. If you can’t buy the car and it’s sold for less than the amount outstanding on the loan, you are still liable to pay for this difference, called the deficiency. If you can’t pay the deficiency, the lender files a deficiency judgment against you. Both the forced repossession and the deficiency judgment remain on your credit report for seven years. In another form of repossession, called voluntary repossession, you “voluntarily” give up your car to the creditor. The same auction procedures apply as with forced repossession. However, your credit report reads voluntary repossession instead of forced repossession. Always try to sell the car yourself to pay off the loan to avoid repossession.

Bankruptcy Filing for bankruptcy relieves you of the legal obligations of your debts, but the consequences can scar your credit background for the next ten years. People often use the terms Chapter 7 and Chapter 13 as synonyms for bankruptcy. Chapter 7 is the most widely used form of personal bankruptcy proceedings, and filing for Chapter 7 is a simple process. You complete the necessary legal forms, pay a nominal court fee, and prepare to give up some of your assets. The court considers your assets either exempt or non-exempt. You must sell the assets that the court deems non-exempt in order to pay off your creditors. Exempt assets that can’t be sold

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include such items as clothing, household furnishings, and tools essential for your job. The definitions of these two terms vary from state to state. Chapter 7 bankruptcy releases you from most debt (student loans, taxes, and alimony excluded), but the government will sell certain assets you own to pay off your debts. After the paperwork is complete, contact all your creditors and advise them of your Chapter 7 filing. You are no longer responsible to repay most of your debts. The government considers your unsecured debts (charge and credit cards) charge-offs (see Chapter 2), but you must sell the collateral of any secured credit to pay off the debt. So if you had a car loan, your car is sold to pay off your loan, and you are left without a car. Misguided people who are in despair over their looming debts often file for Chapter 7 to escape their haunting debts. But the consequences of Chapter 7 are enduring and have a devastating effect on your credit background. An alternative to the quick fix of Chapter 7 bankruptcy is Chapter 13, also known as the wage earner plan. Here, under court supervision, you receive counseling to help you establish a workable budget and are then required to repay your debts completely or partially within a three- to five-year period. Chapter 13 bankruptcy is very similar to a debt consolidation loan, except that your debtors waive all interest charged on your outstanding balances under Chapter 13. After you complete and file the Chapter 13 forms, your creditors can no longer bother you. You, your court-appointed trustee, and all your creditors agree to a new repayment plan. The court-appointed trustee makes all payments to the creditors from the money you send in each month. Chapter 13

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CliffsNotes Getting a Loan remains on your credit report for ten years. A Chapter 13 bankruptcy carries a negative connotation, but not as bad as a Chapter 7, a straight bankruptcy. Chapter 13 bankruptcy gives you an opportunity to repay your debts under a manageable plan and allows you to keep your assets.

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CLIFFSNOTES REVIEW Use this CliffsNotes Review to practice what you’ve learned in this book and to build your confidence in doing the job right the first time. After you work through the review questions, the problem-solving exercises, and the fun and useful practice projects, you’re well on your way to achieving your goal of managing your credit wisely.

Q&A 1. What three factors form the basis of the credit evaluation

process? a. Stability, income, collateral b. Income, character, reliability c. Character, capacity, collateral 2. What is one of the first steps you take to establish credit? a. Apply for a car loan b. Open a checking or savings account c. Apply for a mortgage loan 3. What institution has low credit requirements? a. Savings and loan association b. Consumer finance company c. Commercial bank 4. What is a benefit of a 15-year mortgage compared to a 30-year

mortgage? a. Fewer closing costs b. Lower monthly payments c. Less interest over the length of the mortgage

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CliffsNotes Getting a Loan 5. What important document is required before you apply for

most student loans? a. SAR b. ISIR c. FAFSA 6. If you find yourself heavily indebted, what is the first step you

need to take? a. Negotiate with your creditors b. Seek help with the Consumer Credit Counseling Service c. Evaluate all your debt

Answers: (1) c. (2) b. (3) b. (4) c. (5) c. (6) c.

