Credit Management5.01 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

CREDIT…• What is Credit?• What are the different types of Consumer

Credit?• What are some Advantages/Disadvantages to

using Credit?• How do you establish credit?• What are Loan Sources• How do you ‘Shop’ for Credit?• What is Good Credit?• What is a Credit Report• What are some signs of a debt problem?• What is Bankruptcy?

Main Types of Credit

Main Types of Credit• Consumer Credit• A debt that someone incurs for the purpose of

purchasing a good or service. This includes purchases made on credit cards, lines of credit and some loans.

• Consumer Debt

• Commercial Credit• Pre-approved amount of money issued by a bank to

a company that can be accessed by the borrowing company at any time to help meet various financial obligations.

• Commercial credit is commonly used to fund common day-to-day operations and is often paid back once funds become available.

• May be called “Commercial Line of Credit”

Main Types of Credit•Credit: An agreement to obtain money, goods or services now in exchange for a promise to pay in the future•Main Types of Credit• Charge Accounts• Credit Cards• Installment Credit• Consumer Loans

Charge Accounts• A Charge Account represents a contract between creditors and debtors. Charge accounts allow debtors (customers) to receive goods or services from suppliers (creditor) and pay for them at a later date.• Examples• Regular Accounts• Budget Accounts• Revolving Accounts

Charge Accounts•Regular Accounts• Requires the buyer to make a full payment

within a stated period• Used for everyday needs and small

purchases • Example: charge account with an

electrician who re-wired a house

•Budget Accounts• Requires that a customer make payments

of a fixed amount over several months• Example: A charge account with Progress

Energy utility company

Charge Accounts•Revolving Accounts• Most popular form of sales credit• Charge purchases at any time, but

only part of the debt must be paid each month• A credit limit is set for the maximum

amount to be spent• Payments are required once a month,

but it doesn’t have to be the FULL payment• A finance charge is added if the total

bill is not paid (total dollar amount spent plus interest)

Credit Cards• Credit Cards allow debtors (customers)

to receive goods and services from suppliers (creditor) using credit cards and pay for them later.• Types of credit cards• Bank• A bank will pay the business (taking liability

for payment)• Customers are required to pay a fee for

using the credit card• Examples• MasterCard, VISA

Credit Cards• Travel/Entertainment• Pay a yearly membership fee• Expected to pay the full balance each

month• Examples: American Express, Diners Club

•Oil Company• Examples: BP Oil, Exxon

•Retail Store• Cards offered by a particular store• Examples: Belk, Kohl’s

Installment Credit• Installment Sales Credit is a contract issued by the seller that requires intermittent payments at specified times such as bi-weekly or monthly.• Customers are required to make a down payment which is a portion of the entire purchase.•Most often used for furniture and household appliances• Examples:• Rooms to Go Furniture• Aaron’s

Consumer Loans•A Consumer Loan is when a buyer agrees to make monthly payments in specific amounts over a period of time.• Example – • Student Loans, Automobile Loans,

Home Loans, etc.

• Borrowing $1,000 from a bank and agreeing to make $100 payments for a period of time.

Consumer LoansTwo Parties:• The borrower receives money up front

and agrees to pay the price back in full plus interest• The lender needs some assurance that

the borrower will pay the money back.• Promissory note• Collateral (property used as security)• Cosigner

Consumer Loans•Promissory Note• A written promise to repay based on a debtor’s

excellent credit history.

Guarantees that ‘someone’ will repay the loan:

•Collateral• An item promised to the lender if the

borrower does not pay back the loan.

•Cosigner• A person who agrees to pay back the

loan if the borrower fails to.

Advantages & Disadvantages of

using credit

Business Advantages for using Credit

•Establishing a favorable credit rating•Keeping business separate from personal expenses•Minimizing record-keeping and receipts•Keeping track of what employees are spending•Earning rewards

Business Disadvantages for Using Credit

•Experiencing theft of customer records/databases•Overbuying by employees•Overusing credit

Cost of Credit

Cost of Credit• Interest (I)• The cost of using someone else’s money• Principal (P)• Amount of the loan

• Interest Rate (R)• Percent of interest charged or earned

• Time (T)• The length of time for which the interest

will be charged• Expressed in years

Cost of Credit•Simple Interest• I=P*R*T•Time in Years•Multiply by the number of years

