18-1 Credit Fundamentals

Using Credit
Credit – the privilege of using someone else’s money for a period of time, with the belief that the person receiving the
credit will repay the amount owed at a future date (plus interest)

Debtor – anyone who buys on credit or receives a loan

Creditor – the one who sells on credit or makes a loan

* Without trust, the credit system could not operate.

Types of Credit
Trade credit – occurs when a company receives goods from a supplier and pays for them later.

Loan credit – borrowing money to use for some special purpose

Sales credit – charging a purchase at the time you buy a good or service, with the agreement to pay for it later.

Charge Accounts – represents a contract between the firm offering the account and the customer

3 types of Charge Accounts:

1.) Regular Account

 requires the buyer to make full payment within a specific period of time (usually 25-30 days)
 seller may set a limit to the total amount that may be charged during a time period
 people use regular accounts for everyday needs and small purchases
2.) Budget Accounts
 this credit agreement requires that a customer make payments of a fixed amount over several months
 90-day, three payment plans
 utility company budget plans (based off of estimates) --- These plans avoid large payments during some
times of the year.
3.) Revolving Accounts
 most popular form of credit
 you may charge purchases at anytime, but only part of the debt must be paid each month
credit limit – the maximum amount that can be owed at one time
 a payment is required once a month, but the total amount owed does not need to be paid
finance charge – a charge added if the amount owed is not paid, convenience fee for using credit
Credit Cards
Bank Cards
o very popular credit cards (recognized all over the world) --- Examples: MasterCard / Visa
o sometimes an annual fee must be paid for the privilege of using these cards

Independent Sales Organizations (ISO’s) – does most credit card processing

Charge Cards

o American Express and Diners Club, once called travel and entertainment cards .
 o Subscribers pay a yearly membership fee that is usually _higher_ than bank cards
o Cardholders are _not given_ a spending limit, but are usually expected to pay the
full balance each month
o Used by business travelers, because they offer proof of travel expenses .

Affinity Cards

o Some organizations allow their names to be affiliated with a credit card

o Affinity cards are co-branded with an issuing bank (Examples: __charities__, _sports teams__, or _oil
companies_)
o The co-branded company receives a small percentage of credit sales

Retail store Cards

o Many retail stores offer their own credit.

o These cards can only be used at these stores .

Installment Credit
Installment sales credit – a contract issued by the seller that requires periodic payments at specified times

Features of Installment Credit:

 signing a contract that shows the terms of the purchase

 seller has the right to repossess (take back) an item if payments are not made on time
down payment – a payment of part of the purchase price (made at the time of the purchase)
 paying a finance charge on the amount owed
 making payments at stated times
(weekly or monthly)

Consumer Loans --- a loan is an alternative to charge account buying or installment sales credit
 installment loan – one in which you agree to make monthly payments in specified amounts over a period of
time
 single payment loan – you do not pay anything until the end of the loan period (usually 60-90 days)
 promissory note – a written promise to repay based on a debtor’s excellent credit history

Promissory Notes should include the following components:

 Principal – the amount that is promised to be paid

 Time – the days or months from the date of the note until it should be paid
 Date of maturity – date the note is due
 Payee – the one to whom the note is made payable
 Interest rate – the rate paid for the use of money
 Maker – the one who promised to make payment

collateral – property that is used as security for payment

cosigner – the cosigner of a note is responsible for the note if you do not pay as promised
Benefits of Credit
Convenience: Credit can make it easy for you to buy. You can shop without carrying much cash.

Immediate Possession: Credit allows you to have the item now.

Savings: Credit allows you to buy an item on sale a good price.

Credit Rating: If you buy on credit and pay your bills on time, you gain a reputation for being dependable

credit rating – a person reputation for paying bills on time

Useful for Emergencies: Access to credit can help you in unexpected situations.

Credit Concerns
Overbuying: buying things for more than you can afford

Careless Buying: You may fail to make comparisons, causing you to buy at the wrong time or the wrong place.

Higher Prices: Stores that only accept cash may sell items at lower prices than stores that offer credit.

Overuse of Credit: If consumers are not careful they may overuse credit and not be able to make their payments at
the end of the month.

18-2 Cost of Credit

Finding Interest
Interest (I) – the cost of using someone else’s money
To determine the amount you owe on a loan (each month), you need to know the following:
Principal (P) – amount of the loan
Interest Rate (R) – Percentage of interest charged or earned
(can be expressed as a decimal, fraction, or %)
Time (T) – Length of time in which interest will be charged (usually in years or parts of years)

Simple Interest – used for single-payment loans

Formula: I=P X R X T

Examples (time in year, time in months, and time in days)

$100 loan at 12% for one year

Interest = 100*0.12*1 = $12

$100 loan at 12% for one month

Interest = 100*0.12*1/12 = $1

$100 loan at 12% for 60 days

Interest = 100*0.12*60/360 = $2
Calculating Monthly Credit Card Interest (APR)
Example: $1000 Balance on May 1st. On the 10th of May you pay $300 toward the balance. The APR is 24.99%.

Step 1 – Determine the DPR (Daily Percentage Rate) 24.99% / 365 =0.0684%

Step 2 – Determine the average account balance for the month. (1000*9 + 700*22)/31 =787.10

Step 3 – Average Month Balance * DPR * Days in the Month = Interest 787.10 * 0.0684% * 31 = $16.69

Maturity date – the date on which a loan must be repaid

 When the loan is stated in months, the date of maturity is the on the same day of the month as the day the loan
was made.