Scenarios 1. You have established a banking relationship and have developed

your credit background by getting various merchant charge cards. Before you apply for your first car loan, you should review your credit history by __________________________. 2. You receive bank credit card applications in the mail every day,

but you can’t decide which card is most beneficial for you. You evaluate costs such as __________________________. Answers: (1) Ordering your credit report from a credit reporting agency. (2) Interest rate, method of interest computation, annual fee, miscellaneous fees, grace period, minimum payment, and balance transfers.

Consider This ■

Did you know that you can review your credit report before you apply for more credit? Contact any of the three major credit reporting agencies and review the rating codes listed in Chapter 1.

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CliffsNotes Review

113

■

Did you know that you can determine an affordable mortgage payment for your budget? You can also calculate the price of a home you can afford. See Chapter 5 and follow the steps.

■

Did you know that you can learn to review and prioritize your debts before you find yourself hopelessly over extended? Turn to Chapter 11 and periodically evaluate your debts.

Practice Projects 1. Figure your debt-to-income ratio for three cars of varying value.

Refer to Chapter 7 for the calculation. 2. Discover whether refinancing your mortgage would be worth

your while. Refer to Chapter 6 for advice. 3. Evaluate the credit card applications you receive in the mail or

pick up in the stores to determine which card is more advantageous for you. Check out Chapter 9 for the evaluation guidelines.

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CLIFFNOTES RESOURCE CENTER The learning doesn’t need to stop here. CliffsNotes Resource Center shows you the best of the best — links to the best information in print and online about consumer loans. And don’t think that this is all we’ve prepared for you; we’ve put all kinds of pertinent information at www.cliffsnotes.com. Look for these terrific resources at your favorite bookstore or local library and on the Internet. When you’re online, make your first stop www.cliffsnotes.com, where you’ll find more incredibly useful information about getting a loan.

Books CliffsNotes Managing Your Money, by Mercedes Bailey, shows you how get on top of your financial situation. IDG Books Worldwide, Inc. ISBN 0-7645-8516-9. $8.99. CliffsNotes Creating a Budget, by Ro Sila, has everything you need to take control of your spending and start saving. IDG Books Worldwide, Inc. ISBN 0-7645-8512-6. $8.99. CliffsNotes Getting Out of Debt, by Cynthia Clampitt, helps you to get out and stay out of debt if your credit has gotten out of hand. IDG Books Worldwide, Inc. ISBN 0-7645-8513-4. $8.99. Buying a Car For Dummies, by Deanna Sclar, gives you all the ins and outs of buying versus leasing. IDG Books Worldwide, Inc. ISBN 0-7645-5091-8. $16.99.

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CliffsNotes Resource Center

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It’s easy to find books published by IDG Books Worldwide, Inc., and other publishers. You’ll find them in your favorite bookstores (on the Internet and at a store near you). We also have three Web sites that you can use to read about all the books we publish: ■

www.cliffsnotes.com

■

www.dummies.com

■

www.idgbooks.com

Internet Check out these Web sites for more information about consumer credit, loans, and more: Quicken.com, at www.quicken.com — Here you find information about mortgages, home equity loans, the national average interest rates on bank loans, how to find good deals on bank charge cards, good strategies for managing your credit cards, and how to order your own credit report. A Auto Advice Car Prices Site, at www.autoadvice.com — This site takes you through the steps of figuring what type and price of car and loan payment you can afford and how to negotiate a final price. It also helps you decide whether to finance or lease a car and even helps you shop for financing and insurance. Car Buying, Auto Leasing and Car Repair Secrets, at www.carinfo.com — This site highlights up-to-date leasing news from consumer advocate and auto expert Mark Eskeldson. He tells you what’s new in leasing and what to watch for in leasing scams. Equifax, at www.equifax.com — Here you’ll find additional help in understanding the codes and symbols on a credit report. You can even order your own credit report online.

