Unit 4: Chapter 16Credit In America 16.1 Credit: What and Why 16.2 Types and Sources of Credit
Section 1: Credit: What and WhyKey Terms • Credit: Is the use of someone else’s money, borrowed now with the agreement to pay it back later. • Debtor: A person who borrows money from others. • Creditor: A person or business that loans money to others. • Capital: The value of property you possess (such as bank accounts, investments, real estate, and other assets) after deducting your debts. • Collateral: Property pledged to assure repayment of a loan. • Finance Charge: The total dollar amount of all interests and fees you pay for the use of credit. • Line of Credit: A pre-established amount that can be borrowed on demand with no collateral. • Deferred Billing: A service available to charge customers whereby purchases are not billed to the customer until much later than the standard billing time.
The Need for Credit • Over 80% of all U.S. purchases are made with credit rather than cash. • Credit rose when the U.S. from a bartering and trading society to a currency exchanging economy. • Items were manufactured in mass for sale to others. People no longer produced everything exclusively for their own use. • With the money they made, they were able to buy the things they previously had to make for themselves. Soon the need developed for sources of credit to help families meet their financial needs.
Early Forms of Credit • One of the earliest forms of credit was the account at the general store. • Wage earners or farmers would pick up supplies and put the amount due “on account.” • When the borrowers received a paycheck or sold a harvested crop, they would pay their account in full, and the charging process would begin again. • Credit was a convenience that storeowners provided for customers they knew well and trusted. The customers paid off their accountsas soon as they could.
Credit Today • Credit today is a way of life. • Banks, stores, and credit card companies offer credit in the form of cards, loans, and lines of credit. • Millions of Americans are overextended with credit. They have adopted a lifestyle that is dependent on the use of credit to make ends meet. • They are barely able to make the minimum payment on outstanding debt and resort to tactics such as using one credit card to pay another credit card.
Qualifying for Credit • To qualify for credit, you must have the ability to repay the loan. Qualifications are based on three things: income, financial position, and collateral. • You need to have a job and earn an income in order to make loan payments. • Your financial position is based on capital. • Having capital tells the creditor that you have accumulated assets, which indicates responsibility. • To borrow large amounts of money, creditors often want more than just your promise to repay; they want collateral. • For example, when you buy a car on credit, the car serves as collateral. If you do not repay the loan, the car can be repossessed.
Making Payments • The principal (amount borrowed) plus interest for the time you have the loan is called the balance due. • The payments include both principal and interest, and with each payment, the amount you owe is reduced. • Credit card or store account statements usually specify a minimum payment. This is the least amount you may pay that month under your credit agreement, though you may pay more to further reduce your debt. • given 10 to 25 days from the date you receive a bill in which to pay.
Advantages of Credit • Credit can greatly expand your purchasing power and raise your standard of living. • Credit can provide emergency funds. • Credit customers often get better service.
Disadvantages of Credit • Credit purchases may cost more than cash purchases. • Finance charges • The larger your balance and the longer you take to pay it off, the greater the finance charges. • You tie up future income, you commit to making payments. This puts a strain on your budget.
Section 2: Types and Sources of CreditKey Terms • Open-end credit: where a borrower can use credit up to stated limit. • Annual percentage rate: The cost of credit expressed as a yearly percentage. • Grace period: A time frame within which you may pay your current balance in full and incur no interest charges. • Closed-end credit: A loan for a specific amount that must be repaid in full, including all finance charges, but a stated due date. • Service credit: The providing of a service for which you will pay later. • Finance company: An organization that makes high-risk consumer loans. • Loan sharks: Unlicensed lenders who charge illegally high interest rates. • Usury law: A state law that sets a maximum interest rate that may be charged for consumer loans. • Pawnbroker: A legal business that makes high-interest loans based on the value of persona; possessions pledged as collateral.
