Managing Debt MODULE - 4

Learning Objectives

Define Explain Differentiate Differentiate Outline

• Define debt. • Explain the • Differentiate • Differentiate • Outline

psychology between between strategies
of debt. good debt different for
and bad types of managing
debt. consumer and
loans. eliminating
debt.
 Something, usually money, that is
owed to a person, lender, etc.

6.1 Define Debt

Owing money to somebody else for
products or services provided to
you, that you did not pay for yet is
debt—even if it is interest-free!
 Debt

• What you acquire once you

actually borrow
Debt Versus • A loan or obligation
Credit
Credit

• The amount of money

available to you to borrow
Debt and the DEBT ALLOWS THE
ECONOMY TO
APPEAR VERY LARGE

Economy
BUT ALSO CREATES
MORE RISK IN THE
ECONOMY.
 Allows you to buy things now instead of waiting

Interest = Fee to borrow money

Whether you pay now or pay later, it is still debt.

Characteristics
of Debt • No payments for 6 months
• 12-months same as cash
• 0% interest

Debt consolidation loans are still debt.

Paying the money, you owe, plus any interest, is the only
way to pay off your debt.
 Reasons people get into debt
◦ Keeping up with the Joneses
6.2 Explain the ◦ Using money to punish
Psychology of ◦ Emotional difficulties
Debt ◦ Unrealistic expectations
◦ Lack of communication
◦ Increasing finance charges
Avoiding Debt (1 of 2)
Focus on what you do have, not what you don’t have.
As a couple, remember you are on the same team and
help each other achieve your common goals.
Avoid shopping as a way to resolve your needs.
◦ Focus on goals to avoid unnecessary spending.
Think about your goals from a step-by-step approach.
◦ List what you expect to have and prioritize that list.
 Share your financial goals with your
Share partner and have regular discussions
about those goals.

Avoiding Debt (2
of 2)
Do not fall for the monthly payment trap.
Do not • Small payments add up; think about the overall
fall cost.
 Characteristics of good debt
◦ The asset or thing you purchased with the debt
should
6.3 Differentiate 1. appreciate in value,
between Good 2. last longer than the term of the loan, and
3. provide positive financial leverage.
Debt and Bad ◦ A situation where the value gained from
Debt (1 of 2) acquiring an asset using debt is greater than
the cost of borrowing
◦ All three characteristics must be present for
debt to be considered good debt.
 Characteristics of bad debt
◦ It is bad debt if the asset or item financed with
debt
6.3 Differentiate 1. depreciates in value,
between Good 2. does not last as longer as the term of the
Debt and Bad debt, and
Debt (2 of 2) 3. generates negative financial leverage.
◦ Although good debt requires all three
characteristics to be present, bad debt only has
to have one of the three characteristics.
Interest Rates

Annual Percentage Rate (APR) Exhibit 6.1: $200,000 30-year Mortgage Fees and A
PRs Compared
◦ It is the interest rate stated on an
annual basis, which may include
fees, such as loan origination
Mortgage A B C
fees.
◦ If fees are involved, then the APR Interest rate 5.00% 5.25% 5.50%
is higher than the interest rate. Fees $8,500 $2,500 $3,000
◦ Consumers can compare Monthly Payment $1,074 $1,104 $1,136
mortgages that have different
interest rates and different fees. APR 5.37% 5.36% 5.64%
Types of Debt
❑Mortgages
❑Car loans
❑Student loans
❑Personal loans
Lender Loan products Significant features 6.4 Differentiate
Commercial
banks
Automobile loans They accept deposits and issue
loans.
between
Commercial Credit cards National banks must be member of
Different Types
banks the Federal Reserve System.
of Consumer
Commercial
banks
Home improvement
loans
blank
Loans (1 of 4)
Commercial Mortgages State-chartered banks have state EXHIBIT 6.2: LENDERS AND LOAN
banks regulating agencies. OPTIONS—COMMERCIAL BANKS

Commercial Personal loans Residential mortgages are a

banks relatively small part of their
portfolio.

Commercial Second mortgages blank

banks
Lender Loan products Significant features

Credit unions Automobile loans They are member-owned, not-for-profit cooperatives.

