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Credit in America

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  1. Chapter 16 Credit in America

  2. The Need for Credit • Credit is the use of someone else’s money, borrowed now with the agreement to pay it back later. Chapter 16

  3. The Use of Credit • A debtor is a person who borrows money from others. • This money, called debt, must be repaid. • A creditor is a person or business that loans money to others. • Creditors charge money for this service in the form of interest and fees. • A debtor must be qualified to receive credit. Chapter 16

  4. Qualifying for Credit • To qualify for credit, you must have the ability to repay the loan. • Qualification is based on three things: • Income • Financial position • Collateral Chapter 16

  5. Income • Sources of income include: • Job • Interest • Dividends • Alimony • Royalties • Income represents cash inflow. • When your earnings exceed your expenses, you have the capacity to take on debt. Chapter 16

  6. Financial Position • Capital is the value of property you possess (such as bank accounts, investments, real estate, and other assets) after deducting your debts. • Having capital tells the creditor that you have accumulated assets, which indicates responsibility. • Your debt represents cash outflow and will be compared to your cash inflow (income). Chapter 16

  7. Collateral • To borrow large amounts of money, creditors often want more than just your promise to repay; they want collateral. • Collateral is property pledged to assure repayment of a loan. • If you do not make your loan payments, the creditor can seize the pledged property. Chapter 16

  8. Making Payments • Once you have completed a credit purchase, you owe money to the creditor. • The principal (amount borrowed) plus interest for the time you have the loan is called the balance due. • The finance charge is the total dollar amount of all interest and fees you pay for the use of credit. Chapter 16

  9. Advantages Purchasing power Emergency funds Convenience Deferred billing Proof of purchase Safety Disadvantages Higher costs Finance charges Tie up income Overspending Advantages andDisadvantages of Credit Chapter 16

  10. Lesson 16.2 Types of Credit • Open-end credit • Closed-end credit • Service credit Chapter 16

  11. Open-End Credit • Open-end credit is where a borrower can use credit up to a stated limit. • Charge cards • Revolving accounts Chapter 16

  12. Credit Card Agreements • A credit card is a form of borrowing and usually involves interest and other charges. • The terms of the credit card agreement affect the overall cost of the credit you will be using. Chapter 16

  13. (continued) Credit Card Agreements • Credit card agreement terms to consider: • Annual percentage rate (APR) • The annual percentage rate (APR) is the cost of credit expressed as a yearly percentage. • Grace period • The grace period is a timeframe within which you may pay your current balance in full and incur no interest charges. • Fees • Annual fees, transaction fees, and penalty fees • Method of calculating the finance charge Chapter 16

  14. Closed-End Credit • Closed-end credit is a loan for a specific amount that must be repaid in full, including all finance charges, by a stated due date. • Also called installment credit • Does not allow continuous borrowing or varying payment amounts • Often used to pay for very expensive items, such as cars, furniture, or major appliances Chapter 16

  15. Service Credit • Service credit involves providing a service for which you will pay later. • For example, your utility services are provided for a month in advance; then you are billed. • Many businesses extend service credit. • Terms are set by individual businesses. Chapter 16

  16. Sources of Credit • Retail stores • Credit card companies • Banks and credit unions • Finance companies • Pawnbrokers • Private lenders • Other sources of credit Chapter 16

  17. Retail Stores • Examples of retail stores include department stores, discount stores, and specialty stores. • Many retail stores offer their own credit cards. • These cards are accepted only at the issuing store. • Store credit customers often receive discounts, advance notice of sales, and other privilegesnot offered to cash customers or to customers using bank credit cards. • Most retail stores also accept credit cards issued by major credit card companies. Chapter 16

  18. Credit Card Companies • Credit card issuers • Financial institutions • Other organizations Chapter 16

  19. Banks and Credit Unions • Credit cards • Closed-end loans Chapter 16

  20. Finance Companies • A finance company is an organization that makes high-risk consumer loans. • There are two types of finance companies: • Consumer finance companies • Sales finance companies • Loan sharks are unlicensed lenders who charge illegally high interest rates. • A usury law is a state law that sets a maximum interest rate that may be charged for consumer loans. Chapter 16

  21. Pawnbrokers • A pawnbroker (or pawnshop) is a legal business that makes high-interest loans based on the value of personal possessions pledged as collateral. • Possessions that are readily salable (such as guns, cameras, jewelry, radios, TVs, and collector’s coins) are usually acceptable collateral. Chapter 16

  22. Private Lenders • One of the most common sources of cash loans is the private lender. • Private lenders might include parents, other relatives, friends, and so on. • Private lenders may or may not charge interest or require collateral. Chapter 16

  23. Other Sources of Credit • Life insurance policies • Borrowing against a deposit • Borrowing against an asset Chapter 16

  24. Chapter17 Credit Recordsand Laws

  25. Lesson 17.1 Credit Records • Before granting you credit, a creditor will check into your past credit performance: • Did you pay your bills on time? • How much total credit did you receive? • How much do you owe now and how large are your payments? Chapter 17

  26. Credit History • Your credit history is the complete record of your borrowing and repayment performance. • This record will provide answers to these questions and thus help the creditor determine your ability to pay new debts. Chapter 17

  27. Your Credit File • Every person who uses credit has a credit history on file at a credit bureau. • A credit bureau is a business that gathers, stores, and sells credit information to other businesses. Chapter 17

  28. National Credit Bureaus • TransUnion • Experian • Equifax Chapter 17

  29. Credit Report • A credit report is a written statement of a consumer’s credit history, issued by a credit bureau to businesses. • You can order a copy of your credit report online at the credit bureau’s web site or by writing to the bureau. • When you are denied credit, you can get a free credit report if you ask within 30 days of being denied. Chapter 17

