Credit Management 5.01 Understand Credit Management
Topics: • 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
CREDIT… • What is Credit? • What are the different types of Consumer Credit? • What are some Advantages/Disadvantages to using Credit? • How do you establish credit? • What are Loan Sources • How do you ‘Shop’ for Credit? • What is Good Credit? • What is a Credit Report • What are some signs of a debt problem? • What is Bankruptcy?
Main Types of Credit • Consumer Credit • A debt that someone incurs for the purpose of purchasing a good or service. This includes purchases made on credit cards, lines of credit and some loans. • Consumer Debt • Commercial Credit • Pre-approved amount of money issued by a bank to a company that can be accessed by the borrowing company at any time to help meet various financial obligations. • Commercial credit is commonly used to fund common day-to-day operations and is often paid back once funds become available. • May be called “Commercial Line of Credit”
Main Types of Credit • Credit: An agreement to obtain money, goods or services now in exchange for a promise to pay in the future • Main Types of Credit • Charge Accounts • Credit Cards • Installment Credit • Consumer Loans
Charge Accounts • A Charge Account represents a contract between creditors and debtors. Charge accounts allow debtors (customers) to receive goods or services from suppliers (creditor) and pay for them at a later date. • Examples • Regular Accounts • Budget Accounts • Revolving Accounts
Charge Accounts • Regular Accounts • Requires the buyer to make a full payment within a stated period • Used for everyday needs and small purchases • Example: charge account with an electrician who re-wired a house • Budget Accounts • Requires that a customer make payments of a fixed amount over several months • Example: A charge account with Progress Energy utility company
Charge Accounts • Revolving Accounts • Most popular form of sales credit • Charge purchases at any time, but only part of the debt must be paid each month • A credit limit is set for the maximum amount to be spent • Payments are required once a month, but it doesn’t have to be the FULL payment • A finance charge is added if the total bill is not paid (total dollar amount spent plus interest)
Credit Cards • Credit Cards allow debtors (customers) to receive goods and services from suppliers (creditor) using credit cards and pay for them later. • Types of credit cards • Bank • A bank will pay the business (taking liability for payment) • Customers are required to pay a fee for using the credit card • Examples • MasterCard, VISA
Credit Cards • Travel/Entertainment • Pay a yearly membership fee • Expected to pay the full balance each month • Examples: American Express, Diners Club • Oil Company • Examples: BP Oil, Exxon • Retail Store • Cards offered by a particular store • Examples: Belk, Kohl’s
Installment Credit • Installment Sales Credit is a contract issued by the seller that requires intermittent payments at specified times such as bi-weekly or monthly. • Customers are required to make a down payment which is a portion of the entire purchase. • Most often used for furniture and household appliances • Examples: • Rooms to Go Furniture • Aaron’s
Consumer Loans • A Consumer Loan is when a buyer agrees to make monthly payments in specific amounts over a period of time. • Example – • Student Loans, Automobile Loans, Home Loans, etc. • Borrowing $1,000 from a bank and agreeing to make $100 payments for a period of time.
Consumer Loans Two Parties: • The borrower receives money up front and agrees to pay the price back in full plus interest • The lender needs some assurance that the borrower will pay the money back. • Promissory note • Collateral (property used as security) • Cosigner
Consumer Loans • Promissory Note • A written promise to repay based on a debtor’s excellent credit history. Guarantees that ‘someone’ will repay the loan: • Collateral • An item promised to the lender if the borrower does not pay back the loan. • Cosigner • A person who agrees to pay back the loan if the borrower fails to.
