Essential Standard 5.00Objective 5.01 Understand credit management
Topics • Main types of credit • Common advantages and disadvantages of businesses using credit • Cost of credit • Main factors examined for granting credit • Credit documents • Credit regulations • Credit assistance
What is credit? An agreement to obtain money, goods, or services now in exchange for a promise to pay in the future. When buying on credit, you are delaying the payment for an item. “Buy now and Pay Later”
Who Uses Credit? 1. Consumer CreditCredit used by people for personal reasonsconsumer loans, mortgage loans, credit cards, charge cards2. Commercial CreditCredit used by businessescommercial loans, corporate bonds3. Government Creditcredit used by local, state, federalmunicipal bonds, treasury bonds, T-bills, T-notes
Terms • Promissory Note • Legal loan document • Written promise to repay with interest • Usury Laws • State law that restricts the amount of interest that can be charged. • Creditor • One who sells on credit or makes a loan • Debtor • Anyone who buys on credit or receives a loan • Obligated to pay back the loan
Closed vs. Open Ended Credit • Open-end credit • Gives a credit limit - maximum $ you can borrow • Loan balance varies for purchases/payments made • Example: credit card with $500 limit. You might spend $50 and pay $10, spend 30 and pay $25. The loan amount “revolves” as you spend and pay back. • Closed-end credit • Used for a specific purpose • Loan of a definite amount of money • Loan balance reduced with each payment • Example: car loan for $20,000 is a specific, one time amount of money • String examples
Secured vs. Unsecured • Secured loans: • Backed by collateral (help guarantee the repayment of a loan) • Backed by a cosigner who agrees to pay • Collateral-asset used as security on a loan • Can be taken by creditor if loan payments are not made to creditor • Mortgage loans- real estate • Subject to Foreclosure if not paid • Personal loans- car, motorcycle, boat • Subject to Repossession if not paid
Cosigner • Responsible for the repayment of a loan if the original party does not pay • Party who signs with applicant for a loan • Who might co-sign a loan for you?
Credit Document- The contract • Credit contracts are legal binding documents that allow debtors to use credit to obtain goods and services. Know what you are signing! • Debtors should know the content of the credit contract before signing such as: • Amount of finance charges • Repairs covered • Add-on features • Reduction of finance charge if contract paid in full prior to ending date • Receive a copy of the contract • Repossession conditions
Credit Document – Statement of Account • Comes once credit is granted and purchases are made on credit. • Mailed monthly and includes summary of transactions completed during the billing period • May also view online or access info by phone • What kind of information may be found on the statement of account? • Previous balance • Transactions: • Purchases • Returns • Payments • Finance charges • Late fees • Rebates or bonuses earned • Current Balance • Minimum payment due • Due date
Types of Credit • Charge Accounts • Credit Cards • Installment Credit • Consumer Loans • Payroll Advance Loans • Pawn Shop Loans • Life Insurance Loans • Retirement Plan Loans • Small Business Administration • Business only
Charge Accounts Allows debtors to receive goods or services from suppliers and pay for them at a later date • Regular Charge Accounts • Require that you pay for purchases in full within a certain period of time • EX: charge account with an electrician who wired your house • Revolving Charge Accounts • Allows you to borrow or charge up to a certain amount of money (credit limit) and pay back a part or the entire balance each month • EX: home equity line of credit • Budget Charge Accounts • Allows you to pay for costly items in equal payments spread out over a period of time • EX: a charge account with Progress Energy utility company
Credit Cards *Unsecured Loans Retail store, Single Purpose – aka charge cards • Balance and payments vary • Can only be used to buy goods or services at the business that issued the card • Examples: JC Penney, Sears, BP Multipurpose, Bank cards • Revolving credit accounts • Balance and payments vary • May be used at different locations • Examples: Visa, Master Card Travel and Entertainment • Similar to charge accounts • Must be paid in full each month • Example: American Express, Diner’s Club compare credit cards
Credit Card Terminology • Grace Period • Time period during which no finance charges will be added to an account. From monthly statement cutoff until payment is due! • Maturity (due) date is at least 14 days from statement date. If you pay account in full by due date, you will not usually owe interest. • Cash Advance • Borrow money on a credit card • Costs more than regular credit card purchases • *read your contract before signing application or taking a cash advance!
