Unit 2 – Finance Topic #2 – Credit 1. Users of Credit 2. Advantages and Disadvantages of Credit 3. Types of Credit 4. Cost of Credit 5. Obtaining Credit Unit 2 – Finance Topic #2 – Credit 1. Users of Credit 2. Advantages and Disadvantages of Credit 3. Types of Credit 4. Cost of Credit 5. Obtaining Credit

The World of Credit Credit Defined  The privilege of using someone else’s money for a period of time  Substitute for liquid cash Parties involved in a Credit transaction Creditor – Person or business that grants a loan or sells on credit Debtor – person or business that buys on credit and receives the loan.

Advantages of Using Credit Advantages  Instant enjoyment and/or gratification  Convenience  Help in an emergency  Establish a healthy credit rating  May help with budgeting due to monthly statement Disadvantages  Impulse buying  Overspending  Financial difficulties  Credit loses

USERS OF CREDIT 1. General Consumers 2. The Government 3. Businesses

USERS OF CREDIT Consumers  General consumers use credit to purchase: 1. Big ticket items such as a home, car, TV, and vacations as well as 1. Big ticket items such as a home, car, TV, and vacations as well as 2. Smaller items such as a restaurant meal, shoes, clothes, etc. 2. Smaller items such as a restaurant meal, shoes, clothes, etc. From Whom Do Consumers Borrow Money?  Banks, Businesses for short-term credit, Credit Card companies.

Users of Credit Businesses  Credit may be used for long-term purchases such as land, building, equipment, start-up costs to start open or start a new business  Credit may be used for short-term reasons such as inventory, supplies, etc. From Whom Do Consumers Borrow Money?  Banks, Credit Card companies, government, other businesses

Users of Credit The Government  Borrows money at the federal, provincial, and municipal level to provide goods and services to citizens  For example, money is borrowed to build schools, hospitals, highways, airports, pay the salaries of employees. Where Does the Government Borrow Money From?  Citizens through Savings Bonds, Canada Treasury Bills (T-Bills, ) and Banks etc.

Business Which Grant Credit 1. Financial Businesses Banks Banks Credit Unions Credit Unions Trust Companies Trust Companies 2. Retail Businesses Retail credit cards Retail credit cards Purchase merchandise, no money down for a certain time frame Purchase merchandise, no money down for a certain time frame Credit accounts where customers pay within 30 days of purchase and the business keeps track (Accounts Receivable for a business) Credit accounts where customers pay within 30 days of purchase and the business keeps track (Accounts Receivable for a business)

Extending Business Credit Advantages  Major purchases  Consolidate numerous billings at once  Convenience of company expenses  Overcome cash-flow shortages Disadvantages  Increased costs due to interest  Defaulting on a loan, loss of credibility, risk of insolvency, bankruptcy

Types and Sources of Credit 1. Credit Cards Bank-issued credit cards Bank-issued credit cards Travel and entertainment credit cards Travel and entertainment credit cards Retailer credit cards Retailer credit cards 2. Installment Credit Cards 3. Loans Term loans Term loans Demand loans Demand loans Student loans Student loans Mortgage loans Mortgage loans

Credit Cards  Provide quick and easy credit to individuals who do not want to pay in cash or don’t have the cash on hand at the time of purchase  Upon successful application for a credit card, individuals are permitted up to a predetermined maximum amount of credit on their card. Amounts may increase or decrease depending upon a track record of responsible usage.  If used correctly, credit cards provide up to a 30 day interest- free loan to the consumer  If the entire monthly balance or balance due is not paid off within the time permitted, interest is charged from the date of each purchase, usually around 18% a year, or.0493% daily.  Interest does accumulate on top of interest until it is paid in full.

Credit Cards  Credit card issuers (banks, retailers) will likely check an individual’s credit rating before granting a credit card.  If it is the individual’s first credit card, the dollar limit one can spend each month will be small to minimize risk of losing money on amounts not paid by the user. The amount may also depend on whether the individual has a job.

Credit Cards  Users must pay of the minimum balance due indicated by the credit card issuer to ensure his/her credit rating is not hurt. Interest, however will begin to be charged from the date of purchase until the balance is paid in full.  Credit card issuers offer various rewards to encourage individuals to use their credit card versus another company and to use it as often as possible. Why – to make and/or save money depending on who the issuer is.  What type of reward programs are out there? - Aeroplan for air miles - Aeroplan for air miles - free groceries - free groceries - 2% rebate on all purchases - 2% rebate on all purchases

Credit Cards  Bank credit card companies (Visa and Mastercard) make money in two ways: 1. Charging interest on purchases 1. Charging interest on purchases 2. Charging stores that accept their credit cards from customers a fee on the purchase price of the sale – usually between 2-4% of the sale price. 2. Charging stores that accept their credit cards from customers a fee on the purchase price of the sale – usually between 2-4% of the sale price.

Credit Cards  Retailer credit cards (Canadian Tire, Sears, etc) make money from their cards in two ways: 1. charging interest 1. charging interest 2. save money on charges and fees that bank credit card companies would charge them for consumers purchasing items using bank visa or mastercard credit cards. 2. save money on charges and fees that bank credit card companies would charge them for consumers purchasing items using bank visa or mastercard credit cards.

Credit Cards  Banks and retailers would prefer customers pay off their credit card balances in full every month. Why?

Credit Cards  On average, Canadians carry 3 credit cards  There are over 600 issuers of credit cards  Bank-issued cards such as Visa and Mastercard, account for largest percentage of consumer spending  Non retail charge cards (i.e. Canadian Tire Credit card) will be accepted virtually everywhere for any type of purchase

Source  Wilson, Jack et al. The World of Business, 5 th Ed., Nelson Education Ltd., Canada, 2007