The Three C’s of Credit Objectives: – Students will be able to describe the “Three C’s of Credit (Capacity, character, and collateral) and factors used.

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Presentation transcript:

The Three C’s of Credit Objectives: – Students will be able to describe the “Three C’s of Credit (Capacity, character, and collateral) and factors used to assess them. – Students will be able to evaluate the riskiness of lending to an individual in each of the three categories (Capacity, character, and collateral) – Students will be able to weigh the benefits and costs of approving a loan and make a decision to approve or deny the loan

FICO Score FICO – Named for the score’s developer, Fair Isaac Corporation. FICO score ranges from 350 to 850. Scores between 675 – 850 are considered good credit. Scores less than 600 are considered poor credit.

FICO Score You can buy your score from one of the three major credit reporting companies: – Equifax – Experian – TransUnion

How To Improve Your Score Establish credit by obtaining some form of loan. Be punctual and CONSISTANT! Check credit report often. Keep debt in check. Avoid excessive inquiries. Keep accounts open. Keep a healthy mix (mortgage, credit card, a car loan, and perhaps a retail card)

Credit Score Components Source: myfico.com 5 Lesson 3: A Fresh Start

PAYMENT HISTORY (35%) – Number of accounts, number paid on time, number paid late – Amounts past due on delinquent accounts AMOUNTS OWED (30%) – Total amount owed on all accounts – Number of accounts with balances – Balances due on installment loans – Revolving credit – credit utilization rate (amount owed / credit limits) Credit Score Components

LENGTH OF CREDIT HISTORY (15%) – Average time since accounts opened – Length of time accounts open by account type – Date of last activity NEW CREDIT (10%) – Number of recently opened accounts – Length of time since last credit inquiry – Re-establishment of positive credit history – Length of time since new account opened TYPES OF CREDIT USED (10%) – The mix of revolving debt and installment debt 7 Credit Score Components Lesson 3: A Fresh Start

How Mistakes Affect Your Score

The 3 Cs of Credit Capacity – Does the borrower have the capacity to repay the loan? Character – Will the borrower repay the loan? Collateral – Is there a financial asset or piece of property that a creditor can take if the borrower fails to repay the loan?

Debt-to-Income Ratio Debt-to-income ratio measures the amount of debt you have compared to how much money you make. 30% or less: This is the ideal level of debt. 30% to 40%: Still credit worthy. 41% to 49%: Hard to get credit at this level. 50% or more: GET HELP!!!

Calculate Debt-to-Income Ratio Debt: Monthly mortgage or rent ______ Minimum monthly credit card payments ______ Monthly car loan payment ______ Other obligations ______ Total monthly debt payments: ______ $850 $60 $190 $75 $1,175

Calculate Debt-to-Income Ratio Income: Monthly gross salary ______ Other monthly income ______ Total monthly income ______ Debt-to-Income Ratio: Total debt ______ divided by total income ______ = ______ $1,175 $2,950 $90 $3, %

Types of Credit Revolving credit Installment (or term) credit Noninstallment (or service) credit Credit conditions: Secured credit Unsecured credit 13 Lesson 3: A Fresh Start

Revolving Credit Open ended Can be secured or unsecured Allows you to borrow at any time up to a limit set by creditor Offers flexible payments with a minimum payment required Minimum payment usually calculated as a percentage of the balance due Computes periodic finance charges on the unpaid balance Examples: credit card, personal line of credit, home equity line of credit 14 Lesson 3: A Fresh Start

Installment (or Term) Credit Close ended Can be secured or unsecured Allows you to borrow a specific amount for a specific purpose for a specific amount of time at a given interest rate Has the loan term, loan amount, number and dollar value of payments, and total finance charges agreed on at start of loan Typically has fixed number of payments of predetermined amount Examples: home mortgage, car loan, student loan 15 Lesson 3: A Fresh Start

Noninstallment (or Service) Credit Unsecured Paying for a service that you have already used Requires payment in full by a specified date Does not have interest Results in service fees or discontinuation of service if you fail to pay within specified time Examples: cell phone plan, utility bill 16 Lesson 3: A Fresh Start

Examples of typical credit arrangements Revolving Installment Service Secured Unsecured Credit cards Student loans Car loans Cell phone contracts, utility bills Home mortgages Home equity line of credit Personal line of credit 17 TYPES OF CREDIT Lesson 3: A Fresh Start

Activity! Create 10 groups Get 12 “individual characteristic cards” – One member from each group will randomly select one card for each characteristic Get a Loan Request from the teacher

Activity 9-14: Approve or Deny #1: Record the loan request #2: Match the characteristics with the corresponding C’s of credit that it falls under – “Capacity”: Annual Household Income, Years of Working at Current Employer, Education, Monthly Debt Payments as % of Income – “Character”: FICO Score, Years Living at Current Address, Criminal Record, and Length of Credit History – “Collateral”: Short-Term Financial Assets, Long-Term Financial Assets, Equity in Home, & Market Value of Other Real Assets

Activity 9-14: Approve or Deny #3: Complete individually, then compare answers with group and come to an agreement if the measures of risk differ #4: Work together to decided whether to approve or deny for the loan and answer the questions. Discussion!