Chapter 5
Introduction
to Consumer
Credit
Kapoor
 2006 McGraw-Hill Ryerson Ltd.
Dlabay
Hughes
Ahmad
Prepared by Cyndi Hornby, Fanshawe College
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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.
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Learning Objective # 1
Define consumer credit and
analyze its advantages and
disadvantages.
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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
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Consumer credit is the amount of credit
used by consumers to purchase noninvestment 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
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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
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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
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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 I’ll 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?
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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
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Disadvantages of
Consumer Credit
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Purchases are more expensive
Temptation to overspend
Ties up future income.
Possible financial difficulties
Damage to family relationships
Slows progress to future goals
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Learning Objective # 2
Differentiate among various
types of credit.
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Types of Credit
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
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Open-End Credit
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
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Credit Cards
MasterCard
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.
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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
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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
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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
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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.
Don’t 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.
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Protecting Yourself
Against Credit Card Fraud
Immediately report if lost or stolen.
Notify issuer if you don’t 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
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Protecting Yourself
Against Credit Card Fraud
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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
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Personal Lines of Credit
Revolving line of credit
Interest rate linked to lender’s prime
rate
Withdraw up to specified limit using
debit card or cheques
Repay minimum stated or more
Secured with assets
GIC’s or home equity
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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
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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
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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
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Home Equity Loans
vs. Second Mortgage
Similar to a 2nd 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
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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
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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….)
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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
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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
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Learning Objective # 3
Assess your credit capacity
and building your credit
rating.
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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
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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
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Credit Capacity Indicators
Debt Payments-to-Income Ratio
monthly payments*
net monthly income
should not exceed 20%
*Not including housing
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Ex:
Monthly credit payments are $760 and net
income is $3,800
Debt-payments ratio
• $760/$3,800 = 0.20 = 20%
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Credit Capacity Indicators
Debt To Equity Ratio
total liabilities
=
Should be < 1
net worth*
*Excluding home value
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Ex:
Long-term debt of $3,000 and owner’s
equity of $12,000
The debt/equity ratio
• 3000 / 12000 = 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
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Co-Signing a Loan
You are considered as a co-debtor or co-owner
of the loan
Guaranteeing a debt
If borrower doesn’t pay the debt you will have to
Including fees and collection costs
Statistics show that 3 out of 4 co-signors have
to pay
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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
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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
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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
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 Cheques returned for insufficient funds
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Credit Bureaus
Equifax Canada
• www.equifax.ca
Trans Union Canada
• www.tuc.ca
Experian
• www.experiance.com
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
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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
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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%
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Credit Scoring
Used by lenders to assess the risk of
prospective borrower’s
Data is credit report is summarized in a
credit score
Helps to predict creditworthiness
Higher the score the better
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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
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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
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Learning Objective # 4
Describe the information
creditors look for when you
apply for credit.
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What Creditors Look For: 5 C’s
Character – Borrower’s attitude towards
credit obligations
Capacity – Borrower’s financial ability to
meet credit obligations
Capital – Borrower’s assets or net worth
Collateral – Valuable assets that is pledged
to ensure loan payments
Conditions – the general economic
conditions that can affect borrower’s ability to
repay a loan
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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
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Learning Objective # 5
Identify the steps you can
take to avoid and correct
credit mistakes.
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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
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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
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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
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Summary of Learning Objectives
Describe the information creditors look for
when you apply for credit
Character
Capacity
Capital
Collateral
Conditions
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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
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