CreditIntro to Credit & Establishing Good Credit

What is Credit?– A legal agreement to receive cash, goods, or

services now and pay for them in the future.

– The repayment usually includes interest

– Purpose is to allow buyers to purchase items at the present time and pay for them in the future

Types of Credit • Another word for credit is loan…

• 3 Main types of credit:– Sales

• Credit you receive when you make a purchase and promise to pay later.

– Cash• Credit you receive when you borrow cash and promise to

pay it back later.

– Service• Credit given for a service one receives (utilities, dentist,

hospital, etc.) that will be paid for later.

Types of Loans• Single-Payment Credit

• Installment Credit

• Revolving Credit

Types of LoansSingle-Payment Credit

Items and services are paid for in a single payment, within a given time period, after the purchase. Interest is usually not charged.

• Utility companies, medical services• Some retail businesses

Types of LoansInstallment Credit

• A loan in which the amount of payment and the number of payments are predetermined.– Fixed payment– Set period of time– Set or varying interest rates– Some retail businesses, such as car and appliance dealers

Money may also be loaned for a special purpose, with the consumer agreeing to repay the debt in two or more regularly scheduled payments.• Mortgage loan• Auto loan• Personal loan

Types of LoansRevolving Credit

Many items can be bought using this plan as long as the total amount does not go over the credit user’s assigned dollar limit.

Repayment is made at regular time intervals for any amount at or above the minimum required amount.

Interest is charged on the remaining balance.• Retail stores• Financial institutions that issue credit cards

• No stated payoff time

• Limit to credit• Minimum monthly

payments• Finance charges• Example: credit

card

Advantages & Disadvantages of CreditAdvantages

• Able to buy needed items now• Don’t have to carry cash• Creates a record of purchases• More convenient than writing

checks• Consolidates bills into one payment• Current use of goods and services• Demonstrates financial stability• Use for financial emergencies• Convenience when shopping• Safer than cash

Disadvantages

• Interest (higher cost of items)• May require additional fees• Increased impulse buying may occur• Purchases are more expensive• Temptation to overspend• Possible financial difficulties• Possible loss of merchandise

due to late or non-payment• Ties up future income

Sources of Credit

• Bank• Credit Union• Finance Companies• Retail Stores• Savings & Loan Asociations• Internet Stores

Build and Maintain Your Credit Rating

• Establish a steady work record

• Establish a billing history– Put telephone and other utility bills in your name & pay all bills promptly

• Establish both checking and savings accounts– Don’t bounce checks and make regular deposits

• Apply for bank credit card

• Get a cosigner on a loan and pay back the loan as agreed

• Ask bank for small short-term cash loan

• Pay off student loans

What Creditors Look ForCharacter •do you pay bills on time?

Capacity •can you repay the loan?

Capital •what are your assets and net worth?

Collateral •what if you don’t repay?

Conditions •what economic conditions would affect your repayment of the loan?

Credit Rating/ FICO Score• A credit rating assesses the credit worthiness of an

individual. Credit ratings are calculated from financial history and current assets and liabilities.

• A credit rating tells a lender or investor the probability of the person being able to pay back a loan.

• In recent years, credit ratings have also been used to adjust insurance premiums, determine employment eligibility, and establish the amount of a utility or leasing deposit.

• A poor credit rating indicates a high risk of defaulting on a loan, and thus leads to high interest rates, or the refusal of a loan by the creditor.

Credit Reports and Scores

• Credit report– Gives lenders and others information about your credit

history and current status– Available from three major credit bureaus:

Equifax, TransUnion, and Experian (TRW) – Consumers can view their credit reports once a year

without charge

Credit Reports and ScoresCredit Score Description

Up to 499 Unacceptable. Credit requests are denied.

500–599 Poor. Credit requests are denied or carry very high interest rates.

600–699 Fair. Credit requests are granted with medium interest rates and lower limits.

700–749 Good. Credit requests are granted with low interest rates and good limits.

749–799 Very Good. Credit requests are granted with low interest rates and high limits.

800+ Excellent. Credit requests are granted with lowest rates and highest limits.

CreditObtaining Credit & Financing Options

Sources of Credit

• Bank• Credit Union• Finance Companies• Retail Stores• Savings & Loan Asociations• Internet Stores

How Much Can You Afford? (20-10 rule)

Never borrow more than 20% of your yearly Net Income

• If you earn $400 a month after taxes, then your net income in one year is:12 x $400 = $4,800

• Calculate 20% of your annual net income to find your safe debt load.$4,800 x 20% = $960

• So, you should never have more than $960 of debt outstanding.

• Note: Housing debt (i.e., mortgage payments) should not be counted as part of the 20%, but other debt should be included, such as car loans, student loans and credit cards.

Monthly payments shouldn’t exceed 10% of your monthly Net Income

• If your take-home pay is $400 a month:$400 x 10% = $40

• Your total monthly debt payments shouldn’t total more than $40 per month.

• Note: Housing payments (i.e., mortgage payments) should not be counted as part of the 10%, but other debt should be included, such as car loans, student loans and credit cards.

Types of Loans• Single-Payment Credit

• Installment Credit

• Revolving Credit

Open-Ended Charge Accounts

– Application

– Investigation

– Credit ratings and risk scoring

PROCESS FOR OPENING:

Slide 20

Sample Credit Application

7-2 Sources and Benefits of Credit

Credit Costs• Fixed rates

– Interest rate is set and does not change each month

– Can change with written notice

• Variable rates – Can change often without prior notice– Tend to rise fast when interest rates in

general go up