CHAPTER:7

CHOOSING A SOURCE
OF CREDIT: THE COSTS
OF CREDIT
ALTERNATIVES

SOURCES OF CONSUMER
CREDIT CREDIT COSTS MONEY

Always weigh the benefits of buying an item on

credit now versus waiting until you have saved
enough money.

Financial and other institutes provides all kinds of

credits.

Evaluate all the credit options available in the

market so that you can reduce the charges.

Before deciding whether to borrow or notDo I need a loan?

Can I afford a loan?
Can I qualify for a loan?
Avoid credit in two situationYou not need or want a product that require
financing.
You can afford to pay cash.

Kind of loan availableInexpensive loans:

Parents and relatives are source of least

expensive loans. They may only charge the

interest they would have earned had they not
made the loan- deposit account interest.
Money borrowed on financial assets held by

the lending institutions. Eg. Cash value of life

insurance policy, FD OD.

Medium priced loans

All commercial banks and credit unions provide

these loans on percentage varies from 8 to 12%.

Eg. Home loans, auto loans.
Credit unions are good source for availing credits
as its terms repayments are easy.
Expensive loans
Convenient to obtain
Available from finance companies, retailers and
banks.
Interest rates are high.
Consider APR(Annual Percentage Return)

Sources of consumer credit

1) Commercial banks:
ProvidesSingle Payment loans
Personal installment loans
Credit card loans
Mortgage loans
PoliciesCustomers having good credit
Require collateral and security
Prefer to deal in large amt loans

Determine the repayment schedule

As per loan vary credit rates
Take some days for processing application.

2) Consumer finance companies

ProvidesPersonal finance loans
Mortgage loans
PoliciesLend without credit history
Vary interest as size of loans

Variety of payment schedules

Process application quickly

3) Credit unions
ProvidesPersonal installment loans
Mortgage loans
PoliciesLend to members only
Make secured and unsecured loans
Require collateral and cosigner
Large loans through Committee members
approval
Variety of payment schedules.

4) Life insurance companies

ProvidesSingle payment or partial payment
PoliciesLend on cash value of policy
Deduct the amount owed from the value of
benefits

COST OF CREDIT
Whenever a person think of borrowing consider
whether he afford it and how much it will cost.
Two things Finance charges
Annual percentage rate
If the borrower knows both things he can
compare the credit that includes interest costs,
service charges.

TACKLING THE TRADE OFFS

When you choose finance trade offs between
the features you prefer and cost of your plan.
Terms versus interest rate
People who want to have smaller monthly
payments choose longer term finances so
greater amt of interest payment.
Lender risk versus interest rate

If you want to minimize borrowing cost, you

need to accept conditions that reduce lenders
risk.

Variable Interest Rate: based on the fluctuating

rate in the banking system.
Secured loan: pledge property or other asset as
collateral
Up front cash: If you have stake in repaying a loan
then lender gives easy terms for remaining amt.
Shorter term: shorter the period of time for which
you borrow, the smaller the chance of default.

CALCULATING COST OF CREDIT

Simple interestInterest computed on principal only, it is the
cost of borrowing money.
Simple interest on the declining balanceWhen more than one payment is made on
simple Interest loan.
Add on methodInterest calculated on full amount of the
original principal and added to principal amt
and divide that with no of installments.

Cost of open end credit:

This includes the credit cards, departmental
store cards, OD accounts. Till you dont repay
the previous balance you cant enjoy further
credit.
Credit companies use adjusted balance
method or average daily balance method for
finance charge calculation.
Credit card companies also priorly inform
what is the grace period available.

Cost of credit and expected inflation

Each percentage increase in inflation means a
decrease of that percentage in the quantity of
goods and services that a person purchase.
So lenders require protection against the

inflation rates. So interest charges

consideration of inflation part.

need

Cost of credit and tax consideration

Don't get deduction on consumer loans but on
home loans deductions are available.

Avoid the minimum monthly payment trap

The monthly minimum payment is the
smallest amount you can pay still be a card
holder in good standing. This is also called
rollover facility but end of the year the
interest charges are very high.

MANAGING YOUR DEBTS

A sudden illness or loss of your job may

make it impossible for you to pay your bills on
time.

If a person cant make your payments on

time then contact creditor and try out some
settlement.

Auto loan repayment if person fails,

repossess and sell car, still owe the difference
between the selling price unpaid debt plus
other charges.

DEBT COLLECTION
PRACTICES

Banks have been advised by the Reserve Bank of

India to use the forum of Lok Adalat for the recovery
of personal loans, credit card loans or housing loan.
Some banks have hit headlines recently for
harassing customers for nonpayment of loan
installments. The draft guidelines issued by the RBI
say that .Banks, as principals, are responsible for
the actions of their agents. Hence, they should
ensure that their agents engaged for recovery of
their dues should strictly adhere to the guidelines
and instructions, including the BCSBI (Banking
Codes and Standards Board of India)Code.

Frequent reasons of indebtednessEmotional problems

Use of money to punish
Expectation of instant comfort
Overspending for children
Lack of communication
Finance charges

Warning Signs of Debt Problems:

Paying only the minimum balance each month.
Increasing the total balance due each month.
Missing or alternating payments or paying late.
Intentionally using overdraft protection or

taking frequent cash advances.

Using savings to pay routine bills such as food.
Getting second or third payment notices.
Not talking to your partner about money or
talking only about money.
Depending on overtime to meet routine
expenses.

Using up your savings.

Borrowing money to pay old debts.
Not knowing how much you owe.
Going over your credit limit on credit cards.
Having little or no savings for the unexpected.
Being denied credit due to a credit report.
Getting a credit card revoked by the issuer.
Putting off medical or dental visits because you

cant afford them now.

CONSUMER CREDIT
COUNSELING
SERVICE

Credit counseling in India is not such a big

business, though it is increasingly gaining a
foot-hold in the common mans
consciousness.
Sudden loss of jobs, stop on increments, overspending on credit cards multiple loans- a few
or any of these combinations can bring you to
a dead-end called the debt trap.

When you approach a consumer credit

counselor, they will try and convince the

lender to decrease the rate of interest on the
loan taken. That doesnt help you decrease
the loan.
Based on a credit counseling agencys
relationship with a particular bank, the
negotiation between the debtor and the
creditors could be mediated to get reasonably
favourable outcomes.

The credit counselor also ensures that you get

ample time in hand to stabilise your finances

and also to pay off your debt in small
installments.
They can help create awareness about the
costs of misusing credit. This helps improve
the customers financial management and
develop sound spending plans.
These agencies help the distressed people
gain access to the structured financial system,
including banking.

What do you need to check?

How much does the credit counseling agency
charge for its services
Does the agency have due credentials
What are the services that the company can
offer
Have you read the testimonials and reviews of
agencies previous or current clients as well as
checked their official website

DECLARING PERSONAL
BANKRUPTCY

A debtor is required to draw up a petition listing

all assets and liabilities to district court.
The Provincial Insolvency Act, 1920
Subject to the provisions of this Act, the Court
shall have full power to decide all questions
whether of title or priority, or of any nature
whatsoever, and whether involving matters of
law or of fact, Court may decide for the purpose
of doing complete justice or making a complete
distribution of property in any such case.

As per the provisions of this Act and any other

law for the time being in force, every such

decision shall be final and binding for all
debtors as well as creditors.