 When the time is in days you must count the exact number of days to find the date of maturity.

Installment Interest --- When you borrow money, you usually make several partial payments instead of one large
single payment…each payment is an installment .

Installment loans are offered by banks , credit unions , and

consumer finance companies .

Amortization schedule – the payment table of principal and interest over time (on installment credit)

o On some installment loans, interest is calculated on the amount that is unpaid at the end of each month .

o Amortization schedules show that when loans are first taken, a _larger percentage_ of the payments go toward
__interest__.

o The concept of amortization schedules are used in car loans and mortgages .

Finance Charges --- Three things to consider when borrowing money or charging a purchase are…the annual
percentage rate (APR), the total dollar charges, and the alternative sources of credit.

Annual Percentage Rate (APR) – a disclosure required by law that states the percentage cost of credit on a
yearly basis

o All credit agreements, whether sales or loan credit, require disclosure of the APR.

In addition to interest, the APR includes other charges that may be made:

 Service fees – involve the time and money it takes a creditor to investigate your credit history, process your
loan or charge account application, and keep record of your payments and balance.

 Uncollectible accounts / bad debts or doubtful accounts – the cost of collecting from those who do not pay
their accounts may also be passed on to other borrowers

 Cost of credit insurance - This coverage repays the balance of the amount owed if the borrower dies or
becomes disabled.
 Total Dollar Charges --- To make you aware of the total cost of credit, the lender is required by law to tell you
the finance charge.

 Finance charge – the total dollar cost of credit

 Shown on either your initial contract or on your charge account statement .

18-3 Credit Application and Documents

Credit Application Process
 To obtain a loan or credit card, you must prove that you are a __ good credit risk __.
 Not everyone who wants credit will receive it.
Lenders want to be assured of two things, prior to giving you credit…
1.) Your ability to repay a debt
2.) Your willingness to do so

Three C’s of Credit --- In deciding whether to grant you credit businesses consider three main factors.
CHARACTER
CAPACITY
Refers to your honesty and CAPITAL / COLLATERAL
willingness to pay a debt when Refers to a person’s ability to
pay a debt when it is due The value of the borrower’s
it is due.
possessions.
If you have a history of paying The lender must decide if
your bills on time, creditors you have enough income to Includes investments,
believe you are a good risk. pay your bills. money, and property you
own.

The amount of capital gives

the lender some assurance
that you will be able to meet
Credit Applications
your credit obligations.
credit application – a form on when you provide information needed by a lender to make a decision about granting
credit.

One of the most important parts of a credit application is your ___ credit references ___.

credit references – businesses or individuals who are able and willing to provide information about your
creditworthiness.

Your _ signature _ on the application gives a lender permission to contact your credit references.

Actions to Establish Credit (ways to establish good credit at a young age)

 Making regular deposits to your savings account suggest you will be a good credit risk.
 Charging small purchases (pay off your account within 30 days)
 Having a good __ part-time or full-time job __ helps to start a favorable credit record.
 Being on a job for _ two or more years _ years.
 Pay your rent on time
 Cell phone bills.
Credit Bureau
credit bureau – or credit reporting agency, is a company that gathers information on credit users.

Credit bureaus sell information to businesses offering credit , finance companies , and
retail stores .

o Credit Bureaus keep debt records that show…_ if payments are up to date or overdue _.
o If you are new to an area the local credit bureau can obtain information from
_ your previous community _.

Credit Report --- a credit bureau uses your record to grade you as a _credit risk_
A credit report shows…

1.) the debt you owe

2.) how often you use credit
3.) whether you pay your debts on time

Your credit record is _ confidential - only you and those who have a legitimate reason for examining it can obtain it.

Credit Documents
KWYS – “know what you’re signing”

Before signing a credit contract consider the following questions…

 How much are the finance charges? Are they clearly shown on the contract?
 Does the contract include the cost of services you may need, such as repairs to a television or a washing
machine?
 Does the contract have an add-on feature so that you can later buy other items?
 If you pay the contract in full before the ending date, will the finance charge be reduced?
 Is the contract completely filled in before you sign? Be sure to draw a line through any blank space before
signing.
 Will you be given a copy of the contract?

Statement of Account --- you will receive a monthly summary of your account
statement of account – or simply the statement, is a record of the transaction
completed during the billing period.

Most statements report the following information:

The balance that was due when the last statement was mailed.
The amounts charge during the month.
The amounts credited to your account for payments or for returned items.
The current balance, which is the older balance + fiancé charges + purchases – payments
The minimum amount of your next payment and when it is due.

Accuracy of Records --- keeping accurate records will help you avoid _ credit record problems _.
Avoiding Fraud
- The _ Federal Trade Commission reports that credit card fraud is a major problem.
- __Keeping accurate records__ will help you to avoid credit fraud.
- To help prevent Internet Fraud, online credit card transactions require __account numbers__, __expiration
dates__, and __printed security numbers__.

18-4
Credit Problems and Assistance --- A person who cannot pay his or her bills when they are due might take these four
steps.

1.) Contact creditors and explain the situation

2.) Make a realistic proposal for when and what you can pay.
3.) Keep any promises you make.
4.) Make a written copy of your agreement to avoid problems later.

debt repayment plan – a creditor and a debtor develop an agreement to reduce payments to a more manageable level
and still pay off the debt.

credit counselor– discusses and suggest actions to take to reduce spending and eliminate credit difficulties.

bankruptcy – the legal process of reducing or eliminating an amount owed.

 The process is costly and requires legal assistance.

 Last resort option