Shopping for consumer credit
Brenda Procter, M.S., state specialist & instructor, Personal Financial Planning, College of Human Environmental Sciences, University of Missouri Extension
Credit means buying now and paying later. Credit also means going into debt. Of course, that debt must be paid. When you are in debt, you are charged an additional amount for the product, service or money before you pay for it. Interest charges add up fast.
Types of consumer credit
Charge accounts are due in full at a specified future date, usually 15 to 30 days from the billing date. Generally, there is no finance charge if payment is made within the specified period. An example of this credit is a utility bill. This type of credit is also referred to as service credit. A deposit is usually required when you open this kind of account.
Revolving credit accounts allow consumers to charge purchases up to a certain limit. A maximum limit per customer is established, and new purchases may be made as long as the balance stays below that limit. A monthly minimum payment of only a portion of the balance, usually 5 to 10 percent, is required, but any amount above that may be paid. The finance charge is usually calculated on the unpaid balance. However, you may also be charged interest on the previous month’s interest.
Single-use credit cards are issued by department stores and oil companies. It provides the easy credit features of the revolving charge account with the convenience of the regular 30-day charge. If the bill is paid within the allowable period, usually 25 to 30 days from the date of the billing, there is no direct charge for using credit. After that period, however, a charge is made on the unpaid balance.
Travel and entertainment credit cards, like American Express and Diners Club, were originally designed for people who travel a great deal and want to charge most expenses. A membership fee is paid for this card. There is usually no additional finance charge because the balance is paid in full each month. If for some reason a balance is carried forward, a charge is made on the unpaid balance.
Bank credit cards are in wide use now. One
bank, a group of banks, or an independent credit card
company may issue these cards. They offer the
convenience and ease of credit features of the regular
30-day charge and the revolving charge account. Small
cash loans called cash advances, as well as goods and
services, may be charged to this account and repayment
must be made just as for any other purchase.
There is often a special charge for obtaining a cash
advance in addition to the interest charged for
purchases. Many cards charge an annual fee.
Debit and ATM cards are very different from
bank credit cards. The debit card is usually linked to
your checking account, and it allows you to access your
account at an automatic teller machine (ATM) or when you
make a purchase.
Don’t confuse debit cards with credit cards. Debit
cards may look like credit cards, but they act like
checks. Once the debit card is used, the amount is
deducted from your checking or savings account. The
debit card eliminates the need for cash, but it does not
Some cards, those with Visa or MasterCard, can be used to withdraw money from an ATM. If you often get cash at an ATM that is not part of your financial institution’s network, the fees can add up fast.
Installment credit. An installment sale involves a contractual agreement in which a down payment or trade-in is usually made and a predetermined amount is paid periodically until the entire debt is satisfied. The finance charge is added to the price of the merchandise and included as a portion of the subsequent payments. Rates vary widely, depending on the seller, the merchandise purchased and the debtor’s credit rating.
Cash loans may be obtained from a variety of sources with an even wider variety of finance charges. They may be repayable in regular installments or by a single payment made for the loan, plus the finance charge, at the end of the time period.
Sources of credit
Banks lend money for a variety of reasons.
Some small loans may be made on the debtor’s signature
only (unsecured), while large loans usually are secured
Most consumer bank loans are repaid on the
installment basis, much like an installment sales plan.
The annual percentage rate compares favorably with other
sources, but standards for qualifying for a loan may be
higher than with other creditors.
Many banks also cover an automatic overdraft or advance to their checking account customers. To activate such a loan, all the customer has to do is write a check for more than the amount that is in the checking account. This advance, usually called “overdraft protection,” can cost as much as $35 per transaction.
Savings and loan associations also offer a
variety of consumer lending options. In addition to the
traditional cash loans secured by the borrower’s savings
account, savings and loans offer credit cards,
overdrafts, interest-bearing checking accounts and other
types of consumer credit.
Credit unions make consumer loans from money
deposited by members. In addition to consumer loans,
some credit unions are now in the mortgage market. Loans
from credit unions are often the lowest cost loans
available to members.
Many credit unions offer share draft accounts that operate much like a checking account.
Consumer finance (small loan) companies specialize in small cash loans to all income and occupation groups. The borrower need not have as high a credit rating as is usually demanded by other institutions, and most loans are made on signature only. Because of this added risk, finance charges are usually higher than most other lending agencies. Debts are repaid in monthly installments, which includes the finance charge.
Life insurance companies. The cash surrender
value of a whole-life insurance policy has been one of
the least expensive sources of loans available. The
policyholder is allowed to borrow against a policy’s
cash value. The interest rate on such a loan is stated
in the policy.
The amount still owed on the loan is deducted from
the face value of the policy if the insured dies before
repaying the loan.
Rent-to-own businesses advertise no-obligation rentals of items used in the home. Furniture, major appliances, televisions and other electronic goods are some of the items typically offered. Although rent-to-own deals look good because of low payments, it is not uncommon for the total to be 200 to 500 percent of what the item would cost in the store.
Payday loans (also known as paycheck loans) are offered by businesses that operate across Missouri. To obtain a loan, you write a check that is post-dated for after your payday. The amount you actually receive is the loan and the extra amount is the interest and fees. The business holds your check until your payday and then deposits it. Because of interest rates, fees and annual percentage rates, this type of borrowing can become very costly.
Title loans are a way to borrow money against the value of any vehicle with a title (car, truck, motorcycle, boat, trailer, motor home). You can only get a title loan if you own the vehicle free and clear. In a title loan transaction, you keep your vehicle while the lender holds the title as security for repayment. Non-payment of the loan may result in the loss of the vehicle.
Tax refund loans can be another credit alternative at certain times of the year. An income tax refund loan is usually provided by a finance company through a tax preparation office. A tax professional prepares your return for a fee, files the return for another fee, and then can extend a loan in the amount of the return. The loan is paid back when the refund check from the IRS is received, whether the refund comes back in the amount the preparer figured or not. Interest rates on these loans can be quite high.
Pawnbrokers are an alternative source for securing a loan. They hold your property and lend you a small portion of its value. If you repay the loan and the interest on time, you get your property back. If you don’t, the pawnbroker can sell it.
Friends and relatives are sometimes a loan source; however, such loans frequently result in friction between parties. These loans, if used, should be entered into with a contract that clearly states all terms of the agreement and signed by the parties involved.
Unlicensed lenders, commonly known as loan sharks, operate outside the law. The finance charge made by these illegal lenders is frequently more than 1,000 percent per year.
National Association of Insurance Commissioners, Credit Insurance, Safety Net or No Net Gain? Consumer Alert, November 2008, downloaded January 20, 2009 from naic.org.
Last update: Tuesday, May 05, 2009