Understand credit management
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Main types of credit
Common advantages and disadvantages of
businesses using credit
Cost of credit
Main factors examined for granting credit
Credit documents
Credit regulations
Credit assistance
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•An
agreement to obtain money,
goods, or services now in exchange
for a promise to pay in the future.
-When
buying on credit, you are
delaying the payment for an item.
“Buy now and Pay Later”
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Creditor
◦ One who sells on
credit or makes a
loan
Debtor
◦ Anyone who buys on
credit or receives a
loan
◦ Obligated to pay
back the loan
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Promissory Note
◦ Legal loan document
◦ Written promise to
repay with interest
Usury Laws
◦ State law that
restricts the amount
of interest that can
be charged.
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Closed-end credit
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◦ Used for a specific
purpose
◦ Loan of a definite
amount of money
◦ Loan balance reduced
with each payment
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Example: car loan
for $20,000 is a
specific, one time
amount of money
String examples
Open-end credit
◦ Gives a credit limit maximum $ you can
borrow
◦ Loan balance varies for
purchases/payments
made
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Example: credit
card with $500
limit. You might
spend $50 and pay
$10, spend 30 and
pay $25. The loan
amount “revolves”
as you spend and
pay back.
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Secured loans:
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Collateral-asset used as security on a loan
◦ Backed by collateral (help guarantee the
repayment of a loan)
◦ Backed by a cosigner who agrees to pay
◦ Can be taken by creditor if loan payments are
not made to creditor
◦ Mortgage loans- real estate
◦ Subject to Foreclosure if not paid
◦ Personal loans- car, motorcycle, boat
◦ Subject to Repossession if not paid
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Responsible for the
repayment of a loan if the
original party does not
pay
Party who signs with
applicant for a loan
Who might co-sign a
loan for you?
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Credit contracts
are legal binding
documents that
allow debtors to
use credit to
obtain goods and
services.
Know what you are
signing!
◦ Debtors should know the
content of the credit
contract before signing
such as:
Amount of finance charges
Repairs covered
Add-on features
Reduction of finance charge
if contract paid in full prior
to ending date
 Receive a copy of the
contract
 Repossession conditions
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◦ Comes once credit is
granted and purchases
are made on credit.
◦ Mailed monthly and
includes summary of
transactions completed
during the billing period
◦ May also view online or
access info by phone
What kind of information
may be found on the
statement of account?
 Previous balance
 Transactions:
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Purchases
Returns
Payments
Finance charges
Late fees
Rebates or bonuses earned
 Current Balance
 Minimum payment due
 Due date
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Charge Accounts
Credit Cards
Installment Credit
Consumer Loans
Payroll Advance Loans
Pawn Shop Loans
Life Insurance Loans
Retirement Plan Loans
Small Business Administration
 Business only
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Allows debtors to receive goods or services from
suppliers and pay for them at a later date
◦ Regular Charge Accounts
 Require that you pay for purchases in full within a
certain period of time
 EX: charge account with an electrician who wired your
house
◦ Revolving Charge Accounts
 Allows you to borrow or charge up to a certain amount
of money (credit limit) and pay back a part or the
entire balance each month
 EX: home equity line of credit
◦ Budget Charge Accounts
 Allows you to pay for costly items in equal payments
spread out over a period of time
 EX: a charge account with Progress Energy utility
company
*Unsecured Loans
Retail store, Single Purpose
– aka charge cards
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Balance and payments vary
Can only be used to buy goods or services at the
business that issued the card
Examples: JC Penney, Sears, BP
Multipurpose, Bank cards
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Revolving credit accounts
Balance and payments vary
May be used at different locations
Examples: Visa, Master Card
Travel and Entertainment
 Similar to charge accounts
 Must be paid in full each month
 Example: American Express, Diner’s Club
compare credit cards
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◦ Time period during
which no finance
charges will be added
to an account. From
monthly statement
cutoff until payment
is due!
Cash Advance
◦ Borrow money on a
credit card
◦ Costs more than
regular credit card
purchases
◦ *read your contract
before signing
application or taking
a cash advance!
Grace Period
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Maturity (due)
date is at least 14
days from
statement date. If
you pay account in
full by due date,
you will not usually
owe interest.
