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Consumer
Credit |
Objective: To
develop an understanding of two aspects of consumer credit, U.S.
Rule and Credit Cards, as examples of the basic percentage
formula, P = R 
B
Background:
A vast amount of
purchases both by individuals and organizations are purchased
using various methods of credit. Credit purchase means that the
purchaser enters into some type of loan agreement at the time of
the purchase. They types and terms of these loans, or credit,
agreements are many and varied; but, among these there are some
common principals and practices. One common practice, and the
emphasis in our consideration, is that under these credit
arrangements, the purchaser pays off the loan by a series of
partial payments. Theoretically, these payments can be at various
frequencies and for various amounts. In practice, the payments are
normally on a monthly basis and can be for fixed amount or a
variable amount (usually with a specified minimum).
Consumer credit has undergone various changes over the past 30
years. These changes were prompted by (1) litigation by consumer
groups in objection to unfair credit methods, and (2) the
increasing use of credit cards by consumers.
In simple interest, the loan (principal and interest) are paid at
the end of the specified period of time. That is, one
payment for both the principal and interest at the end of the
specified period.
In consumer credit considerations, partial payments
during the period of the loan are made by the purchaser to
pay off the loan. The fundamental question is: " when partial
payments are made, what portion applies to interest and what
portion applies to the amount of the loan?"
Thirty years ago, there were several methods for allocating
principal repayment and interest payment when partial payments
were made. In the intervening years, only one of these methods
remains due to litigation procedures in which these methods were
challenged as to their fairness to consumers. The one method
remaining, previously called the "actuarial method", is
called the U.S. Rule. U. S. is for United States in
recognition of the court's involvement in rendering all but
his method unfair to consumers.
In applying the U.S. Rule to partial payments, when a payment is
made, interest due is paid first; then, any excess in the payment
is used to reduce the principal. This method is fair and equitable
to both borrower and lender.
When partial payments are used to pay off a loan, often the word
balance is used as opposed to principal recognizing that the word
principal normally conveys a fixed dollar amount while balance
reflects a changing amount.
Another factor impacting consumer credit over the past years is
the significant and vast expansion in use of credit cards.
The charge for using a credit card is called a finance
charge. The finance charge includes interest charges and
all administrative fees charged by the lender.
When credit cards initially gained mass usage, the finance charge
was traditionally calculated on the unpaid balance as of the
end of the previous month. This was common practice since
computer processing capabilities at the time were far, far
inferior to modern day capabilities. Not only does this method not
recognize account activity (transactions that affect the amount
owed by the consumer, time of transaction, and the amount of the
transaction), this method has questionable fairness to the
consumer.
With modern day computer processing capabilities and instantaneous
communication ability, account activity is virtually "real
time" so that the balance owed (amount of loan) is affected
daily. Thus, the use of daily balances to calculate
an average daily balance as the basis for the
finance charge is common practice. In addition, the use of the
average daily balance (reflects account activity: type of
transaction, time of transaction, dollar amount) is fair and
equitable to both consumer and lender.
Please see example problems in text, on the sample exam, as well
as those that follow for additional clarification of these
concepts and the mathematical methods involved.
Reading Assignment: As per the
syllabus
Definitions: Contained in the
background material
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Example 1: U.S. Rule for Partial Payments. The
text uses an "accounting" format. A time line
format is demonstrated here. Also, quarterly payments are
customary here to make the problems "manageable"
in the academic environment.
$3,000 loan at 10% interest with quarterly payments of
$300, $50, and $200. What amount due to pay off the one in
one year.
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| 1st
Payment: |
I
= Prt = 3000 * .10 *
= 75 (P = R
B application) |
|
300
- 75 = 225 Applied to Balance |
|
3000
- 225 = 2775 New Balance
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| 2nd
Payment: |
I
= Prt = 2775 * .10 *
= 69.38 |
|
50
- 69.38 = -19.38 !!!
Note:
If the partial payment is not larger that the
interest due, the effect is that no payment is made
at that time. The current payment is held and then
added to the next partial payment.
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| 3rd
Payment: |
I
= Prt = 2775 * .10 *
= 138.75 (Note time is 6 months) |
|
(200
+ 50) - 138.75 = 111.25
($50 prior payment is added to
current payment) |
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2775
- 111.25 = 2663.75
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| Final
Payment: |
I
= Prt = 2663.75 * .10 *
= 66.59 |
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2663.75
+ 66.59 = 2730.34 (Note that interest is added to
the prior balance.) |
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Example 2:
Calculate the finance (FC) on the average daily
balance (ADB) at a 1.75% interest rate for the credit card
account with the "monthly" account activity as
defined by the following table.
| Date |
Days |
Transaction |
Balance |
Days *
Balance |
|
3/20 |
6 |
Beginning
Balance |
360.24 |
6
* 360.24 = 2161.44 |
|
3/26 |
4 |
Charge
24.16 |
384.40 |
4
* 384.40 = 1537.60 |
| *
3/30 |
5 |
Return
52.35 |
332.05 |
5
* 332.05 = 1660.25 |
|
4/5 |
6 |
Payment
200.00 |
132.05 |
6
* 132.05 = 792.30 |
|
4/10 |
5 |
Charge
102.40 |
234.45 |
5
* 234.45 = 1172.25 |
|
4/15 |
5 |
Cash
Advance 50.00 |
284.45 |
5
* 285.45 = 1422.25 |
|
4/20 |
 |
Closing |
Totals |
8746.09 |
ADB =
= 282.13
FC = 282.13 * .0175 =
4.94 |
(Represents the average amount of debt for the 31 day
period recognizing account activity)
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* Page 499 should be used to obtain number of days when
month changes. For example,
| Note:
1.75% may seem a strange interest
rate; but, this is stated on a monthly basis. To
obtain an interest rate on an annual basis,
multiply by 12. Thus, on an annual basis, the
interest rate is 12* .0175 = 0.21 =21% A
more commonly recognized credit card interest
rate. |
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Copyright © Jim Pack,
2000. All Rights Reserved. Last modified
11/20/07
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