•Time in Months•Divide the number of months by 12

•Time in Days•Divide the number of days by 360

Cost of Credit•Maturity Date• The date on which a loan must be repaid• Months• The maturity date is the same day of the month

that the loan was made• Example: One month loan on January 15 will be due

on February 15

• Days• Determine the day the loan was made, and then

count the exact number of days of maturity• Example: A 90-day loan made on March 4 will be

due on June 2

Cost of Credit• Installment Interest: When a loan is repaid in partial paymentsCalculation:• Calculate out how much Interest you

owe

• I = P x R x T• Calculate the Total Cost of the loan

• Total Cost = P + I

Cost of CreditCalculation:• Determine the Number Of Payments

• Based on how often you are required to make payments• Generally, you make monthly

payments• # payments = # years * 12

[because there are 12 months/yr]• Calculate your Payments

• Payments = Total Cost / # of payments

Cost of Credit•Decreasing Loan Payments

• Interest is calculated on the amount that is unpaid at the end of each month

• Calculation:• Interest is calculated on the amount of the loan

that is unpaid.• Interest = Unpaid Balance * Interest rate• Remember: The amount of interest is based on

the portion of the year.• 1 month is 1/12th of a year• Interest Rate for 1 month = Annual Interest Rate /

12• Monthly Payment = Interest + Loan Repayment

Cost of Credit•Annual Percentage Rate (APR)• A disclosure required by law on all credit agreements• States the percentage cost of credit on a yearly basis• Also includes service fees

Factors & Documents

Three C’s of Credit• Character• Honesty to pay a debt when it is due.• How past debt obligations were

handled• Capacity• Refers to a person’s ability to pay a

debt when it is due• How much debt can a person handle

• Capital• Current available assets that could be

used to repay debt if income was to become unavailable

• A form on which you provide information needed by a lender to make a decision about granting credit.• Credit references businesses or individuals who are able and willing to provide information about your creditworthiness• Should be filled out completely, accurately, and honestly.• Requires signature of applicant, which indicates provided information is true.

Credit Application

Creditworthiness:

•An assessment of the likelihood that a borrower will default on their debt obligations.

•Based Upon:•History of Repayment• Credit Score

Documenting Credit Data• Credit data makes 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

Credit BureausWhat is a Credit Bureau?• A company that gathers information on credit users (credit reporting agency)

• 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.

Credit Bureaus• Credit bureaus create a credit report to show the debts an individual owes, how often the individual uses credit, and whether the individual will pay their debts on time.

• 3 Main Credit Bureaus• Equifax• TransUnion• Experian

Credit DocumentsCredit Contracts• KWYS “Know what you’re signing”

• Credit contracts are legal binding documents that allow debtors to use credit to obtain goods and services.

Credit DocumentsCredit Contracts• 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

Credit DocumentsStatement of Account “The Bill”• A record of the transactions completed during the billing period• Statement includes…• Balance that was due from last statement• Amounts charged during the month• Amounts credited to your account for

payments or for returned items• The current balance (old balance +

finance charges +purchases – payments)• The minimum payment due

Credit Regulations & Assistance

Credit Regulations•Truth-in-Lending Law• Requires lenders to reveal the cost of

credit (APR and finance charge) and terms before signing an application or contract

• Protects consumers against unauthorized use of credit cards

Credit Regulations• Equal Credit Opportunity Act• Prohibits creditors from denying a

person credit because of age, race, sex, or marital status• Allows credit applications be judged

on financial responsibility of credit applicants. The three areas of responsibilities are low income, large debts, and a poor payment record.

Credit Regulations• Fair Credit Billing Act • Requires creditors to correct billing mistakes promptly.

• Fair Credit Reporting Act • Allows individuals to scrutinize any information shared by credit reporting agencies with potential creditors and employers.• Individuals also may correct any incorrect credit information.

Credit Regulations•Consumer Credit Reporting Reform Act • Requires that the credit reporting agency must be able to prove that credit information they provide is accurate.

• Fair Debt Collections Act • Prohibits deceptive, harassing, and unfair practices for collecting debt from debtors.

Credit Regulations•Credit Card Accountability, Responsibility, and Disclosure Act • An amendment to the Truth in Lending Act• The act institutes fair and transparent practices of providing credit.

Credit RegulationsSome practices are instituted by the CARD Act are:• Inform customers of increase of cost of credit not less than 45 days prior to effective date.• Provides information about how long it would take to pay off a loan if minimum payments are paid.• Protects potential credit consumers under the age of 21, who must have a cosigner with a means to repay debt of the consumer.

Credit Assistance•Debt Repayment Plan• An agreement between a creditor and debtor that allows the debtor to pay off a debt with more manageable payment plan

•Credit Counseling• Provides information on actions to take in order to manage debt (reduce spending and eliminate credit difficulties)

Credit Assistance•Bankruptcy• The legal process of reducing or eliminating an amount owed• Only should be used for extreme situations• Stays on your credit record for 10 years• Chapter 7 – must sell certain personal

belongings, use proceeds to repay debts• Chapter 13 – can retain most personal

property, but must propose a repayment plan, go to credit counseling, receive financial management education, and be employed