Presentation on theme: "Essential Standard 5.00 Objective 5.01"— Presentation transcript:
1 Essential Standard 5.00 Objective 5.01 Understand credit management
2 Topics Main types of credit Common advantages and disadvantages of businesses using creditCost of creditMain factors examined for granting creditCredit documentsCredit regulationsCredit assistance
3 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”
4 Who Uses Credit? 1. Consumer Credit Credit used by people for personal reasons consumer loans, mortgage loans, credit cards, charge cards 2. Commercial Credit Credit used by businesses commercial loans, corporate bonds 3. Government Credit credit used by local, state, federal municipal bonds, treasury bonds, T-bills, T-notes
5 Terms Usury Laws Creditor Promissory Note Debtor One who sells on credit or makes a loanDebtorAnyone who buys on credit or receives a loanObligated to pay back the loanPromissory NoteLegal loan documentWritten promise to repay with interestUsury LawsState law that restricts the amount of interest that can be charged.
6 Closed vs. Open Ended Credit Closed-end creditUsed for a specific purposeLoan of a definite amount of moneyLoan balance reduced with each paymentExample: car loan for $20,000 is a specific, one time amount of moneyString examplesOpen-end creditGives a credit limit - maximum $ you can borrowLoan balance varies for purchases/payments madeExample: 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.
7 Secured vs. Unsecured Secured loans: Backed by collateral (help guarantee the repayment of a loan)Backed by a cosigner who agrees to payCollateral-asset used as security on a loanCan be taken by creditor if loan payments are not made to creditorMortgage loans- real estateSubject to Foreclosure if not paidPersonal loans- car, motorcycle, boatSubject to Repossession if not paid
8 Responsible for the repayment of a loan if the original party does not pay Party who signs with applicant for a loanWho might co-sign a loan for you?Cosigner
9 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 chargesRepairs coveredAdd-on featuresReduction of finance charge if contract paid in full prior to ending dateReceive a copy of the contractRepossession conditions
10 Credit Document – Statement of Account What kind of information may be found on the statement of account?Previous balanceTransactions:PurchasesReturnsPaymentsFinance chargesLate feesRebates or bonuses earnedCurrent BalanceMinimum payment dueDue dateComes once credit is granted and purchases are made on credit.Mailed monthly and includes summary of transactions completed during the billing periodMay also view online or access info by phone
11 Types of Credit Charge Accounts Credit Cards Installment Credit Consumer LoansPayroll Advance LoansPawn Shop LoansLife Insurance LoansRetirement Plan LoansSmall Business AdministrationBusiness only
12 Charge AccountsAllows debtors to receive goods or services from suppliers and pay for them at a later dateRegular Charge AccountsRequire that you pay for purchases in full within a certain period of timeEX: charge account with an electrician who wired your houseRevolving Charge AccountsAllows you to borrow or charge up to a certain amount of money (credit limit) and pay back a part or the entire balance each monthEX: home equity line of creditBudget Charge AccountsAllows you to pay for costly items in equal payments spread out over a period of timeEX: a charge account with Progress Energy utility company
13 Credit Cards Retail store, Single Purpose – aka charge cards *Unsecured LoansRetail store, Single Purpose– aka charge cardsBalance and payments varyCan only be used to buy goods or services at the business that issued the cardExamples: JC Penney, Sears, BPMultipurpose, Bank cardsRevolving credit accountsMay be used at different locationsExamples: Visa, Master CardTravel and EntertainmentSimilar to charge accountsMust be paid in full each monthExample: American Express, Diner’s Clubcompare credit cards
14 Credit Card Terminology Grace PeriodTime 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 AdvanceBorrow money on a credit cardCosts more than regular credit card purchases*read your contract before signing application or taking a cash advance!
15 Seller-Provided Credit Many stores provide revolving charge to their customersUsers may earn points, bonuses, rebates or get special unadvertised specialsExamples: Kohls, Sears, Best Buy, Belk
16 Installment Loans Used for: Student, mortgage, automobile 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 fullUsed for: Student, mortgage, automobile loansEx: Buy furniture – pay monthly to Rooms To Go Furniture StoreEx: borrowing $1000 from a bank and agreeing to make payments $105 for 10 months.
