Responsibilities and Costs of Credit Chapter 18 Responsibilities and Costs of Credit

Lesson 18.2 Analyzing and Computing Credit Costs Why credit costs vary Computing the cost of credit

Why Credit Costs Vary Several factors determine the cost of credit: Source of credit – type of lender (bank, credit union, credit card company, etc.) Amount financed and length of time – the more money borrowed and longer time to pay it back will increase cost of credit Ability to repay debt – income and creditworthiness reduce cost of credit Type of credit selected – credit plans

Why Credit Costs Vary Several factors determine the cost of credit: Collateral – secured loans have lower interest rates Prime rate – the interest rate that banks offer to their best business customers Economic conditions – inflation increases the cost of credit The business’s cost of providing credit – costs include delinquent accounts, bad debts, and bankruptcy

Computing the Cost of Credit Simple interest formula – assumes one payment at the end of the loan period Interest = Principal X Rate X time Principal – amount borrowed Rate – cost of credit expressed as a percentage Time – length of time to repay loan (expressed as a fraction of a year: 12 months, 52 weeks, 360 days)

Computing the Cost of Credit Figure 18-1 – computing interest costs when principal, rate, and time are known Figure 18-2 – computing principal amount when interest, rate, and time are known Figure 18-3 – computing rate when interest, principal, and time are known

Computing the Cost of Credit Annual percentage rate (APR) formula Used to determine cost of credit when installment plans are used (borrower repays loan with more than one payment) Figure 18-4 and the Math Minute example on p. 439 illustrate the APR calculation Down payment – part of the purchase price paid in cash up front, reducing the loan amount

Computing the Cost of Credit Credit card billing statements The cost of credit for open-ended credit varies based on finance charge method: Adjusted balance method – finance charge is calculated after monthly payment has been applied Previous balance method – finance charge is calculated before monthly payment has been applied Average daily balance method – balance is calculated for each day of the billing cycle and finance charge is based on average (most common method used) Figure 18-5 – illustrates comparison of the three billing systems