Credit
Understanding
Credit
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Credit: the supplying of money,
goods, or services at present in
exchange for the promise of future
payment
Creditor: the business or
organization that extends credit
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Principal: the original amount
borrowed
Ex: you borrow $5,000, You pay a
total of $5,754 when payments are
done
$5,000 is your principal, $754 is your
interest
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Types of credit:
Cash credit: if you take out a loan
and receive cash/check
Sales credit: you buy something
now and wish to pay for it later
Secured credit: is backed by a
pledge of property
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Collateral: the property that is
pledged to guarantee repayment of a
loan
Collateral reduces the lender’s risk,
the lender has a security interest
This means that they can take your
property if you fail to repay the loan
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Closed-end credit: is a one-time
extension of credit for a specific
amount and time period. The total
interest paid is known at the
beginning of the loan
Ex: car loan
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Open-ended credit: cardholders
makes monthly payment on all or
part of an account balance
Also known as a line of credit
Ex: credit cards, equity loans
The interest paid is determined by
the length of time and amount of
your balance
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Installment loans: a set portion of
the loan amount that the borrower
must pay at regular scheduled
intervals.
Ex: furniture store allows you to
purchase a item and pay for it in
four easy payments
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Pros and cons of credit
Advantages:
1. Temporary expansion of income,
especially helpful with unexpected
expenses
2. Convenience: You can carry less
cash, shop online,
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3. Financial responsibility: good
credit provides proof to others of
financial responsibility
Costs of credit:
1. Interest and fees, also known as
finance charges
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2. Increased cost of merchandise,
retailers may increase their prices to
help pays the must pay banks to
collect their credit sales
3. Opportunity cost: in the long run
it reduces your purchasing power.
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Other credit concerns:
1. Security: risk of being lost, stolen,
or used fraudulently
2. Impulse buying: May cause you
to buy on the spur of the moment
without considering the purchasing
decision
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3. Overspending: Can make
purchases seem free, will lead
into financial trouble down the
road
What are some guidelines that
should be put into place?
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Three C’s of credit:
1. Character: refers to a person’s
reputation concerning repaying debt
on time
2. Capacity: refers to a persons
earning power and their ability to pay
debt from a regular income
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3. Capital: refers to items owned or
assets available to the creditor if
necessary
Credit history: a pattern of past
behavior in regard to repaying debt.
Equal Credit Opportunity Act:
ensures that all consumers are given
equal chance to obtain credit
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Credit Bureau: known as credit
reporting agency's. They collect
information about credit worthiness
of consumers.
They get info from stores, banks,
and from public record
Equifax, Experian, and Trans Union
are three national credit agencies
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When credit bureaus and agencies
compile info it is put into a
Credit report: a record of particular
consumer’s transactions and payment
patterns
It includes the number of credit cards
open, balances, monthly payment
amounts, and late payments
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If you get approved for a loan and
the interest rate paid is determined
by your
Credit rating: an evaluation of a
consumers credit history
Your rating leads to a numerical
score known as your
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Credit score: a numerical rating based
on credit report information
These scores range from 300 to 850
Fair Credit reporting Act: assures
consumers rights to access his or her
credit file and dispute incorrect
information
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Establishing credit:
1. Open a checking and savings
account, make regular deposits, and
avoid overdrawn checks
2. Put utility bills in your name and
pay bills promptly
3. Apply for a credit card and use the
card. Pay the bill on time.
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Another way to establish credit is to
have a cosigner
Cosigner: a person with a good credit
history who also signs the application
Secured credit card: one that requires
you to keep a savings account as
security
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Types of cards
1. Private Label: can only be used at
a single retailer ex: JC Penny
2. General purpose: known as bank
cards or major credit card. Can be
used across the country and ATM’S
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Revolving credit: card holder has
several options of payment
1. Pay in full.
2. Pay minimum
3. Pay amount in between
Interest accrues in balance is not
paid in full
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Credit card variations:
1. Status cards; gold or platinum
cards usually have an increased line
of credit and benefits. May have
higher annual fee
2. Co-branded cards: carry the name
of both the card network and
company. Shell/Visa United/Visa
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Affinity cards: carries the name of a
non-profit or charitable organization.
These groups will receive a small
percentage of every dollar charged
Smart cards: have computer chips
which store information
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Things to compare between cards will
include:
Annual fee, APR (annual percentage
rate)
Fixed or variable rate
If you are offered an introductory or
teaser rate look at the terms after the
rate expires
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Grace period: a period of time
during which the balance may be
paid in full to avoid finance charges
Typically grace periods run 20 to 25
days
Also compare minimum payments,
fees for late payments, cash
advances, annual fees
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Credit Limit: the maximum amount
of credit that the creditor will extend
to the borrower.
Do not be fooled by incentives and
special offers
Truth and Lending Act: Lenders
must adequately inform consumers
about credit terms and costs
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Use credit wisely, Remember to
1. Set limits for yourself
2. Pay the full balance when possible
3. Pay bills on time to avoid late
charges or interest rate hikes
4. $1,000 will take you over 20 years to
pay off if you pay minimum payments
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Fair Credit Act: outlines
procedures for settling
credit card disputes
You must contact them
within 60 days of finding
an error in writing
They must respond in 30
days; 90 days to resolve
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Types of loans:
Mortgages: are closed-end
installment loans Home serves as
security for the loan. Loans can
range from 15 to 50 years
Equity: the difference between what
you owe on a home and its market
value
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Home equity loan: loan that uses the
equity in your home as security. Can
be used for a number of purposes
Other loans include, vehicle loans,
education or student loans, personal
line of credit
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Consumer Finance Company: are
business that specialize in making
small and personal loans
The typical borrower is usually a
greater credit risk, because of the risk
the lenders fees and interest rates are
usually much higher than a bank
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Insurance policies can be a source
of a loan, as can Payday loans
Payday loans: short term, high
interest rate loans, typically must be
paid back in a two week to one
month period
Interest rates can run as high as
500%
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Concepts and terms to know:
Loan shark: unlicensed lender who
operates illegally and charges
excessive interest
Down payment: a portion of the
purchase price paid at the time of
purchase Ex: $2,000 down on a
$15,000 auto purchase
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Balloon Payments: a final payment
that is much larger than the other
installment payments
Acceleration clause: gives the seller
the right to declare the entire
balance due if the buyer misses even
one installment payment
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Add-on clause: allows additional
purchases to be added on to an
installment contract
Right of rescission: If you are
pledging your home as security, you
have the right to cancel the loan
within 3 business days
Cancellation must be in writing
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Delinquent: over due payments
Default: failure to fulfill the obligations
of a loan, more aggressive action will
be taken to collect the debt
Repossession: Taking away property
due to failure to make payments
Services can also be shut-off
Ex: electric or water
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Collection agency: business that
collects unpaid debt for others.
They receive a portion of what they
collect
Collection agencies reflect very
poorly on your credit ratings
Lien: a claim upon property to
satisfy a debt
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Garnishment: the legal withholding of
a specified sum from a persons wages
in order to collect debt
Credit counseling: programs to help
train people to learn to live with-in
their means
Debt consolidation loan:combines all
existing debt into a new loan with
more manageable payments
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Bankruptcy: legal relief from
repaying certain debt
Chapter 7 May lose property,
creditors is receive the money from
sales
Chapter 13 debtor keeps property,
submit plan approved by courts