2006 McGraw-Hill Ryerson Ltd. Kapoor Dlabay Hughes Ahmad Prepared by Cyndi Hornby, Fanshawe College Chapter 5 Introduction to Consumer Credit 5-1

2006 McGraw-Hill Ryerson Ltd. Learning Objectives - Chapter 5 1.Define consumer credit and analyze its advantages and disadvantages. 2.Differentiate among various types of credit. 3.Assess your credit capacity and build your credit rating. 4.Describe the information creditors look for when you apply for credit. 5.Identify the steps you can take to avoid and correct credit mistakes. 5-2

2006 McGraw-Hill Ryerson Ltd. Learning Objective # 1 Define consumer credit and analyze its advantages and disadvantages. 5-3

2006 McGraw-Hill Ryerson Ltd. What is Consumer Credit? Credit is an arrangement to receive cash, goods or services now, and pay for them in the future Consumer credit is the use of credit for personal needs, except a home mortgage There are three ways consumers can finance current purchases Take money from savings Use present earnings Borrow against future income Trade-offs are involved in using credit 5-4

2006 McGraw-Hill Ryerson Ltd. Consumer credit is the amount of credit used by consumers to purchase non- investment goods or services that are consumed and whose value depreciates quickly Includes automobiles, recreational vehicles (RVs), education, boat and trailer loans Excludes debts taken out to purchase real estate or margin on investment accounts

2006 McGraw-Hill Ryerson Ltd. Common forms of consumer credit include Credit cards Store cards Motor (auto) finance Personal loans (installment loans) Consumer lines of credit Retail loans (retail installment loans) Mortgages

2006 McGraw-Hill Ryerson Ltd. The cost of credit is the additional amount, over and above the amount borrowed, that the borrower has to pay Includes interest, arrangement fees and any other charges Some costs are mandatory, required by the lender as a part of the credit agreement Other costs may be optional. The borrower chooses whether or not they are included as part of the agreement

2006 McGraw-Hill Ryerson Ltd. Credit Considerations Before you use credit for a major purchase, ask yourself some questions Could I pay cash or make a down payment? Do I want to use savings for this purchase? Does purchase fit with my goals and budget? Could I use the credit Ill need in some better way? Can I postpone this purchase? What are the opportunity costs of postponing this purchase? What are the dollar and psychological costs of using credit for this purchase? 5-5

2006 McGraw-Hill Ryerson Ltd. Advantages of Credit Current use of goods and services Permit purchase even when funds are low Use for financial emergencies Convenient when shopping Safer than cash Can take advantage of float time May get rebates, airline miles or other bonuses Demonstrates financial stability 5-6

2006 McGraw-Hill Ryerson Ltd. Disadvantages of Consumer Credit Purchases are more expensive Temptation to overspend Ties up future income. Possible financial difficulties Damage to family relationships Slows progress to future goals 5-7

2006 McGraw-Hill Ryerson Ltd. Learning Objective # 2 Differentiate among various types of credit. 5-8

2006 McGraw-Hill Ryerson Ltd. Types of Credit 5-9 Closed-End Credit For a specific purpose and amount. Payments of equal amounts Mortgage, automobile and installment loans Open-End Credit Use as needed until reaching line of credit. You pay interest and finance charges if you do not pay the bill in full when due Department store or bank credit card, overdraft protection, bank line of credit, home equity loan

2006 McGraw-Hill Ryerson Ltd. Open-End Credit 5-10 Credit Limit The dollar amount which may or may not be borrowed that lender makes available to a borrower Interest A periodic charge for use of credit Personal Line of Credit A prearranged loan from a bank for a maximum specified amount

2006 McGraw-Hill Ryerson Ltd. Credit Cards Nearly 83% of Canadian households carry one or more credit cards. One-third are convenience users. They pay their balance off in full each month. The other two-thirds are borrowers. Co-branding - linking a credit card with a business offering rebates on products and services. Smart cards have an imbedded computer chip. Debit cards are not credit cards MasterCard

