Cash Course 1

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Step 3: Learn About Credit 1/17 Develop Smart Spending Habits Often, you can get your debt under control by developing smart spending habits and making better choices with your money. Try taking the following steps:

Avoid impulsive spending, and stick to buying only the things you need When you can, use cash instead of a credit card Limit the number of credit cards you use Pay your credit card bill on time and in full each month instead of wasting your money on interest payments

There are times when simply adjusting your spending habits might not solve the problem. If youre in serious debt, you might find that your financial situation requires an even bigger change. 2/17 Warning Signs The convenience of credit can make it easy to fall into debt. But if youre able to recognize the warning signs, you may be able to avoid a serious problem and get your finances back on track. Watch out for these red flags:

You pay only the minimum due on your credit cards You skip some card or loan payments You're maxed out on your credit limit You dont know how much you owe Your lender lowers your credit limit

If one or more of these situations rings a bell, its time to get a handle on your debt.

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3/17 Checking Your Credit Report Each year, you can get one free copy of your credit report from each of the three credit reporting agenciesEquifax, TransUnion, and Experian. You can request the reports all at once, but it makes sense to spread them out over the year. That way, you can spot problems shortly after they happen. You can request your credit reports online at www.annualcreditreport.com. Its not just lenders who look at your scores. Landlords do, and so do insurance companies. And, if you give them permission, potential employers can look at your credit report. So the way you use credit affects a lot more than being able to borrow. Credit reports also include other publicly available information that might affect your creditworthiness, like divorce proceedings, bankruptcies, tax problems, and court judgments. 4/17 The Impact of a Credit Score Your FICO score does more than let potential lenders decide whether youre a good or bad credit risk. Based on your score, creditors also determine your interest rate, which impacts your borrowing costs. Consider the cost of a $15,000 car loan. With a good FICO score, your creditor might offer you a 4.5% interest rate. With a poor FICO score, youre likely to pay a higher ratesay 15%significantly increasing your borrowing costs. At 4.5% interest:

Loan: $15,000 Loan terms: 60 months at 4.5% Payment: $280 per month Total cost of payments: $280 x 60 = $16,800 Borrowing cost: $1,800

At 15% interest:

Loan: $15,000

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Loan terms: 60 months at 15% Payment: $357 per month Total cost of payments: $357 x 60 = $21,420 Borrowing cost: $6,420

With the poor FICO scoreand the resulting higher interest ratethe same car costs nearly $5,000 more. 5/17 FICO Score Components While there are other credit scoring systems, FICO is the most widely used measure of creditworthiness in the United States. Your FICO score, which ranges from 300 to 850, is calculated using the information in your credit report. Although the formula is complex, there are five main components: 1. 2. 3. 4. 5. Your credit payment history which shows how youve repaid what you borrowed The total amount of debt you currently have The length of your credit history The different types of credit you use The new credit you hope to have extended to you

When you use credit wisely, you improve your FICO score. If you exhibit poor repayment behaviors, youre putting your score at risk. 6/17 Building a Credit History Anytime you use credit, youre adding a chapter to your credit history. All your credit transactions are recorded in a credit report, which is available to potential lenders who want to know how youve used credit in the past. Your credit history includes all uses of creditfrom student loans to everyday credit purchasesbut not other payments, like the ones you make to the utility company or your landlord. Youre assigned a credit score based on the details of your credit report. Your credit score is a snapshot of your creditworthiness, which lenders use to decide if you present a credit risk. The higher your credit score, the more creditworthy you are, and the more likely you are to receive credit. 7/17

Cash Course 4 Getting Into Credit Trouble While mounting interest charges and late fees can increase your debt and make it even harder to pay your bills on time, they arent the only problems caused by poor borrowing habits. For example, with poor borrowing habits:

It may be hard to find a lender who is willing to give you a credit card or make you a loan, even if you need the money It will probably cost you more if you can borrow, since lenders usually charge higher rates of interest to borrowers who arent creditworthy

Did you ever wonder how lenders know youve got a money problem? 8/17 How Using Credit Can Hurt While many people use credit wisely, the convenience of credit can sometimes lead to big trouble. One downside of credit cards is that many people tend to spend more when they use credit than when they pay with cash. If thats true for you, it can be hard to pay your bill on time, let alone in full. Over time, interest and late fees add up, making everything you buy on credit even more expensive. Theres a downside to loans as well. Even if you borrow to pay for something that can benefit youlike a student loan or a car that gets you to workyou can get in over your head. Thats why its important to be honest with yourself about how much you can afford to borrow. Keep in mind that the amount you can afford to borrow is defined by the amount you can realistically afford to repaynot what the lender will allow you to borrow. 9/17 Consumer Rights and Protections Things can go wrong even when you use your credit card responsibly. It can be lost or stolen, or you can buy something thats a total lemon. Fortunately, federal laws limit your liability. Thats the amount youre responsible to pay for charges you didnt make. For example, if you lose your card or if its stolen, and someone uses it without your permission, the most youll owe is $50. But you have to report the card missing within two days of realizing its gone by calling the customer service number on your statement. If the charges show up on your bill, you have 60 days to report the problem. If you miss the deadlines, you could owe more.