Credit unions Credit cards blank

Credit unions Home improvement loans Generally, they only lend money to members.

Credit unions Personal loans National credit unions are regulated by the National Credit Union
Administration.

Credit unions Second mortgages State-chartered credit unions are regulated at the state level.

Credit unions blank Residential mortgages are a relatively small part of their portfolio.

6.4 Differentiate between Different Types of Consumer Loans (2 of 4)

EXHIBIT 6.2: LENDERS AND LOAN OPTIONS —CREDIT UNIONS
LENDER LOAN PRODUCTS SIGNIFICANT FEATURES

Consumer finance Automobile loans They do not accept deposits; they only loan money.
companies

Consumer finance Medical loans blank

companies

Consumer finance Personal loans They are regulated by the state in which they operate.
companies

Consumer finance blank They do not have to abide by the same rules as credit card issuers.
companies

6.4 Differentiate between Different Types of Consumer Loans (3 of 4)

E X H I B I T 6 . 2 : L E N D E R S A N D L O A N O P T I O N S — C O N S U M E R F I N A N C E C O M PA N I E S
Lender Loan products Significant features

Savings and loan companies Mortgages They are regulated by the Office of Thrift Supervision.
(thrifts)

Savings and loan companies Personal loans blank

(thrifts)

Savings and loan companies blank They are primarily focused on mortgages.
(thrifts)

Savings and loan companies blank They must have 65% of their assets invested in residential
(thrifts) mortgages and other consumer-related assets in some instances.

6.4 Differentiate between Different Types of Consumer Loans (4 of 4)

E X H I B I T 6 . 2 : L E N D E R S A N D L O A N O P T I O N S — S AV I N G S A N D L O A N C O M PA N I E S ( T H R I F T S )
What Are Consumer
Loans? (1 of 2)
Consumer loans
◦ Any loan to a consumer, including mortgages, car
loans, and credit cards
◦ However, most people think of personal loans when
they hear consumer loans:
◦ Credit cards
◦ Personal loans
◦ Consumer lines of credit
◦ Retail loans
◦ Payday and car title loans
 Consumer loans, by this definition:
What Are ◦ Some of the most expensive
Consumer ◦ Least borrower-friendly
Loans? (2 of 2) ◦ More are coming from a greater number
of questionable lenders
Credit Cards (1 of 10)
The key to credit cards is to understand the
following:
◦ The consumer protections laws governing credit
cards
◦ How credit cards work
◦ What purpose they should serve
◦ When you should and should not use them
 The 2009 Credit Card Accountability,
Responsibility, and Disclosure Act
◦ Credit card companies can no longer solicit on
college campuses by offering free items to get
students to sign up
Credit Cards (2 ◦ Elimination of questionable practices, such as
of 10) universal default and two-cycle billing
◦ Requires bills to be sent at least 21 days before
payment is due
◦ Requires payments to be credited up to 5 p.m.
on the due date
◦ Adds multiple restrictions on fees and rates
 Getting a credit card
◦ Shop around for a credit card that best
meets your needs.
Credit Cards (3 ◦ Look for balance transfers, reward points,
of 10) low interest rates, etc.
◦ Make sure to read the offer (“fine print”)
to determine if there are restrictions or
fees you do not like.
 Schumer box
◦ Table of information on credit card
applications that summarizes important
Credit Cards (4 information:
of 10) ◦ Annual fee
◦ Interest rate
◦ Grace period
◦ Other fees
 Common and most confusing credit card terms (1 of 3)
◦ Annual fee
◦ Fee a credit card company charges the cardholder simply for the privilege of
having the card
◦ APR
◦ Annual Percentage Rate
◦ Balance Transfer
◦ Moving the unpaid balance of one credit card to another credit card

Credit Cards (5 of 10)

 Common and most confusing credit card terms (2 of 3)
◦ Billing cycle
◦ The period between credit card billing statements
◦ Cash advance
◦ Cash loan from a credit card
◦ Credit line
◦ The maximum amount that can be borrowed on any single credit card
◦ Finance charge
◦ Interest charged on the balance on a credit card within the current cycle

Credit Cards (6 of 10)