2006 McGraw-Hill Ryerson Ltd. Credit Card in Vietnam According to Visa International, only 88,000 of 85mil people in Vietnam (1%) are using Visa credit cards with the transaction turnover of $115millions Meanwhile, the percentages of populations using Visa cards are much higher in other countries 68.5% in Singapore 10.6% in Thailand 20.3% in Malaysia

2006 McGraw-Hill Ryerson Ltd. ANZ and HSBC are well known as banks that issue international credit cards Both the banks have high technology and a lot of experience in international and domestic credit cards

2006 McGraw-Hill Ryerson Ltd. Domestic banks also issue credit cards For example, Vietcombank began issuing MasterCard in 1996 After 10 years of development, the international card market now has 10 banks-issuers, including Vietcombank, ACB, ANZ, Eximbank, EAB and HSBC There are three main brand name cards Visa, MasterCard and American Express

2006 McGraw-Hill Ryerson Ltd. Protecting Yourself Against Credit Card Fraud Sign new cards as soon as they arrive. Treat the cards like money - keep them secure. Shred anything with your account number on it. Dont give your number over the phone unless you initiate the call. Get your card and a receipt after every transaction and compare them to your bills when they arrive. 5-12

2006 McGraw-Hill Ryerson Ltd. Protecting Yourself Against Credit Card Fraud Immediately report if lost or stolen. Notify issuer if you dont get your billing statement Check your credit report every few years If you make purchases online; use a secure browser keep records of your online transactions 5-13

2006 McGraw-Hill Ryerson Ltd. Protecting Yourself Against Credit Card Fraud If you make your purchases online; review monthly statements for errors and unauthorized purchases read the policies of sites you visit keep your personal information private give payment information only to businesses you know and trust Never give your password to anyone online Do not download files from strangers 5-14

2006 McGraw-Hill Ryerson Ltd. Personal Lines of Credit Revolving line of credit Interest rate linked to lenders prime rate Withdraw up to specified limit using debit card or cheques Repay minimum stated or more Secured with assets GICs or home equity 5-15

2006 McGraw-Hill Ryerson Ltd. Line of credit Any credit source extended to a government, business or individual by a bank or other financial institution A line of credit may take several forms Overdraft protection Demand loan Special purpose Export packing credit Term loan Discounting, purchase of commercial bills

2006 McGraw-Hill Ryerson Ltd.

The lender determines a line of credit based largely on the individual's credit worthiness and income potential Most people encounter a line of credit when dealing with credit cards or home equity loans

2006 McGraw-Hill Ryerson Ltd. Home Equity Loans A loan based on the current market value of your home less the amount still owing on your mortgage Can borrow up to 85% of your equity Interest on loan is tax deductible if proceeds are being used for an investment (outside of registered plans) Usually set up as a revolving line of credit 5-16

2006 McGraw-Hill Ryerson Ltd. Home Equity Loans vs. Second Mortgage Similar to a 2 nd mortgage, a home equity line of credit establishes a maximum amount of money a homeowner can borrow In a second mortgage, the bank lends the entire amount of money and the borrower makes regular payments based on the balance due A line of credit arrangement allows the homeowner to borrow smaller amounts of money to pay off contractors or bills without incurring a large debt up front

2006 McGraw-Hill Ryerson Ltd. Closed End Credit Mortgage and Mortgage Loans Mortgage A contract to buy a real estate, plan A pledge of property to secure payment of a debt Mortgage Loans A debt Loans to value is 80% at max Ex: –Home Mortgage –Plant Mortgage

2006 McGraw-Hill Ryerson Ltd. Closed End Credit CAR LOAN Automobile is your second largest investment Financing Sources 1.Financing at the Dealer –Affiliated with manufacturer or financial institution –Significantly lower interest rates on some models –Other incentives offered (no down payment, no late charge….) 5-17