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CliffsNotes Getting a Loan eHomeCredit.com, at www.ehomecredit.com — This site specializes in home purchasing and financing, along with refinancing and second mortgages. It includes interest and payment calculators and credit report requests. Finaid! The SmartStudent Guide to Financial Aid, at www.finaid.org — This is one of the most comprehensive financial aid sights on the Web. Here you find answers to many of your financial aid questions and links to other great sites. The College Board, at www.collegeboard.org — This site has great info and a direct tie-in to the PROFILE, the FAFSA, and student loans. Next time you’re on the Internet, don’t forget to drop by www.cliffsnotes.com — We created an online Resource Center that you can use today, tomorrow, and beyond.

Send Us Your Favorite Tips In your quest for learning, have you ever experienced that sublime moment when you figure out a trick that saves time or trouble? Perhaps you realized you were taking ten steps to accomplish something that could have taken two. Or you found a little-known workaround that gets great results. If you’ve discovered a useful tip that helped you get a loan more effectively and you’d like to share it, the CliffsNotes staff would love to hear from you. Go to our Web site at www.cliffsnotes.com and click the Talk to Us button. If we select your tip, we may publish it as part of CliffsNotes Daily, our exciting, free e-mail newsletter. To find out more or to subscribe to a newsletter, go to www.cliffsnotes.com on the Web.

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CliffsNotes Resource Center

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INDEX A adjustable-rate mortgages (ARMs), 51 American Association of Retired Persons (AARP), 101 annual fees, 92 appraisals, 52, 53, 59 assets bankruptcy and, 114 exempt, 115 importance of, in the credit decision-making process, 15 reviewing, when reducing your debt, 106, 107, 112 selling, to pay off debt, 113 attorneys, 58, 110 auto loans basic description of, 68, 70 comparing, 71 credit unions and, 36 sources for, 71 Web sites with information about, 121

B balance transfers, 47, 93, 94 bankruptcy, 114, 115 books, recommended, 9, 120 brokerage firms, 37, 39 buy-downs, 59 buy-ups, 59 buyers programs, 36

C capacity, to repay debt, 13 caps, 52

certificates of deposit (CDs), 26 character, personal, 12 checking accounts, 15, 25, 26, 40 CliffsNotes Daily, 9, 122 CliffsNotes Resource Center, 120 CliffsNotes Web site, 9, 120 closed-end credit, 39 closing costs, 58, 59 collateral, 14, 27, 35, 68, 113 collection agencies, 45, 110 College Board, 122 commercial banks, 34, 38 consolidation, of debts/loans, 84, 112 Consumer Credit Counseling Service (CCCS), 104, 110 consumer finance companies, 35, 38, 45 contractors, 44 contracts, 46, 49, 58, 91, 113 conventional (fixed-rate) mortgages, 51 cosigners, 27 credit. See also credit ratings; credit reports establishing initial, 25, 26, 28 scoring, 16, 17 seniors and, 101 types of, 39, 41, 42 women and, 97, 98, 99, 100 young adults and, 102 credit bureaus, 18, 19, 20, 27. See also credit reports credit cards balance transfers and, 47, 93, 94 cash advances from, 94, 95 choosing, 86, 87, 89, 90 costs of, evaluating/understanding, 91 searching for the best, 96 secured, 27

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Index credit ratings. See also credit; credit reports codes for, 23, 24 criteria for, how your profile fits in, 14, 15, 16, 17 evaluating, 11, 12, 13 repairing poor, 29 credit reports. See also credit bureaus; credit ratings basic description of, 17, 18 correcting errors in, 29, 30, 31 credit rating codes used in, 23, 24 evaluating, 20, 21, 22 ordering, 16, 18, 20 credit unions, 36, 38 creditors communicating with, 107 negotiating with, 109 repossession and, 113, 114

D debts bankruptcy and, 114, 115 communicating with creditors regarding, 107 dealing with collection agencies regarding, 109, 110 debt-to-income ratios and, 13 examining your current, 105, 106 negotiating with creditors regarding, 109 prioritizing, 108 reducing, 106, 107 reducing your expenses and, 112 resources for handling, 111 restructuring, 111, 112 review of, in the credit decisionmaking process, 15 seeking supplemental income in order to repay, 112 selling assets in order to repay, 113

