Personal Financial Planning Study Set 5
Quiz 6 :
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Reasons for using credit: There are various reasons for using credit by different people. It depends upon the requirement, amount and income of people. These reasons are: • Lack of large amount of funds: If someone wants to purchase a house or a car, then the lack of such a large amount of fund may tend him towards using credit. • In the case of financial emergencies like sickness, accidents and unemployment, people use credit to meet their needs. • To retain the liquidity of cash in the bank balance people use credit. • Credit is also used for the investment purposes. • For the convenience of payments also people use credits like bill payments.
Person CM and IM, both in their mid-20s, are newly married. Person CM is a senior in college while Person IM works as a sales rep, earning a net monthly salary of $4,250. Currently, they pay for all expenses using their checking account, but are considering applying for their first bank credit card. However, they do not know how to do so. 1. The first step to obtaining a bank credit card is to fill out a credit card application. An application can usually be obtained by visiting the bank, at the businesses that accept the card, or by request from the issuing company. It is used to determine whether an applicant has the character and capacity to use the credit card appropriately. A credit card application (shown in Exhibit 6.5 in the textbook) will generally require the following information: • Personal/family information such as name, address, marital status, social security number and birthdate. • Employment information such as employer name, position, length of time of employment, and work contact information. • Financial information such as annual household income, bank accounts, residence type, and amount of monthly rent/mortgage payment. 2. After the credit card application has been completed and turned in, the bank will begin a credit investigation. The investigation is done to evaluate the applicant's credit risk and to verify the information provided on the application. The bank will want to evaluate key factors such as income level, employment history, outstanding debt, and housing information. A high income and stable credit history will obviously increase the chances of approval. In addition, the bank will almost always access the applicant's credit report , which is provided by credit bureaus. The main functions of a credit bureau are to collect and store credit information about individual borrowers. They then sell this information to banks and other financial institutions that use it to evaluate credit worthiness. 3. Banks will normally use a form of credit scoring in order to decide whether or not to provide credit to applicants. This method of evaluation assigns values to various factors obtained from the credit card application and credit investigation, such as: • Annual income • Whether a home is rented or owned • Number and types of existing credit cards • Amount of existing • Existence of a savings account • General credit references Banks will use anywhere from 10-20 different factors that are assigned a specific value based on some predetermined standard. If the score is high enough, the bank will decide to issue credit. 4. Once a credit card is obtained, it is extremely important that the borrower uses the credit card "correctly" in order to build a strong credit record. In order to do so, the credit card holder should follow this advice: • Be disciplined with credit card usage. o Reduce the number of credit cards used, and don't fill out every credit card application that you receive. o Lenders are wary of borrowers with too many open credit cards, even if they are not carrying a balance. Generally, it is recommended to have only two bank credit cards. • Keep credit card balances low o If your balances are higher than you'd like, stop making any new charges until the credit cards are paid off. o Make a repayment plan, such as deciding to pay off the highest-interest cards first. Make a point to pay more than the minimum balance each month. o Consider transferring your balances to a card with a zero or very low introductory interest rate. • Reduce your chances of credit card fraud o Never give account information to people or organizations who call you. Only provide financial information over the phone if you have initiated the call. o Never put your credit card number on a check. o Report lost or stolen credit cards immediately.