Understand credit management
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• 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
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•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”
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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
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.
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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
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.
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
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 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
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◦ 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
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◦ 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
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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
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 Clubcompare credit cards
*Unsecured Loans
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!
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.
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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 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 StoreEx: borrowing $1000 from a bank and agreeing to make
payments $105 for 10 months.
Specialize in loans to people with poor credit ratings
Cost of credit is higher than other institutions
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
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
◦ 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
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
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
Consumers
Businesses
Government◦ Local◦ State◦ Federal
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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
• Municipal Bonds– State and local governments use to finance
projects• Savings Bonds
– Sold by federal government– T-bills, T-notes, T-bonds
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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
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Bond is an investment for creditor
Marty borrowed $450 for 12 months from First Federal Bank to buy a bike at 8% APR.
1. Who is the creditor?2. Who is the debtor?3. What is the interest rate?4. What does APR stand for?5. How much will his monthly payment be?
“Creditors have better memories than debtors.” -Benjamin Franklin
Do you agree or disagree with this quote and why?
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
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
Theft of customer records/databases
Overbuying by employees
Overusing Credit
Credit Fees - Interest paid on balance
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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
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
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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
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1. Credit Application2. Documentation3. Processing4. Underwriting5. Closing 6. Funding
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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.
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!
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
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
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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
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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
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
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
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
KWYS – know what you’re signing
READ and UNDERSTAND BEFORE signing any contract
Contract – legally binding agreement between two parties
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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
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– 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
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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
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Steps in Order:1.___credit application
2.___documentation
3.___processing4.___underwriting5.___closing
6.___funding
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
Fair Credit Opportunity Act requires that credit denial cannot be based on sex, family, religion, etc.
Loan decision must be based on ability to pay back loan.
http://www.youtube.com/watch?v=1u4NpD_sZy0
Credit Bureau◦ An agency that collects information & calculates a
score/rating on how promptly people/businesses pay their bills
◦ Information retrieved from banks, finance companies, landlords, retail stores, utility companies, stores, credit card companies
Corporations: Standard & Poors, Fitch Rating, Moody’s
Individuals: Equifax, Experian, TransUnion
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Open a checking or savings account
Apply for a local department store charge card
Apply for a multipurpose credit card
Take out a small loan from local bank
PAY ALL LOANS, BILLS, AND CREDIT CARDS ON TIME!!!
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Nick wants to buy a four wheeler. It costs $2500. He has $500 for a down payment. He qualifies for a bank loan for $2000 @ 5% simple interest. The bank sets up payment terms of monthly installment for 2 years beginning on the 10th of next month.
Questions What is Nick’s
principle? What is the interest
rate? What is the time? When is maturity
date? How many payments
will Nick make? How much interest
will Nick pay in 2 years?
What is the total cost of the 4-wheeler?
Use Interest formula to calculate Nick’s finance cost.
I= Interest (finance charges/fees) P= Principle R= Rate (APR % charged) T= Time (year or portion of year)
I=P*R*T I=2000*5%*2 I=$200 What is the total cost to Nick for purchasing
the four wheeler? $2500 + 200 interest paid=$2700
What would happen to the interest fees if Nick paid off the loan in 6 months?
I=2000*5%*6/12 (6 out of 12 months) I=$50
Protect rights of credit applicants & rights of credit users from fraudulent & unfair practices
Truth in Lending Law (TILA) requires lenders to reveal the cost of credit (APR & $ amount of finance charge) & terms before signing an application or contract
Federal Trade Commission (FTC) enforces laws on credit
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allows credit applications be judged on financial responsibility of credit applicants.
Cannot discriminate based on gender, age, ethnicity, or religion
Credit can be denied due to these areas of responsibility: Income too low Other large debts compared to income Poor payment record in past
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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.
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prohibits deceptive, harassing, and unfair practices for collecting debt from debtors.
Collectors:◦ Must identify themselves◦ Cannot tell others about debt◦ Cannot harass debtor
Consumer Credit Reporting Reform Act◦ requires that credit reporting agency must be
able to prove that credit information they provide is accurate.
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Amendment to the Truth in Lending Act Institutes fair and transparent practices of
providing credit
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Some 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.
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Debt repayment planIs 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, one on one with debtor.
BankruptcyMay be used by
debtors to reduce debt or amount owed to creditors. Legal process in which some or all of the assets of a debtor are distributed among the creditors because the debtor is unable to pay his or her debts.
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Chapter 7 (Liquidation)List assets and
liabilities
Most of the debtor’s assets are sold to pay off creditors (liquidation)
Cannot release debt on alimony, child support, taxes, fines, educational loans, or court fees
Chapter 13 Propose a plan for
using future earnings and assets to eliminate debts over a period of time
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Reorganization of debt, re-negotiating terms of debt to stay in business
For Businesses Only
Creditors often accept terms to get partial payment, or an extended period to get paid, rather than not get repaid at all!
Chapter 11 bankruptcy reorganization: what is it and how does it work
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