2006 McGraw-Hill Ryerson Ltd. Car Loan 2. Leasing Closed-end lease You can buy vehicle at lease end or return it to company Open-end leas You are responsible for residual value of vehicle at lease end Vehicle owned by leasing company, you pay maintenance, repairs, insurance May have mileage restrictions 5-15

2006 McGraw-Hill Ryerson Ltd.

3. Paying Cash Advantages: Least expensive Avoids interest charges Used by people with limited/poor credit line Disadvantages: Investment returns higher than cost to borrow –Using saving money to buy or borrowing –Using saving money to buy or investing Automobile depreciations –15-20% on the first year –50% after three years

2006 McGraw-Hill Ryerson Ltd. Learning Objective # 3 Assess your credit capacity and building your credit rating. 5-19

2006 McGraw-Hill Ryerson Ltd. Measuring Your Credit Capacity Before you take out a loan, ask yourself... Can you afford the loan? Ability to make principal and interest payments Extra money after covering up the loan What do you plan to give up in order to make the payment? Saving or investing money 5-20

2006 McGraw-Hill Ryerson Ltd. Credit Capacity The maximum amount of debt a person or entity can be expected to assume and repay based on financial ability Based on a formula that factors existing debt payments and net income to arrive at a percent of net income that is available for debt repayment

2006 McGraw-Hill Ryerson Ltd. Credit Capacity Indicators * Not including housing Debt Payments-to-Income Ratio monthly payments* net monthly income should not exceed 20% 5-21

2006 McGraw-Hill Ryerson Ltd. Ex: Monthly credit payments are $760 and net income is $3,800 Debt-payments ratio $760/$3,800 = 0.20 = 20%

2006 McGraw-Hill Ryerson Ltd. Credit Capacity Indicators Debt To Equity Ratio total liabilities net worth* = Should be < 1 *Excluding home value 5-22

2006 McGraw-Hill Ryerson Ltd. Ex: Long-term debt of $3,000 and owners equity of $12,000 The debt/equity ratio 3000 / = 0.25 If the ratio is greater than 1, the majority of assets are financed through debt If it is smaller than 1, assets are primarily financed through equity

2006 McGraw-Hill Ryerson Ltd. Co-Signing a Loan You are considered as a co-debtor or co-owner of the loan Guaranteeing a debt If borrower doesnt pay the debt you will have to Including fees and collection costs Statistics show that 3 out of 4 co-signors have to pay 5-23

2006 McGraw-Hill Ryerson Ltd. If you do co-sign a loan Be sure you can afford to pay Cover the debt of others when they default Liability can keep you from getting other credit Credit line will be affected Could lose the property you pledge as security Lost of automobile or furniture Understand provincial laws Rights as a co-singer Request copy of all over due notices

2006 McGraw-Hill Ryerson Ltd. Build and Maintain Your Credit Rating Your credit experiences, or lack of, is a major consideration for the creditor a good credit rating is a valuable asset use credit with discretion limit borrowing to your capacity to repay abide by the terms of the lending contracts 5-24

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Your Credit File The Credit Bureau is a reporting agency that collects credit and other information about consumers and sells the date to creditors to help in evaluating applications. Your Credit file includes; Your employer and position Former address and employer Spouses name, social insurance number and employer Public records and information Cheques returned for insufficient funds 5-21

2006 McGraw-Hill Ryerson Ltd. Credit Bureaus Equifax Canada Trans Union Canada Experian Others

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Credit Bureau Regulation Most provinces have legislation to protect Consumer privacy Right not to suffer from false credit or personal information Others may only view your file if written consent has been given First bankruptcy remains on your file 7 years, second bankruptcy is permanent Errors in your credit file should be corrected immediately 5-26

2006 McGraw-Hill Ryerson Ltd. Credit Bureaus in Vietnam The State Bank of Vietnam's Credit information center, established in 1999, remains the country's sole credit bureau The credit bureau targets small- and medium-size enterprises (SMEs) and individuals

