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Personal Finance Chapter 5 - baj01275_c05_106-133 17:01PM...

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Starting Point Go to www.wiley.com/college/bajtelsmit to assess your knowledge of consumer credit. Determine where you need to concentrate your effort. What You’ll Learn in This Chapter Consumer credit options Credit card types Credit card risks After Studying This Chapter, You’ll Be Able To Compare advantages and disadvantages of using consumer credit to make purchases Assess the various types of consumer credit Take steps to protect and establish good consumer credit Evaluate credit card alternatives, including terms and costs Predict the hazards of credit card use, including the risk of identity theft 5 CONSUMER CREDIT Credit Cards and Consumer Loans baj01275_c05_106-133 02/09/2007 17:01PM Page 106 EPG_Team-C 105:JWQD032:bajch05:
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5.1 WHAT IS CONSUMER CREDIT? 107 INTRODUCTION Learning how to manage consumer credit effectively by reducing reliance on high-cost borrowing is an important component of financial success. In this chapter, we first look at the types of consumer credit and then how to apply for credit. This chapter examines the advantages and disadvantages of credit and how to protect your credit and correct credit mistakes. Finally, it discusses credit cards in more detail, including their risks. 5.1 What Is Consumer Credit? Any time you receive cash, goods, or services now and arrange to pay for them later, you are buying on credit. If you use credit for personal needs other than home purchases, you’re using consumer credit. You can borrow from a friend or family member, a firm with which you do business, or a financial institution (e.g., bank, credit union, insurance company). The most common types of con- sumer credit are Credit card accounts. Automobile loans. Home equity loans. Student loans. In each case, the lender lets you have the use of the money now and expects you to repay it with interest, often over a specified time period. Before you decide to borrow funds to make a purchase, whether through a credit card or a con- sumer loan, you should be careful to evaluate the short-term and long-term effects on your monthly cash flow. The future payments, including the original purchase price and interest charges, will reduce your net monthly cash flow and thus your ability to make contributions to savings. Interest charges will increase the total cost of the prod- uct you are purchasing. Thus, in deciding whether to pay cash, take money from savings, or borrow the funds to make a purchase, you need to be sure to consider the trade-offs between the cost of borrowing and the lost earnings on savings. Many types of consumer credit—most credit cards, for example—require that you pay interest rates that are much higher than what you can earn on your savings. If you have to pay 18 percent interest on your credit card and you’re earning only 5 percent on a savings account, you’d be better off taking the money from savings than borrowing the funds for the purchase. Sometimes, though,
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