  30. Services Available Related to Your Credit Files • Credit guard services • Credit freezing services Chapter 17

  31. How Information Is Gathered • Credit bureaus gather information from businesses, called subscribers, that pay a monthly fee to the credit bureau for access to this information. • Each subscriber supplies information about its accounts with customers including: • Names • Addresses • Credit balances • On-time payment record • Credit bureaus also gather information from many other sources. Chapter 17

  32. How Information Is Used • When someone applies to a business for credit, the business (subscriber) asks the credit bureau for the applicant’s credit report. • Information in the credit report is then used as the basis for granting or denying credit. • Usually credit grantors (banks and retail businesses), employers, landlords, and insurance companies have an interest in credit reports. • Before entering into a financial agreement with someone, they want evidence that the person is financially responsible. Chapter 17

  33. Types of Information Stored • Public information becomes part of your credit record. • Examples of activities that result in public information: • Failing to pay your property taxes • Filing for bankruptcy • Filing for divorce • Applying for a marriage license • Announcing the birth of a child • Announcing a job promotion • Being involved in a lawsuit • Information you provide on a credit application becomes part of your credit record. Chapter 17

  34. Creditworthiness • Before potential creditors will grant credit to you, they must determine whether you are a good risk—that you are creditworthy. • A person who is considered creditworthy usually meets five basic qualifications, called the five Cs of credit: • Character • Capacity • Capital • Conditions • Collateral Chapter 17

  35. Character • Will you repay the debt? • Character is a responsible attitude toward honoring obligations, often judged on evidence in the person’s credit history. • Creditors often use stability as a measure of character as well. Chapter 17

  36. Capacity • Can you repay the debt? • The financial ability to repay a loan with present income is known as capacity. • Before lending you money, creditors want to make certain that your income is sufficient to cover your current expenses each month plus the payments on the new loan. Chapter 17

  37. Capital • Do you have sufficient assets to support the debt? • Capital refers to financial assets (bank accounts, investments, and property) you possess that are worth more than your debts. • When you add up all that you own (assets) and subtract all that you owe (liabilities), the difference (net worth or capital) should be sufficient to ensure payment of your debt. Chapter 17

  38. Conditions • What affects your ability to repay the debt? • There may be “external” conditions that affect your ability to repay a debt. • Therefore, creditors want to know the following: • How secure is your job? • How secure is the firm for which you work? • How is the employment situation in your geographic location and in your occupation? Chapter 17

  39. Collateral • What assets are pledged to support the debt? • Collateral is property pledged to assure repayment of a loan, such as the house, car, or furniture being purchased. • Collateral protects creditors, making them more willing to lend to you. • If you do not repay your debt as agreed, they can sell the collateral to collect on the debt. Chapter 17

  40. Getting Started with Credit • Begin with a savings account. • Open a checking account. • Open a store credit account. • Many stores will allow you to open a small account with a responsible adult as a cosigner. • A cosigner is someone who promises to pay if the borrower fails to pay. • Get a small loan. • Apply for a credit card. Chapter 17

  41. Lesson 17.2Evaluating Credit • Credit bureaus evaluate each consumer based on his or her credit history, amount of credit, and ability to take on additional debt. • There are two major classifications used to evaluate consumers: • Credit rating • Credit score Chapter 17

  42. Credit Rating • Your credit rating is a measure of creditworthiness based on an analysis of your credit and financial history. • This process rates consumers according to how reliably they pay back money borrowed or charged. • Excellent credit rating • Good credit rating • Fair credit rating • Poor credit rating Chapter 17

  43. Credit Score • Credit bureaus as well as some larger creditors have point systems on which credit ratings are based. • In a point system, the credit bureau assigns points based on factors such as amount of current debt, number of late payments, number and types of open accounts, current employment, and amount of income. • When your points are added up, they result in a credit score that tells potential creditors the likelihood that you will repay debt as agreed. • The higher your score, the greater the chance you will be a good credit risk. Chapter 17

  44. Credit Score • Your FICO score • How errors are made • Credit inquiries • Improving your FICO score Chapter 17

  45. Credit Reports • Credit files are updated continuously. • Information stays in the file for seven years. • Bankruptcy information stays in the file for ten years. • Credit reports are requested for credit applications, employment applications, and insurance reasons. Chapter 17

  46. Credit Reports • Formats vary, but credit reports contain sections similar to these: • Summary of information • Public record information • Credit information • Account detail • Requests for credit history • Personal information Chapter 17

  47. Credit Laws • Consumer Credit Protection Act • It is also known as the Truth-in-Lending Law. • It requires lenders to fully inform consumers about all costs of a credit purchase before an agreement is signed. • Fair Credit Reporting Act • It gives you the right to know what is in your file and who has seen your file. Chapter 17

  48. (continued) Credit Laws • Fair Credit Billing Act • It requires creditors to resolve billing errors within a specified period of time. • Equal Credit Opportunity Act • It was designed to prevent discrimination in the evaluation of creditworthiness. • Discrimination is treating people differently based on prejudice rather than individual merit. Chapter 17

  49. Credit Laws • Fair Debt Collection Practices Act • It was designed to eliminate abusive collection practices by debt collectors. • A debt collector is a person or company hired by a creditor to collect the overdue balance on an account. Chapter 17

  50. Credit Card Billing Methods • Adjusted balance method • Previous balance method • Average daily balance method • Two-cycle billing Chapter 18