Seller-Provided Credit • Many stores provide revolving charge to their customers • Users may earn points, bonuses, rebates or get special unadvertised specials Examples: Kohls, Sears, Best Buy, Belk
Installment Loans Installment loan - contract issued by the seller that requires payments at specified times such as bi-weekly or monthly until loan is paid in full Used for: Student, mortgage, automobile loans Ex: Buy furniture – pay monthly to Rooms To Go Furniture Store Ex: borrowing $1000 from a bank and agreeing to make payments $105 for 10 months.
Consumer Finance Companies • Specialize in loans to people with poor credit ratings • Cost of credit is higher than other institutions •
Payroll Advance Services Short-term loan • “Borrow Until Payday” Loan • Cost is extremely high • includes flat fees, high interest rate • You get cash ahead of getting your paycheck. Secured Loan- secured by promise of paycheck
PAWNING A short term loan • Give up an asset (ring, watch) • Pawnshop gives you cash • Usually less than 50% of value • You can get property back • Time limit • Pay amount & interest charged • Pawn shop can sell your item Secured Loan
Life Insurance Plans • Cash Value Insurance –whole life • Provides both savings and death benefits • You cannot borrow against term life insurance policies…no cash value *Secured Loan-collateral is $ in cash value
Retirement Plans Can legally borrow from them but not recommended since the purpose is to have money when you retire *Secured Loan- collateral is $ in retirement plan
Other Sources of Credit for Businesses • Small Business Administration (SBA) • Offers a number of financial, technical, and management programs to help businesses • Loan funds available • Info available at local Community colleges
Review : Who Uses Credit? • Consumers • Businesses • Government • Local • State • Federal
Government Credit • Federal government - uses credit to pay for: • Public services and programs provided for its citizens • Examples-military, foreign aid, roads, courts, prisons • Loan sources include: Federal savings bonds, treasury bills, bonds, notes • State & local governments-use credit to pay for: • highways, water systems, public housing , and stadiums, airports • Loan sources : municipal bonds, school bonds
Government Credit • Municipal Bonds • State and local governments use to finance projects • Savings Bonds • Sold by federal government • T-bills, T-notes, T-bonds
Bonds Bonds – written promise to repay a loan with interest on a specific date Buyer of the bond is the creditor • Corporate Bonds • Usually used to finance buildings and equipment • Blue chip companies vs. junk bonds • Part of investment portfolio Bond is an investment for creditor
Consumer Loan Example • Marty borrowed $450 for 12 months from First Federal Bank to buy a bike at 8% APR. • Who is the creditor? • Who is the debtor? • What is the interest rate? • What does APR stand for? • How much will his monthly payment be?
Famous Quotation “Creditors have better memories than debtors.” -Benjamin Franklin Do you agree or disagree with this quote and why?
Why Use Credit? • Convenience • Shop without carrying cash • Immediate Possession • Allows possession of goods or services now • Especially BIG TICKET ITEMS • Homes, business expansion • Buy now, pay later • Emergencies • Helps in case of a serious situation
Common Advantages of Businesses Using Credit • Establishing favorable credit rating • Keeping business separate from personal expenses • Earning rewards/points • Minimizing record-keeping and receipts • Keeping track of what employees are spending • Saving Money –Buy item when it is on sale without cash • Growth of the Economy-Buying goods & services helps stimulate the economy
Common Disadvantagesof Businesses Using Credit • Theft of customer records/databases • Overbuying by employees • Overusing Credit • Credit Fees - Interest paid on balance
Results of Overuse • Bad Credit Rating • Higher interest rates in future • Inability to get loan in future • Repossession/Foreclosure • Loss of property because of failure to repay loan • Bankruptcy • Can’t qualify for credit for seven years
Cost of Credit • Using someone else’s money has a cost. • Interest is the cost of using someone else’s money. • Factors for computing interest include: • Principal, P = Amount of the loan • Interest Rate, R = Percent of interest charged or earned. • Time, T = Length of time for which interest will be charged, usually expressed in years or parts of a year. • Formula for computing simple interest: I = P x R x T
Cost of Credit – Time Calculation • How is time determined for a loan for each of the following lengths? • Years – multiply by # of years • Months – ex 2/12 • Days 24/365 • How is the maturity date calculated? • Months-the maturity date is the same day of the month that the loan was made. • Days-Determine the day the loan was made, and then count the exact number of days of maturity. • How is a decreasing loan payment calculated? • Interest is calculated on the amount of the loan that is unpaid. • What is disclosed in APR? • % cost of credit, service fees
Process of Obtaining Credit • Credit Application • Documentation • Processing • Underwriting • Closing • Funding
Credit Application • Form used to provide information needed by a lender to make a decision about granting credit (approving a loan). • Fill out completely, accurately, & honestly • Requires signature of applicant, which indicates provided information is true Credit decision must be based on your ability to repay a loan, Other discrimination is illegal.