Cash Course 5 If something you buy with your credit card is defective, you have a legal right to refuse to pay for it. Check with your card issuer about what to do if you get stuck this way. There are also laws to protect you against unfair fees and lending practices. As a result:

Grace periods are longer Penalty fees are capped Introductory interest rates must last at least six months

To learn more about these recent changes, visit http://www.federalreserve.gov/consumerinfo/wyntk_creditcardrules.htm 10/17 Avoidable Credit Card Fees and Charges In addition to interest, there are avoidable credit card fees and charges that can add to your total cost of borrowing. Here are some to look out forand avoid. What It's Called What It Means

Annual fee

The cost you pay each year to use a card. Annual fees are usually charged on cards that offer special perks and extras, like cash back or miles. The cost of the fees often outweighs the benefits.

Late payment fee

The amount you pay if you dont pay the minimum balance on time.

Over limit fee The amount you pay if you charge more than your credit limit. Cash advance feeThe amount you pay for using your card to borrow cash using an ATM. Interest is charged from the moment you get the cashand its charged at a higher APR.

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11/17 Cost of a Loan

What a loan costs depends on how much you borrow, the time it takes you to repay, and the APR. For example, say you borrow $15,000 at 6% interest to buy a car. The longer you take to repay the loan, the more interest you will pay. Term Number of payments Amount of each payment* Amount repaid Total interest paid 3 Years 36 $456 $16,428 $1,428 4 Years 48 $352 $16,909 $1,909 5 Years 60 $290 $17,400 $2,400

*Payments are rounded to the nearest dollar.

It works the same way with the APR. The higher your interest rate, the more your total cost of borrowing will be. Interest rate (APR) Number of payments Amount of each payment* Amount repaid Total interest paid 6% APR 36 $456 $16,428 $1,428 8% APR 36 $470 $16,922 $1,922 10% APR 36 $484 $17,424 $2,424

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*Payments are rounded to the nearest dollar.

12/17 Credit with a Card A credit card can be a handy way to borrow if you choose the right card and are smart about using it. Using credit this way doesnt have to cost you a cent provided the card has a grace period and you always pay the full amount you owe on time. A grace period is the minimum of 21 days you have to pay your bill after the lender sends it to you. If you pay the whole thing in full by the day that its due, theres no finance charge. But if theres no grace period or if you pay only part of what you owe, using this type of credit will cost you moneypotentially, big money. To figure your finance charge for the month, the lender multiplies 1/12th of your APR times your unpaid balance. Thats the interest you owe. 13/17 Why Use Credit? Credit makes it convenient to buy practically anything you need or want without having the money in your pocket or in the bank. You can:

Pay for major expenses like college tuition or a new car Finance unplanned expenses like repairing your car or replacing a damaged laptop Buy the things you need now, like books for your courses or a winter coat Make purchases online or over the phone

14/17 What Credit Costs For revolving and installment credit, the cost of borrowing depends on the same factors:

How much youve borrowed, called the balance or principal The annual percentage rate (APR) the lender uses to figure the finance charge How long it takes you to repay, sometimes called the term

Cash Course 8 With a credit card, the finance charge includes only interest. But with a loan, it also includes other costs, like application fees and checks on your creditworthiness.

14/17 What Credit Costs For revolving and installment credit, the cost of borrowing depends on the same factors:

How much youve borrowed, called the balance or principal The annual percentage rate (APR) the lender uses to figure the finance charge How long it takes you to repay, sometimes called the term

With a credit card, the finance charge includes only interest. But with a loan, it also includes other costs, like application fees and checks on your creditworthiness. 15/17 Whats Credit? Credit is the ability to borrow money. Lenders, also called creditors, are willing to lend because they expect to get their money back and make a profit. Different types of lenders - such as banks, investment companies, credit unions, and even the federal government - provide different types of credit. You're the borrower. You qualify for credit if lenders consider you creditworthy. That means lending to you isnt too risky. When you borrow, you promise to repay the amount of money you use within a certain period of time, plus a fee for using the money. If you don't meet your legal obligation to repay what you owe on time, you'll pay penalties and face other problems. 16/17 Loans There are times when a credit card isnt the best kind of credit to use. For example, if you want to buy something that costs more than you have available on your credit line or that you cant possibly pay off in a year or two, you can apply for a loan.

Cash Course 9 For example, you can use a loan to:

Buy a car Pay your college tuition Buy a home Start your own business

Some loans, such as car and home loans, are secured, which means if you dont repay, the lender can repossess what you bought. Unsecured loans, including student loans, are backed only by your promise to pay what you owe. But repayment isnt an option. Its required. 17/17 Types of Credit Most people use two primary types of credit: credit cards and loans.

Credit cards are a type of revolving credit. That means you can use your credit card over and over, as long as you spend less than the credit limit your lender sets and you pay your bills regularly. As you repay what youve borrowed, you can borrow that amount again. Loans are installment credit. You borrow a fixed amount and make regular repayments, usually once a month, until youve paid off the loan. If you need to borrow more, you try to arrange another loan.