2006 McGraw-Hill Ryerson Ltd. Vietnam's first private credit information company (PCB) officially began providing services in 2010 with more than 20 banks committing to supply information The company was established by the Private Credit Bureau Investment Joint Stock Company (PCB) Total charter capital of 50 billion VND (2.7 million USD) was contributed by 11 Vietnamese commercial banks: ACB, ABBank, Vietinbank, BIDV, Southeast Asia Bank, Techcombank, Vietcombank, SB, VIB, Vietbank and VPBank

2006 McGraw-Hill Ryerson Ltd. Vietnam has a population of more than 86 million and over 480,000 SMEs Only 5% of the population and 30% of the SMEs have engaged in credit transactions with banks A low rate in the region, as the rates in Thailand and Malaysia are 70 to 80%

2006 McGraw-Hill Ryerson Ltd. Credit Scoring Used by lenders to assess the risk of prospective borrowers Data is credit report is summarized in a credit score Helps to predict creditworthiness Higher the score the better 5-27

2006 McGraw-Hill Ryerson Ltd. Credit Scoring The following categories are weighted Payment history Length of credit history Amounts owed Types of credit used Number of recent applications for credit 5-28

2006 McGraw-Hill Ryerson Ltd. Improve your score Managing your debt responsibly Pay your debt on time Avoid over spending on credit limit Avoid certain types of credit Not applying for too many credit cards at the same time

2006 McGraw-Hill Ryerson Ltd. Learning Objective # 4 Describe the information creditors look for when you apply for credit. 5-29

2006 McGraw-Hill Ryerson Ltd. What Creditors Look For: 5 Cs Character – Borrowers attitude towards credit obligations Capacity – Borrowers financial ability to meet credit obligations Capital – Borrowers assets or net worth Collateral – Valuable assets that is pledged to ensure loan payments Conditions – the general economic conditions that can affect borrowers ability to repay a loan 5-30

2006 McGraw-Hill Ryerson Ltd. If you are denied credit? Ask questions if application for credit is denied If based on your credit report ask; what specific information on credit report lead to denial? Check with credit bureau to find out what information has been reported and investigate and correct any inaccurate or incomplete information 5-31

2006 McGraw-Hill Ryerson Ltd. Learning Objective # 5 Identify the steps you can take to avoid and correct credit mistakes. 5-32

2006 McGraw-Hill Ryerson Ltd. Avoiding & Correcting Credit Mistakes To correct mistakes or misunderstandings in your credit accounts; contact creditor first to correct error If your identity has been stolen; contact the fraud department of major credit bureaus contact creditors for accounts that have been opened fraudulently file a police report close all bank accounts immediately and cancel credit cards 5-33

2006 McGraw-Hill Ryerson Ltd. Summary of Learning Objectives Define consumer credit and analyze its advantages and disadvantages Is borrowing money to obtain goods and services for personal needs Advantages include; Purchase goods when you need them and pay for them gradually Ability to deal with financial emergencies Convenience in shopping Establishment of credit rating Disadvantages include; Credit costs money Encourages overspending Ties up future income 5-34

2006 McGraw-Hill Ryerson Ltd. Summary of Learning Objectives Differentiate among various types of credit Closed end (installment) credit Pay back one time loan in a stated period of time and with a specified number of payments Open end (revolving) credit Take loans on a continuous basis and is billed for partial payments periodically Assess your credit capacity and build your credit rating Debt payment to income ratio Debt to equity ratio Creditor seeks information from credit bureaus 5-35

2006 McGraw-Hill Ryerson Ltd. Summary of Learning Objectives Describe the information creditors look for when you apply for credit Character Capacity Capital Collateral Conditions 5-36

2006 McGraw-Hill Ryerson Ltd. Summary of Learning Objectives Identify the steps you can take to avoid and correct credit mistakes If billing error occurs notify creditor in writing within 60 days If your dispute is not settled place your version in your credit file Can withhold payment for defective goods or services as long as you attempt to solve dispute with merchant 5-36