What is Credit? Chapter 25

Credit is an agreement to get money, goods, or services now in exchange for a promise to pay in the future.

Creditor – the one who lends money or provides credit Debtor – the one who borrows money or uses credit Interest – the fee creditors charge for using their money

Trust Commitment Promise These are words that form the fundamental principles of credit

When you apply for a credit card or sign a loan contract you promise to fulfill the terms of the deal. Your signature is your good faith statement to uphold the three principles (trust, commitment, and promise) with your lender.

When you apply for credit, there are five primary considerations, known as the Five C's, that affect a lender's decision to approve or decline your loan application.

Capacity Your ability to repay the loan. Do you have a job or another income source? Do you have any outstanding debts?

Debt - An obligation or liability to pay something to someone else. Outstanding debts – debts that are not yet paid. What you still owe.

Character Whether your lender thinks you'll repay the loan. Have you used credit before? Do you pay your bills on time?

Credit History Report that tells whether you pay your bills on time or have failed to pay debts. Also indicates the amount of debt that you have. Credit rating/score – measure of a person’s ability and willingness to pay debts on time.

Collateral What you agree to forfeit if you fail to repay your loan. For example, if you are buying a car, it may be used as collateral to insure that you repay the loan. If you default, you lose your car.

Capital What you are worth. Do you have other assets, such as a savings account, car, or certificate of deposit that could be used to repay the debt?

Federal and state regulations govern how lenders determine whether or not to accept loan applications, but lenders primarily base their decision on the Five Cs of credit.

Types of Credit Consumer credit – used by people for personal reasons. Commercial credit – used by businesses. When businesses borrow money, they often pass along the cost of interest to consumers by charging higher prices on their products.

Charge Account One of the most common types of short-term and medium-term credit

Types of Charge Accounts Regular Charge Accounts Revolving Charge Accounts Budget Charge Accounts

Regular Charge Accounts Require that you pay for purchases in full within a certain period, usually 25 or 30 days If the bill is paid on time, you don’t have to pay interest If you do not pay the entire bill, interest is charged on the amount that hasn’t been paid Example Monthly utility bill

Revolving Charge Accounts A charge account that does not have to be paid to a zero balance. Allows you to borrow or charge up to a certain amount of money, and pay back a part of the total or the entire balance for each month. Interest is charged on the unpaid amount. Example Department store purchases

Budget Charge Accounts Let you pay for costly items in equal payments spread out over a period of time. Many are medium-term loans for up to five years. Each payment includes part of the total due on the item plus interest Used to purchase: Large home appliances Cars Furniture

Credit Cards Single-Purpose Cards Multipurpose Cards Travel and Entertainment Cards

Single-Purpose Cards These cards can only be used to buy goods or services at the business that issued the card Best Buy Kohls Sears Exxon/Mobil

Multipurpose Cards Also called bank credit cards because banks issue them Citibank Visa MBNA Visa LL Bean MasterCard

Travel and Entertainment Cards Usually work like regular charge accounts (must be paid in full when due) Usually have an annual fee American Express Diner’s Club

Banks and Other Financial Institutions Financial institutions, such as banks, savings and loans, and credit unions offer many types of loans. They do place more demands on the borrower, which can make it more difficult to get a loan. They only want to lend money to people with good credit ratings.

Examples Single Payment Loan Installment Loan Mortgage Loan

Single Payment Loan Loans repaid in one payment, including interest. Used by farmers Borrow money in the spring to buy seed and fertilizer Pay back the loan in the fall after they have harvested their crops

Installment Loan Loans repaid in regular payments over a period of time Student loans Personal loans Home improvement loans Car loans Example – car payment of $250 per month for 60 months.

Mortgage Loan Installment loan written for a long period of time Debtor makes regular payments Written over a long period of time 15 to 30 years Home is used as collateral

Other Forms of Borrowing Money Payroll Advance Services Pawnshop Loan Based on the value of something you own The cost of this type of loan is very high “Borrow Until Payday” Loan Short-term loan for 5 to 14 days Cost of loan is very high – could be as high as 1,000% when calculated on an annual basis

Chapter 25 Book Work Fast Review Page 408 #’s 1-3 Using Business Key Words Page 414 #’s 1-10