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Many stores provide revolving charge to
their customers
Users may earn points, bonuses, rebates
or get special unadvertised specials
Examples: Kohls, Sears, Best Buy, Belk
Installment loan - contract issued by the seller that requires
payments at specified times such as bi-weekly or monthly
until loan is paid in full
Used for: Student, mortgage, automobile loans
Ex: Buy furniture – pay monthly to Rooms To Go
Furniture Store
Ex: borrowing $1000 from a bank and agreeing to
make payments $105 for 10 months.
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Specialize in loans to people with poor
credit ratings
Cost of credit is higher than other
institutions
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Short-term loan
 “Borrow Until Payday” Loan
◦ Cost is extremely high
◦ includes flat fees, high interest rate
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You get cash ahead of getting your
paycheck.
Secured Loan- secured by promise
of paycheck
A short term loan
◦ Give up an asset (ring, watch)
◦ Pawnshop gives you cash
 Usually less than 50% of value
◦ You can get property back
 Time limit
 Pay amount & interest charged
◦ Pawn shop can sell your item
Secured Loan
◦ Cash Value
Insurance –
whole life
 Provides both
savings and death
benefits
◦ You cannot
borrow against
term life
insurance
policies…no cash
value
*Secured Loan-collateral is $ in cash value
Can legally borrow from
them but not
recommended since
the purpose is to have
money when you retire
*Secured Loancollateral is $ in
retirement plan
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Small Business Administration (SBA)
◦ Offers a number of financial, technical, and
management programs to help businesses
◦ Loan funds available
◦ Info available at local
Community colleges
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Consumers
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Businesses
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Government
◦ Local
◦ State
◦ Federal
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Federal government - uses credit to pay for:
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State & local governments-use credit to pay for:
◦ Public services and programs provided for its citizens
◦ Examples-military, foreign aid, roads, courts, prisons
◦ Loan sources include: Federal savings bonds, treasury bills,
bonds, notes
◦ highways, water systems, public housing , and stadiums,
airports
◦ Loan sources : municipal bonds, school bonds
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Municipal Bonds
– State and local governments use to finance
projects
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Savings Bonds
– Sold by federal government
– T-bills, T-notes, T-bonds
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Bonds – written promise to
repay a loan with interest on
a specific date
Buyer of the bond is the
creditor
• Corporate Bonds
– Usually used to finance
buildings and equipment
– Blue chip companies vs. junk
bonds
– Part of investment portfolio
Bond is an investment for creditor
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Marty borrowed $450 for 12 months from
First Federal Bank to buy a bike at 8%
APR.
Who is the creditor?
Who is the debtor?
What is the interest rate?
What does APR stand for?
How much will his monthly payment be?
“Creditors have better memories
than debtors.” -Benjamin
Franklin
Do you agree or disagree with
this quote and why?
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Convenience
◦ Shop without carrying cash
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Immediate Possession
◦ Allows possession of goods or services now
◦ Especially BIG TICKET ITEMS
 Homes, business expansion
◦ Buy now, pay later
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Emergencies
◦ Helps in case
of a serious situation
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Establishing favorable credit rating
Keeping business separate from personal
expenses
Earning rewards/points
Minimizing record-keeping and receipts
Keeping track of what employees are
spending
Saving Money –Buy item when it is on sale
without cash
Growth of the Economy-Buying goods &
services helps stimulate the economy
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Theft of customer
records/databases
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Overbuying by employees
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Overusing Credit
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Credit Fees - Interest paid
on balance
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Bad Credit Rating
◦ Higher interest rates in future
◦ Inability to get loan in future
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Repossession/Foreclosure
◦ Loss of property because of
failure to repay loan
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Bankruptcy
◦ Can’t qualify for credit for
seven years
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Using someone else’s money has a cost.
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Interest is the cost of using someone else’s money.
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Factors for computing interest include:
◦ Principal, P = Amount of the loan
◦ Interest Rate, R = Percent of interest charged or earned.
◦ Time, T = Length of time for which interest will be charged,
usually expressed in years or parts of a year.
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Formula for computing simple interest:
I
=
P
x
R
x
T
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How is time determined for a loan for each of the following lengths?