Open-end Credit • Credit card accounts are an open-end form of credit. • Charge Cards • A consumer promises to pay the full balance owed each month. • American express is an example of a charge card. • On all charges, the balance must be paid in full when bill is received. • 25 day billing period is common. • Often include rewards or rebates based on purchases. • Revolving Accounts • Consumer has the option each month of paying in full or making payments at least as high as the stated minimum. • Minimum payment is based on amount of balance due. • Retail store cards (department stores and gasoline company cards)
Open-end Credit Cont. • Credit Card Agreements • Credit card companies keep a record of transactions made on your account and send you a bill at the end of each billing period. • Pay off total at the end of each month, probably avoid finance charge. • Annual Percentage Rate: • The APR must be disclosed to you when you open the account and must be noted on each monthly bill. • APR variable rate, can be very high on credit cards. • Grace Period: • 10- 15 days. • If no grace period specified, the card issuer will impose an interest charge from the date you use your credit card.
Open-end Credit Cont. • Annual Fees: • Charge an annual fee. • Fee can range $15 to $ 35 or more. • You must pay whether or not you use the card. • Transaction Fees: • If you use credit card check, pay by phone, or request a balance transfer, may be charged a transaction fee. • Fees run from 3 to 10 percent of the transaction account. • Penalty Fees: • Pay late or go over charge, you may be charged with a penalty fee. • $30 to $50 • Method of Calculating the Finance Charge • Paying purchases over time, card issuer will calculate your finance charge. • Sometime make a difference, in how much you pay.
Closed-end Credit • Used to pay for items, such as: cars furniture, or major appliances. • Often called installment credit. • Does not allow continuous borrowing or varying payment amounts. • Sometimes the down payment is required.
Service Credit • Almost everyone uses some type of service credit. • Your telephone and utility services are provided for a month in advance; then you’re billed. • Many businesses—including doctors, lawyers, hospitals, dry cleaners, and repair shops—extend service credit.
Retail Stores • Sells goods directly to consumers. • Department stores, discount stores, and specialty stores. • Offer their own credit cards, these cards are only accepted by issuing stores. • With store credits receive discounts, advance notice on sales, and other privileges not offered to cash customers. • Most retail stores also accept credit cards by credit card companies.
Credit Card Companies • Visa, MasterCard, American Express, Discover. • These are generally accepted nationwide or even internationally. • Affinity cards are credit cards sponsored by professional organizations, college alumni associations, and some members of the travel industry. • With an all-purpose credit card, you have an automatic line of credit up to the limit of the card. Allows you to take a cash advance. • Access Checks are supplied by the credit company, look like a check and treated by the credit card company as a purchase. • Some companies offer both charge cards, where the balance must be paid in full each month, and credit cards, where you’re required to only pay a portion of the balance each month.
Banks and Credit Unions • In addition to offering credit cards, commercial banks and unions make closed-end loans to individuals and companies. • Loan money to consumer for specific purchases, such as a home, car, or vacation. • Interest on closed-end loans tend to be lower than credit cards. • Credit unions make loans to their members only. • Credit unions are nonprofit and are organized for the benefit of members. • Credit unions are willing to make loans.
Finance Companies • Two types: Consumer finance companies and Sales finance companies. • Consumer Finance company makes most of it’s loans to consumers who are buying durable goods. • Durable goods are items expected to last several years, such as automobiles, appliances, and electronics. • Sales Finance Company make loans to consumers through authorized representatives, such as car dealerships. • Finance companies take more risks than banks. • More careful to protect their loans.
Finance Companies • Loan sharks are unlicensed lenders who charge illegally high interest rates. • Difficult to eliminate such practices, which take advantage of the poorest members of society. • Usury law is a state law that sets a maximum interest rate that may be charged for consumer loans. • In states where usury laws exist, finance companies charge maximum rate allowed.
Pawnbrokers and Private Lenders • Customer brings in an item of value to be appraised. • Pawnbrokers makes a loan for considerably less than the appraised value of the item. • Pawnshops give only 10 to 25 percent of the value of the article. • Most give no more than 50 to 60 percent. • Private Lenders are one of the most common sources of cash loans. • Friends, parents, other relatives, and so on. • Can not charge interest or require collateral.