Business Advantages for using Credit • Establishing a favorable credit rating • Keeping business separate from personal expenses • Minimizing record-keeping and receipts • Keeping track of what employees are spending • Earning rewards
Business Disadvantages for Using Credit • Experiencing theft of customer records/databases • Overbuying by employees • Overusing credit
Cost of Credit • Interest (I) • The cost of using someone else’s money • Principal (P) • Amount of the loan • Interest Rate (R) • Percent of interest charged or earned • Time (T) • The length of time for which the interest will be charged • Expressed in years
Cost of Credit • Simple Interest • I=P*R*T • Time in Years • Multiply by the number of years • Time in Months • Divide the number of months by 12 • Time in Days • Divide the number of days by 360
Cost of Credit • Maturity Date • The date on which a loan must be repaid • Months • The maturity date is the same day of the month that the loan was made • Example: One month loan on January 15 will be due on February 15 • Days • Determine the day the loan was made, and then count the exact number of days of maturity • Example: A 90-day loan made on March 4 will be due on June 2
Cost of Credit • Installment Interest: When a loan is repaid in partial payments Calculation: • Calculate out how much Interest you owe • I = P x R x T • Calculate the Total Cost of the loan • Total Cost = P + I
Cost of Credit Calculation: • Determine the Number Of Payments • Based on how often you are required to make payments • Generally, you make monthly payments • # payments = # years * 12 [because there are 12 months/yr] • Calculate your Payments • Payments = Total Cost / # of payments
Cost of Credit • Decreasing Loan Payments • Interest is calculated on the amount that is unpaid at the end of each month • Calculation: • Interest is calculated on the amount of the loan that is unpaid. • Interest = Unpaid Balance * Interest rate • Remember: The amount of interest is based on the portion of the year. • 1 month is 1/12th of a year • Interest Rate for 1 month = Annual Interest Rate / 12 • Monthly Payment = Interest + Loan Repayment
Cost of Credit • Annual Percentage Rate (APR) • A disclosure required by law on all credit agreements • States the percentage cost of credit on a yearly basis • Also includes service fees
Three C’s of Credit • Character • Honesty to pay a debt when it is due. • How past debt obligations were handled • Capacity • Refers to a person’s ability to pay a debt when it is due • How much debt can a person handle • Capital • Current available assets that could be used to repay debt if income wasto become unavailable
Credit Application • A form on which you provide information needed by a lender to make a decision about granting credit. • Credit references businesses or individuals who are able and willing to provide information about your creditworthiness • Should be filled out completely, accurately, and honestly. • Requires signature of applicant, which indicates provided information is true.
Creditworthiness: • An assessment of the likelihood that a borrower will default on their debt obligations. • Based Upon: • History of Repayment • Credit Score
Documenting Credit Data • Credit data makes 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
Credit Bureaus What is a Credit Bureau? • A company that gathers information on credit users (credit reporting agency) • 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.
Credit Bureaus • Credit bureaus create a credit report to show the debts an individual owes, how often the individual uses credit, and whether the individual will pay their debts on time. • 3 Main Credit Bureaus • Equifax • TransUnion • Experian
Credit Documents Credit Contracts • KWYS “Know what you’re signing” • Credit contracts are legal binding documents that allow debtors to use credit to obtain goods and services.
Credit Documents Credit Contracts • 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
Credit Documents Statement of Account “The Bill” • A record of the transactions completed during the billing period • Statement includes… • Balance that was due from last statement • Amounts charged during the month • Amounts credited to your account for payments or for returned items • The current balance (old balance + finance charges +purchases – payments) • The minimum payment due
Credit Regulations • Truth-in-Lending Law • Requires lenders to reveal the cost of credit (APR and finance charge) and terms before signing an application or contract • Protects consumers against unauthorized use of credit cards
Credit Regulations • Equal Credit Opportunity Act • Prohibits creditors from denying a person credit because of age, race, sex, or marital status • Allows credit applications be judged on financial responsibility of credit applicants. The three areas of responsibilities are low income, large debts, and a poor payment record.
Credit Regulations • 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.
Credit Regulations • Consumer Credit Reporting Reform Act • Requires that the credit reporting agency must be able to prove that credit information they provide is accurate. • Fair Debt Collections Act • Prohibits deceptive, harassing, and unfair practices for collecting debt from debtors.
Credit Regulations • Credit Card Accountability, Responsibility, and Disclosure Act • An amendment to the Truth in Lending Act • The act institutes fair and transparent practices of providing credit.
Credit Regulations 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.
Credit Assistance • Debt Repayment Plan • An agreement between a creditor and debtor that allows the debtor to pay off a debt with more manageable payment plan • Credit Counseling • Provides information on actions to take in order to manage debt (reduce spending and eliminate credit difficulties)
Credit Assistance • Bankruptcy • The legal process of reducing or eliminating an amount owed • Only should be used for extreme situations • Stays on your credit record for 10 years • Chapter 7 – must sell certain personal belongings, use proceeds to repay debts • Chapter 13 – can retain most personal property, but must propose a repayment plan, go to credit counseling, receive financial management education, and be employed