119

deferment, 83 deficiency, 114 delinquency, 46 Department of Veterans Affairs, 53 disability insurance, 70 due on sale clause, 53

E e-mail newsletters, 9, 122 educational loans alternative options for, 85 basic description of, 72 FAFSA and, 73, 74, 78, 80, 82 Perkins loans, 81, 82 PLUS loans, 79, 80 repayment time for, 83, 84, 85 Stafford loans, 75, 77, 78 employment, length of, 12, 14 entertainment credit cards, 90, 95 Equal Credit Opportunity Act, 98, 101 Equifax, 17, 20, 121 equity. See home equity loans escrow, 55, 59 expanded lending option (ELO), 82 Expected Family Contribution (EFC), 73 Experian, 17, 20

F Fair Credit Billing Act, 32 Fair Credit Reporting Acts, 32 Federal Housing Administration (FHA) insured loans, 52 Federal Perkins Loan Program, 81, 82 Federal Stafford Loan Program, 74, 75, 76, 77, 78 Federal Trade Commission, 32 Finaid.com Web site, 122

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financing applying for, 45 making it work, 46, 47, 49 retail, 46, 47, 49 seller, 53, 54 understanding, 44 fixed-rate mortgages, 51 flood insurance, 55 forebearance, 83 Free Application for Federal Student Aid (FAFSA), 72, 73, 78, 80, 82 friends, seeking help from, 27

G

credit cards and, 91, 95 credit unions and, 36 educational loans and, 77, 80, 82 mortgages and, 51, 53, 55, 58

L Lawstreet.com Web site, 97 lawyers, 58, 110 lien, 24, 30, 44, 71 life insurance, 37, 39, 70 Life of the Loan cap, 52 lines of credit, 63 liquidation, 113

grace periods, 46, 78, 93

M

H

market value, of property, 65 MasterCard. See credit cards merchant charge cards, 26 mortgages adjustable-rate (ARMs), 52 buy-downs/buy-ups and, 59 calculating payments for, 54, 56, 57, 58 closing costs and, 58, 59 credit unions and, 36 FHA/VA insured, 52 fixed-rate, 51 refinancing, 60, 62, 63 types of, choosing, 50, 52, 53, 54

home equity loans, 41, 63 advantages of, 64 credit unions and, 36 determining your equity for, 65 searching for the best, 65 homeowners insurance, 55

I icons, used in this book, 8 IDG Books Worldwide Web site, 120 income consistent/steady, importance of, 15 ratio of debt to, 13 supplemental, seeking, 113 installment loans, 39 Institutional Student Information Record (ISIR), 74 insurance, 55, 58, 70 interest rates auto loans and, 69 consumer finance companies and, 35

N National Flood Insurance Reform Act of 1994, 55 newsletters, 9, 122

O occupation, 15 open-end credit, 40 overdraft protection, 40

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Index

P personal line of credit, 40 personal loans, 26 PLUS Loans, 79, 80 points, use of the term, 61 principal, use of the term, 39, 55 property taxes, 55

Trans Union, 17, 20 transfer fees, 59 travel credit cards, 90, 95

U U.S. Treasury Bills, 51 undisclosed obligations, 16

Q

V

Quicken Web site, 121

veterans, 53, 76 Veterans Administration (VA) insured loans, 53 Visa. See credit cards

R recording fees, 59 relatives, seeking help from, 27 repossession, 113, 114 residence, length of, 14

S savings accounts, 15, 25, 26 savings and loan associations, 34, 38 secured loans, 64, 68, 113 Selective Service, 75 seller financing, 53, 54 senior citizens, 101, 102 service fees, 95 single-payment loans, 40 Student Aid Report (SAR), 73 subscribers, use of the term, 18 subsidized loans, 75, 78

T taxes, 30, 55, 61, 63 Three Cs, for evaluating credit, 12, 13, 14 titles, 58

121

W wage earner plan, 115 Web sites CliffsNotes, 9 women credit laws applying to, 98, 99, 100 establishing credit and, 99, 100

Y young adults, 102, 103

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