◦ Years – multiply by # of years
◦ Months – ex 2/12
◦ Days 24/365
How is the maturity date calculated?
◦ Months-the maturity date is the same day of the month that the
loan was made.
◦ Days-Determine the day the loan was made, and then count the
exact number of days of maturity.
How is a decreasing loan payment calculated?
◦ Interest is calculated on the amount of the loan that is unpaid.
What is disclosed in APR?
% cost of credit, service fees
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5.
6.
Credit Application
Documentation
Processing
Underwriting
Closing
Funding
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Form used to provide information needed by a
lender to make a decision about granting credit
(approving a loan).
Fill out completely, accurately, & honestly
Requires signature of applicant, which indicates
provided information is true
Credit decision must be based on your ability
to repay a loan, Other discrimination is
illegal.
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Provide the following information:
◦ Salary, Employer,
◦ Outstanding Credit (Debt), Credit References
◦ Assets, Checking and Savings Accounts, Stock
Portfolio, etc.
◦ Disclose every piece of information about your
financial background to obtain loan
◦ Be honest!
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Creditor will collect and verify necessary
documentation for the extension of
credit.
◦ Examples: Bank statements, credit card
statements, past W-2’s, etc.
◦ Verify using phone, mail, documents
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Credit data make up the information that
applicants provide on credit applications.
Documentation of credit data may be
verified by:
◦ Employers (former and current)
 Type of data: Employment dates and salary
◦ Financial institutions
 Type of data: Saving or checking accounts
◦ Personal references
 Type of data: Manner how personal business is conducted
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Information provided by Credit Bureaus
◦ Credit bureaus sell lenders credit information about
credit users such as debt records, payment history,
and if any action has been taken to collect overdue
bills
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Lender builds loan file
Evaluates credit worthiness
Creditors examine factors
about potential debtors
when deciding whether to
grant them credit
◦ The C’s of Credit Worthiness
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Capacity
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Character
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How much debt can comfortably be handled?
Considers current income and debt levels
Honesty to pay debt when due
Earned by paying bills on time and being a
trustworthy, reliable, stable person financially
References – people you have borrowed from
in the past who indicate you paid on time
Capital (money)
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How much you have beyond what you owe
Current available assets that could be used to
repay debt if income was unavailable
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Review loan info for soundness,
creditworthiness
Make decision about granting credit
Consumer Reporting Agencies
◦ Company that compiles and keeps records on
consumer payment habits.
◦ Used to evaluate creditworthiness
 Examples: Equifax, Experian, and TransUnion
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Representative explains terms of creditusually loan officer
Attorney may be present at closing,
especially real property
Debtor/creditor sign contract
Contract is binding on signing parties
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KWYS – know what
you’re signing
READ and
UNDERSTAND
BEFORE signing any
contract
Contract – legally
binding agreement
between two parties
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Creditor issues money/funds to the
debtor for the item purchased
Example: mortgage company pays seller
in full, debtor then pays mortgage
company monthly installments to repay
the loan
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Legally binding documents that allow debtors
to use credit to obtain goods and services
Debtors should know the content of the credit
contract before signing such as:
Amount of finance charges
Repairs covered
Add-on features
Reduction of finance charge if contract paid in full prior
to ending date
• Receive the copy of the contract
• Repossession conditions
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•
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Printed monthly once credit is granted and
purchases are made on credit (also online)
◦ Includes summary of transactions completed during
the billing period
What kind of information may be found on the
statement of account?
Balance due
Amounts charged during the billing period
Amounts paid during the billing period
Current balance
Minimum amount of next payment
Late fees, interest charges
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Steps in Order:
1.___credit application
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2.___documentation
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3.___processing
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4.___underwriting
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5.___closing
6.___funding
Description of Activity
A. loan officer builds a loan file
B. borrower completes form info for
lender to review
C. creditor issues money to the
debtor
D. debtor/creditor sign contract
E. creditor collects and verifies
information
F. loan officer reviews loan for
creditworthiness
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Fair Credit Opportunity Act requires
that credit denial cannot be based on
sex, family, religion, etc.