 Common and most confusing credit card terms (3 of 3)
◦ Grace period
◦ Time allowed to pay a credit card balance without incurring any finance or interest
charges
◦ Introductory rate
◦ A special lower interest rate used to attract new customers
◦ Minimum payment
◦ The lowest amount of money that can be paid on a credit card balance each month
to prevent the credit card account from going into default

Credit Cards (7 of 10)

Credit
Cards (8
of 10)
YOUR CR E DI T CAR D
ACCOU N T STATEMENT ( 1
OF 2 )
Credit
Cards (9
of 10)
YOUR CR E DI T CAR D
ACCOU N T STATEMENT ( 2
OF 2 )
 Advantages
◦ Convenient
◦ Fraud and refund protection
Disadvantages
◦ Hidden costs and high interest rates
◦ Easy to overspend
◦ Complex rules

Credit Cards (10 of 10)

 Best practices for credit card usage
◦ Negotiate better terms
◦ Call and ask for late fee waiver
◦ Make your payments on time

Credit Card Usage

Personal loan Consumer line of credit Retail loan
Loans based only on the promise to An arrangement between a bank A loan attached to a specific item
repay and do not require any and a customer that allows the purchased, offered by either a retail
collateral customer to borrow up to a certain store or a third-party finance
amount, that they can access at any company; you borrow a fixed
time, if they choose amount that you repay over a
specified period of time

Other Types of Consumer Loans (1 of 2)

 A small short-term loan
Payday loan that is unsecured and is
usually due upon the
borrower’s next payday

Other Types of
Consumer Loans
(2 of 2) A short-term loan where
borrowers use their car
title as collateral. If they
Car title loan do not repay, the lender
can take possession of
the car and sell it to
meet the debt obligation
 How to eliminate debt
◦ List all of your debts.
6.5 Outline
◦ Establish an emergency fund.
Strategies for
◦ Arrange debts in order.
Managing and
◦ Pay off first debt.
Eliminating Debt
◦ Use money from first debt to pay off next
debt, etc.
 Sell unused items.

Earn extra income.

Finding Money
to Pay Off Debt
Be creative and find a way to bring in some
extra money for a short period of time.

Use “found” money only to pay off debts.

 Buy past due accounts for
pennies on the dollar

Attempt to collect debt, as well as

How Debt interest, penalties, and late fees
Collection
Agencies You can negotiate and settle for
Operate original debt or less.
• Never pay penalties and late fees.

All correspondence should be via

certified mail.
• This is to document everything.
 ▪ Must call during convenient hours
▪ Discreet mail contact
▪ Can call spouse (or parents, if you are a
Basic Collection minor)
Laws ▪ Can call others to find you, but cannot tell
others about your debt
▪ Not allowed to contact you after you give
written notification for them to stop
 Two types of personal bankruptcies
◦ Chapter 7 Bankruptcy
◦ Chapter 13 Bankruptcy
In either case, you must provide the courts with the
following information:
Bankruptcy ◦ List of all creditors and amount and nature of their
claim
◦ Source, amount, and frequency of debtor’s income
◦ List of all debtor’s property
◦ Detailed list of debtor’s monthly living expenses, such
as food, clothing, shelter, taxes, medicine
 ❑ The courts may discharge all or most of your debts after
your liquid assets are turned over to the courts.
❑ Courts can only seize or require nonexempt assets.
❑ Exempt assets include your house, 401(k), and possibly
your vehicle.
Chapter 7 ❑ After all is settled, you may no longer owe anything, and
Bankruptcy your creditors can no longer attempt to collect money.
❑ To qualify for Chapter 7 bankruptcy,
◦ Your income must be below the median income in
your state.
◦ You must receive credit counseling from an
approved agency.
 You repay all or part of your debt through a three-
or five-year repayment program worked out by the
courts.

You pay the court; the court pays the creditors.

Chapter 13
Bankruptcy
Once you successfully complete the program, any
remaining debt is discharged.

One advantage is that you may save your home

from foreclosure.
Chapter Review

In this module, you learned

about the following:
◦ Debt versus credit
◦ Reasons why people get
into debt and how to
avoid it
◦ Good debt versus bad
debt
◦ Different types of
consumer loans
◦ Strategies for managing
and eliminating debt Financial Success Pyramid
Fin