Monday Warm-Up

What is a good reason to borrow money?

Who do you think decides your borrowing limit?

What happens when you go over your limit?

When can you get credit for the first time?

What will you need to get credit the first time?

5.01 UNDERSTAND CREDIT MANAGEMENT.

Credit Management

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 CreditCharge AccountsCredit CardsInstallment CreditConsumer Loans

Business Disadvantages for Using Credit

Overbuying by employees Planning to buy an item, then buying more or

better than what you really needed

Overusing credit Using credit when you didn’t plan to, just

because it is easy and convenient. (Shopping Sprees)

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 AccountsRegular Accounts

Requires the buyer to make a full payment within a stated period

Used for everyday needs and small purchases Example: ordered items for inventory, payment is

not due for 30 days (No interest)

Budget Accounts Requires that a customer make payments of a

fixed amount over several months Example: A charge account with Duke Energy,

AT&T 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

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

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

ExamplesMasterCard, VISA

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

Consumer Loans

A consumer loan is when a buyer agrees to make monthly payments in specific amounts over a period of time.

The loaner receives money up front and agrees to pay the price back in full plus interest Promissory note Collateral (property used as security) Cosigner

Business Advantages for using Credit

Establishing a favorable credit ratingUse cash for more important bills

NOWKeeping business separate from personal

expensesKeeping track of what employees are

spendingEarning rewards

Business Disadvantages for Using Credit

Overbuying by employees Planning to buy an item, then buying more or

better than what you really needed

Overusing credit Using credit when you didn’t plan to, just

because it is easy and convenient. (Shopping Sprees)

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 InterestI=P*R*TTime in Years

Multiply by the number of yearsTime in Months

Divide the number of months by 12

Time in Days Divide the number of days by 360

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 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

How Does Interest Affect You?

http://www.channelone.com/generationmoney/

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

Decreasing Loan Payments Interest is calculated on the amount that is

unpaid at the end of each monthCalculation:

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 /

12Monthly Payment = Interest + Loan Repayment

Cost of Credit

Annual Percentage Rate (APR)A disclosure required by law on all

credit agreementsStates the percentage cost of credit

on a yearly basisAlso includes service fees

Credit Application

A form on which you provide information needed by a lender to make a decision about granting credit.

Credit referencesbusinesses 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.

Three C’s of Credit

Character Honesty to pay a debt when it is due.How past debt obligations were

handledCapacity

Refers to a person’s ability to pay a debt when it is due

CapitalCurrent available assets that could be

used to repay debt if income was to become unavailable

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

A company that gathers information on credit users (Equifax, TransUnion, Experian)

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 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

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.

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

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.

annualcreditreport.com

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 ActThe 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)

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