Application Information • Provide the following information: • Salary, Employer, • Outstanding Credit (Debt), Credit References • Assets, Checking and Savings Accounts, Stock Portfolio, etc. • Disclose every piece of information about your financial background to obtain loan • Be honest!
Documentation • Creditor will collect and verify necessary documentation for the extension of credit. • Examples: Bank statements, credit card statements, past W-2’s, etc. • Verify using phone, mail, documents
Main Factors Examined for Granting Credit • Credit data make up the information that applicants provide on credit applications. • Documentation of credit data may be verified by: • Employers (former and current) • Type of data: Employment dates and salary • Financial institutions • Type of data: Saving or checking accounts • Personal references • Type of data: Manner how personal business is conducted
Main Factors Examined for Granting Credit • Information provided by Credit Bureaus • Credit bureaus sell lenders credit information about credit users such as debt records, payment history, and if any action has been taken to collect overdue bills
Processing • Lender builds loan file • Evaluates credit worthiness • Creditors examine factors about potential debtors when deciding whether to grant them credit • The C’s of Credit Worthiness
Processing – The C’s of Credit Worthiness • Capacity • How much debt can comfortably be handled? • Considers current income and debt levels • Character • Honesty to pay debt when due • Earned by paying bills on time and being a trustworthy, reliable, stable person financially • References – people you have borrowed from in the past who indicate you paid on time • Capital (money) • How much you have beyond what you owe • Current available assets that could be used to repay debt if income was unavailable
Underwriting • Review loan info for soundness, creditworthiness • Make decision about granting credit • Consumer Reporting Agencies • Company that compiles and keeps records on consumer payment habits. • Used to evaluate creditworthiness • Examples: Equifax, Experian, and TransUnion
Closing • Representative explains terms of credit-usually loan officer • Attorney may be present at closing, especially real property • Debtor/creditor sign contract • Contract is binding on signing parties
Closing • KWYS – know what you’re signing • READ and UNDERSTAND BEFORE signing any contract • Contract – legally binding agreement between two parties
Funding • Creditor issues money/funds to the debtor for the item purchased • Example: mortgage company pays seller in full, debtor then pays mortgage company monthly installments to repay the loan
Credit DocumentsUnderstand loan features and credit activities to minimize potential credit problems.Two commonly used credit documents that assist with minimizing credit problems are:*Credit Contract*Statement of Account Read and understand all documents before you sign.
Credit Contract • Legally binding documents that allow debtors to use credit to obtain goods and services • Debtors should know the content of the credit contract before signing such as: • Amount of finance charges • Repairs covered • Add-on features • Reduction of finance charge if contract paid in full prior to ending date • Receive the copy of the contract • Repossession conditions
Statement of Account • Printed monthly once credit is granted and purchases are made on credit (also online) • Includes summary of transactions completed during the billing period • What kind of information may be found on the statement of account? • Balance due • Amounts charged during the billing period • Amounts paid during the billing period • Current balance • Minimum amount of next payment • Late fees, interest charges
Review Steps to Get Loan Description of Activity • A. loan officer builds a loan file • B. borrower completes form info for lender to review • C. creditor issues money to the debtor • D. debtor/creditor sign contract • E. creditor collects and verifies information • F. loan officer reviews loan for creditworthiness Steps in Order: 1.___credit application 2.___documentation 3.___processing 4.___underwriting 5.___closing 6.___funding