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Essential Standard 5.00 Objective 5.01

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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 credit Cost of credit Main factors examined for granting credit Credit documents Credit regulations Credit 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 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.

6 Closed vs. Open Ended Credit
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.

7 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

8 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? 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 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

10 Credit Document – Statement of Account
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 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

11 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

12 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

13 Credit Cards Retail store, Single Purpose – aka charge 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 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

14 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!

15 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

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 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.

17 Consumer Finance Companies
Specialize in loans to people with poor credit ratings Cost of credit is higher than other institutions

18 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

19 PAWNING A short term loan Secured 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

20 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

21 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

22 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

23 Review : Who Uses Credit?
Consumers Businesses Government Local State Federal

24 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

25 Government Credit Municipal Bonds Savings Bonds
State and local governments use to finance projects Savings Bonds Sold by federal government T-bills, T-notes, T-bonds

26 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

27 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?

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 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

30 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

31 Common Disadvantages of Businesses Using Credit
Theft of customer records/databases Overbuying by employees Overusing Credit Credit Fees - Interest paid on balance

32 Results of Overuse Bad Credit Rating Repossession/Foreclosure
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

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 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

34 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

35 Process of Obtaining Credit
Credit Application Documentation Processing Underwriting Closing Funding

36 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.

37 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!

38 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

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 salary Financial institutions Type of data: Saving or checking accounts Personal references Type of data: Manner how personal business is conducted

40 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

41 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

42 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

43 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

44 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

45 Closing KWYS – know what you’re signing
READ and UNDERSTAND BEFORE signing any contract Contract – legally binding agreement between two parties

46 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

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 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

49 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

50 Review Steps to Get Loan
Steps in Order: 1.___credit application 2.___documentation 3.___processing 4.___underwriting 5.___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

51 Denial of Credit 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.

52 Credit Reporting Credit Bureau
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

53 How to Build Credit 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!!!

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. 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?

55 Calculate Interest 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)

56 Calculate Interest Answer
I=P*R*T I=2000*5%*2 I=$200 What is the total cost to Nick for purchasing the four wheeler? $ interest paid=$2700

57 Recalculate Interest 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

58 Credit Regulations (Laws)
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

59 Equal Credit Opportunity Act
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

60 Fair Credit Billing Act Fair Credit Reporting Act
Fair Credit Acts 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.

61 Fair Debt Collections Act
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.

62 Credit Card Accountability, Responsibility, and Disclosure Act (CARD Act)
Amendment to the Truth in Lending Act Institutes 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 counseling Provides information on actions to take in order to manage debt, one on one with debtor. Bankruptcy May 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 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

67 Chapter 11 Bankruptcy 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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