17 Consumer Finance Companies Specialize in loans to people with poor credit ratingsCost of credit is higher than other institutions
18 Payroll Advance Services Short-term loan“Borrow Until Payday” LoanCost is extremely highincludes flat fees, high interest rateYou get cash ahead of getting your paycheck.Secured Loan- secured by promise of paycheck
19 PAWNING A short term loan Secured Loan Give up an asset (ring, watch) Pawnshop gives you cashUsually less than 50% of valueYou can get property backTime limitPay amount & interest chargedPawn shop can sell your itemSecured Loan
20 Life Insurance Plans Cash Value Insurance – whole life Provides both savings and death benefitsYou cannot borrow against term life insurance policies…no cash value*Secured Loan-collateral is $ in cash value
21 Retirement PlansCan legally borrow from them but not recommended since the purpose is to have money when you retire*Secured Loan- collateral is $ in retirement plan
22 Other Sources of Credit for Businesses Small Business Administration (SBA)Offers a number of financial, technical, and management programs to help businessesLoan funds availableInfo available at localCommunity colleges
23 Review : Who Uses Credit? ConsumersBusinessesGovernmentLocalStateFederal
24 Government Credit Federal government - uses credit to pay for: Public services and programs provided for its citizensExamples-military, foreign aid, roads, courts, prisonsLoan sources include: Federal savings bonds, treasury bills, bonds, notesState & local governments-use credit to pay for:highways, water systems, public housing , and stadiums, airportsLoan sources : municipal bonds, school bonds
25 Government Credit Municipal Bonds Savings Bonds State and local governments use to finance projectsSavings BondsSold by federal governmentT-bills, T-notes, T-bonds
26 BondsBonds – written promise to repay a loan with interest on a specific dateBuyer of the bond is the creditorCorporate BondsUsually used to finance buildings and equipmentBlue chip companies vs. junk bondsPart of investment portfolioBond is an investment for creditor
27 Consumer Loan ExampleMarty 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?
28 Famous Quotation“Creditors have better memories than debtors.” -Benjamin Franklin Do you agree or disagree with this quote and why?
29 Why Use Credit? Convenience Immediate Possession Emergencies Shop without carrying cashImmediate PossessionAllows possession of goods or services nowEspecially BIG TICKET ITEMSHomes, business expansionBuy now, pay laterEmergenciesHelps in caseof a serious situation
30 Common Advantages of Businesses Using Credit Establishing favorable credit ratingKeeping business separate from personal expensesEarning rewards/pointsMinimizing record-keeping and receiptsKeeping track of what employees are spendingSaving Money –Buy item when it is on sale without cashGrowth of the Economy-Buying goods & services helps stimulate the economy
31 Common Disadvantages of Businesses Using Credit Theft of customer records/databasesOverbuying by employeesOverusing CreditCredit Fees - Interest paid on balance
32 Results of Overuse Bad Credit Rating Repossession/Foreclosure Higher interest rates in futureInability to get loan in futureRepossession/ForeclosureLoss of property because of failure to repay loanBankruptcyCan’t qualify for credit for seven years
33 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 loanInterest 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
34 Cost of Credit – Time Calculation How is time determined for a loan for each of the following lengths?Years – multiply by # of yearsMonths – ex 2/12Days 24/365How 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
35 Process of Obtaining Credit Credit ApplicationDocumentationProcessingUnderwritingClosingFunding
36 Credit ApplicationForm used to provide information needed by a lender to make a decision about granting credit (approving a loan).Fill out completely, accurately, & honestlyRequires signature of applicant, which indicates provided information is trueCredit decision must be based on your ability to repay a loan, Other discrimination is illegal.
37 Application Information Provide the following information:Salary, Employer,Outstanding Credit (Debt), Credit ReferencesAssets, Checking and Savings Accounts, Stock Portfolio, etc.Disclose every piece of information about your financial background to obtain loanBe honest!
38 DocumentationCreditor 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
39 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 salaryFinancial institutionsType of data: Saving or checking accountsPersonal referencesType of data: Manner how personal business is conducted
40 Main Factors Examined for Granting Credit Information provided by Credit BureausCredit 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
41 Processing Lender builds loan file Evaluates credit worthiness Creditors examine factors about potential debtors when deciding whether to grant them creditThe C’s of Credit Worthiness
42 Processing – The C’s of Credit Worthiness CapacityHow much debt can comfortably be handled?Considers current income and debt levelsCharacterHonesty to pay debt when dueEarned by paying bills on time and being a trustworthy, reliable, stable person financiallyReferences – people you have borrowed from in the past who indicate you paid on timeCapital (money)How much you have beyond what you oweCurrent available assets that could be used to repay debt if income was unavailable
43 Underwriting Review loan info for soundness, creditworthiness Make decision about granting creditConsumer Reporting AgenciesCompany that compiles and keeps records on consumer payment habits.Used to evaluate creditworthinessExamples: Equifax, Experian, and TransUnion
44 Closing Representative explains terms of credit- usually loan officer Attorney may be present at closing, especially real propertyDebtor/creditor sign contractContract is binding on signing parties
45 Closing KWYS – know what you’re signing READ and UNDERSTAND BEFORE signing any contractContract – legally binding agreement between two parties
46 FundingCreditor issues money/funds to the debtor for the item purchasedExample: mortgage company pays seller in full, debtor then pays mortgage company monthly installments to repay the loan