Loan decision must be based on
ability to pay back loan.
http://www.youtube.com/watch?v=1u4NpD_sZy0
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Credit Bureau
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Corporations: Standard & Poors, Fitch Rating,
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Individuals: Equifax, Experian, TransUnion
◦ An agency that collects information & calculates a
score/rating on how promptly people/businesses
pay their bills
◦ Information retrieved from banks, finance
companies, landlords, retail stores, utility
companies, stores, credit card companies
Moody’s
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Open a checking or
savings account
Apply for a local
department store charge
card
Apply for a multipurpose
credit card
Take out a small loan from
local bank
PAY ALL LOANS, BILLS,
AND CREDIT CARDS ON
TIME!!!
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Nick wants to buy a four
wheeler. It costs $2500.
He has $500 for a down
payment. He qualifies
for a bank loan for
$2000 @ 5% simple
interest. The bank sets
up payment terms of
monthly installment for
2 years beginning on the
10th of next month.
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Questions
What is Nick’s
principle?
What is the interest
rate?
What is the time?
When is maturity date?
How many payments
will Nick make?
How much interest
will Nick pay in 2
years?
What is the total cost
of the 4-wheeler?
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Use Interest formula to calculate Nick’s
finance cost.
I= Interest (finance charges/fees)
P= Principle
R= Rate (APR % charged)
T= Time (year or portion of year)
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I=P*R*T
I=2000*5%*2
I=$200
What is the total cost to Nick for purchasing
the four wheeler?
$2500 + 200 interest paid=$2700
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What would happen to the interest fees if
Nick paid off the loan in 6 months?
I=2000*5%*6/12 (6 out of 12 months)
I=$50
Protect rights of credit applicants & rights of
credit users from fraudulent & unfair
practices
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Truth in Lending Law (TILA) requires lenders
to reveal the cost of credit (APR & $ amount
of finance charge) & terms before signing an
application or contract
Federal Trade Commission (FTC) enforces
laws on credit
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 allows credit applications be judged on
financial responsibility of credit applicants.
 Cannot discriminate based on gender, age, ethnicity, or
religion
 Credit can be denied due to these areas of responsibility:
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Income too low
Other large debts compared to income
Poor payment record in past
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Fair Credit Billing Act
 requires creditors to
correct billing
mistakes promptly.
Fair Credit Reporting
Act
 allows individuals to
scrutinize any
information shared
by credit reporting
agencies with
potential creditors
and employers.
Individuals also may
correct any incorrect
credit information.
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prohibits deceptive, harassing, and unfair
practices for collecting debt from debtors.
Collectors:
◦ Must identify themselves
◦ Cannot tell others about debt
◦ Cannot harass debtor
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Consumer Credit Reporting Reform Act
◦ requires that credit reporting agency must be able
to prove that credit information they provide is
accurate.
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Amendment to the Truth in Lending Act
Institutes fair and transparent practices of
providing credit
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Some practices are instituted by the CARD Act
are:
– Inform customers of increase of cost of credit not
less than 45 days prior to effective date.
– Provides information about how long it would take
to pay off a loan if minimum payments are paid.
– Protects potential credit consumers under the age
of 21, who must have a cosigner with a means to
repay debt of the consumer.
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Debt repayment plan
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Credit counseling
 Is an agreement
between a creditor and
debtor that allows the
debtor to pay off a
debt with more
manageable payment
plan.
 Provides information
on actions to take in
order to manage debt,
one on one with
debtor.
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Bankruptcy
 May be used by
debtors to reduce debt
or amount owed to
creditors. Legal
process in which some
or all of the assets of a
debtor are distributed
among the creditors
because the debtor is
unable to pay his or
her debts.
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Chapter 7 (Liquidation)
 List assets and
liabilities
 Most of the debtor’s
assets are sold to pay
off creditors
(liquidation)
 Cannot release debt
on alimony, child
support, taxes, fines,
educational loans, or
court fees
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Chapter 13
 Propose a plan for
using future earnings
and assets to
eliminate debts over a
period of time
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Reorganization of debt, re-negotiating terms
of debt to stay in business
For Businesses Only
Creditors often accept terms to get partial
payment, or an extended period to get paid,
rather than not get repaid at all!
Chapter 11 bankruptcy reorganization: what is
it and how does it work
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