47 Credit Documents Understand 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.
48 Credit ContractLegally binding documents that allow debtors to use credit to obtain goods and servicesDebtors should know the content of the credit contract before signing such as:Amount of finance chargesRepairs coveredAdd-on featuresReduction of finance charge if contract paid in full prior to ending dateReceive the copy of the contractRepossession conditions
49 Statement of AccountPrinted monthly once credit is granted and purchases are made on credit (also online)Includes summary of transactions completed during the billing periodWhat kind of information may be found on the statement of account?Balance dueAmounts charged during the billing periodAmounts paid during the billing periodCurrent balanceMinimum amount of next paymentLate fees, interest charges
50 Review Steps to Get Loan Steps in Order: 1.___credit application 2.___documentation 3.___processing 4.___underwriting 5.___closing 6.___fundingDescription of ActivityA. loan officer builds a loan fileB. borrower completes form info for lender to reviewC. creditor issues money to the debtorD. debtor/creditor sign contractE. creditor collects and verifies informationF. loan officer reviews loan for creditworthiness
51 Denial of CreditFair 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.
52 Credit Reporting Credit Bureau Credit BureauAn agency that collects information & calculates a score/rating on how promptly people/businesses pay their billsInformation retrieved from banks, finance companies, landlords, retail stores, utility companies, stores, credit card companiesCorporations: Standard & Poors, Fitch Rating, Moody’sIndividuals: Equifax, Experian, TransUnion
53 How to Build Credit Open a checking or savings account Apply for a local department store charge cardApply for a multipurpose credit cardTake out a small loan from local bankPAY ALL LOANS, BILLS, AND CREDIT CARDS ON TIME!!!
54 Example: Calculations The 4-wheeler Nick wants to buy a four wheeler. It costs $ He has $500 for a down payment. He qualifies for a bank loan for 5% simple interest. The bank sets up payment terms of monthly installment for 2 years beginning on the 10th of next month.QuestionsWhat 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?
55 Calculate InterestUse Interest formula to calculate Nick’s finance cost.I= Interest (finance charges/fees)P= PrincipleR= Rate (APR % charged)T= Time (year or portion of year)
56 Calculate Interest Answer I=P*R*TI=2000*5%*2I=$200What is the total cost to Nick for purchasing the four wheeler?$ interest paid=$2700
57 Recalculate InterestWhat 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
58 Credit Regulations (Laws) Protect rights of credit applicants & rights of credit users from fraudulent & unfair practicesTruth in Lending Law (TILA) requires lenders to reveal the cost of credit (APR & $ amount of finance charge) & terms before signing an application or contractFederal Trade Commission (FTC) enforces laws on credit
59 Equal Credit Opportunity Act allows credit applications be judged on financial responsibility of credit applicants.Cannot discriminate based on gender, age, ethnicity, or religionCredit can be denied due to these areas of responsibility:Income too lowOther large debts compared to incomePoor payment record in past
60 Fair Credit Billing Act Fair Credit Reporting Act Fair Credit ActsFair Credit Billing Actrequires creditors to correct billing mistakes promptly.Fair Credit Reporting Actallows individuals to scrutinize any information shared by credit reporting agencies with potential creditors and employers. Individuals also may correct any incorrect credit information.
61 Fair Debt Collections Act prohibits deceptive, harassing, and unfair practices for collecting debt from debtors.Collectors:Must identify themselvesCannot tell others about debtCannot harass debtorConsumer Credit Reporting Reform Actrequires that credit reporting agency must be able to prove that credit information they provide is accurate.
62 Credit Card Accountability, Responsibility, and Disclosure Act (CARD Act) Amendment to the Truth in Lending ActInstitutes fair and transparent practices of providing credit
63 CARD ACT Practices 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.
64 Credit Assistance Available to minimize or eliminate the credit problems of debtors
65 Credit Assistance Debt repayment plan Credit counseling Bankruptcy Is an agreement between a creditor and debtor that allows the debtor to pay off a debt with more manageable payment plan.Credit counselingProvides 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.
66 Types of Bankruptcy Chapter 7 (Liquidation) List assets and liabilitiesMost 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 feesChapter 13Propose a plan for using future earnings and assets to eliminate debts over a period of time
67 Chapter 11 BankruptcyReorganization of debt, re-negotiating terms of debt to stay in businessFor Businesses OnlyCreditors 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