Understand credit management

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• Main types of credit• Common advantages and disadvantages of

businesses using credit• Cost of credit• Main factors examined for granting credit• Credit documents• Credit regulations• Credit assistance

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•An agreement to obtain money, goods, or services now in exchange for a promise to pay in the future.

-When buying on credit, you are delaying the payment for an item.

“Buy now and Pay Later”

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Creditor◦ One who sells on

credit or makes a loan

Debtor◦ Anyone who buys on

credit or receives a loan

◦ Obligated to pay back the loan

Promissory Note ◦ Legal loan document◦ Written promise to

repay with interest

Usury Laws ◦ State law that

restricts the amount of interest that can be charged.

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Closed-end credit◦ Used for a specific

purpose◦ Loan of a definite amount

of money◦ Loan balance reduced

with each payment

Example: car loan for $20,000 is a specific, one time amount of money

String examples

Open-end credit ◦ Gives a credit limit -

maximum $ you can borrow

◦ Loan balance varies for purchases/payments made

Example: credit card with $500 limit. You might spend $50 and pay $10, spend 30 and pay $25. The loan amount “revolves” as you spend and pay back.

Secured loans:◦ Backed by collateral (help guarantee the

repayment of a loan)◦ Backed by a cosigner who agrees to pay

Collateral-asset used as security on a loan◦ Can be taken by creditor if loan payments are not

made to creditor

◦ Mortgage loans- real estate◦ Subject to Foreclosure if not paid

◦ Personal loans- car, motorcycle, boat◦ Subject to Repossession if not paid

Responsible for the repayment of a loan if the original party does not pay

Party who signs with applicant for a loan

Who might co-sign a loan for you?

Credit contracts are legal binding documents that allow debtors to use credit to obtain goods and services.

Know what you are signing!

◦ 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 a copy of the contract

Repossession conditions

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◦ Comes once credit is granted and purchases are made on credit.

◦ Mailed monthly and includes summary of transactions completed during the billing period

◦ May also view online or access info by phone

What kind of information may be found on the statement of account?

Previous balance Transactions:

Purchases Returns Payments Finance charges Late fees Rebates or bonuses earned

Current Balance Minimum payment due Due date

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◦ Charge Accounts◦ Credit Cards◦ Installment Credit◦ Consumer Loans◦ Payroll Advance Loans◦ Pawn Shop Loans◦ Life Insurance Loans◦ Retirement Plan Loans◦ Small Business Administration

Business only

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Allows debtors to receive goods or services from suppliers and pay for them at a later date

◦ Regular Charge Accounts Require that you pay for purchases in full within a

certain period of time EX: charge account with an electrician who wired your

house

◦ Revolving Charge Accounts Allows you to borrow or charge up to a certain amount

of money (credit limit) and pay back a part or the entire balance each month

EX: home equity line of credit

◦ Budget Charge Accounts Allows you to pay for costly items in equal payments

spread out over a period of time EX: a charge account with Progress Energy utility

company

Retail store, Single Purpose – aka charge cards

Balance and payments vary Can only be used to buy goods or services at the

business that issued the card Examples: JC Penney, Sears, BP

Multipurpose, Bank cards Revolving credit accounts Balance and payments vary May be used at different locations Examples: Visa, Master Card

Travel and Entertainment Similar to charge accounts Must be paid in full each month Example: American Express, Diner’s Clubcompare credit cards

*Unsecured Loans

Cash Advance◦ Borrow money on a

credit card◦ Costs more than

regular credit card purchases

◦ *read your contract before signing application or taking a cash advance!

Grace Period◦ Time period during

which no finance charges will be added to an account. From monthly statement cutoff until payment is due!

Maturity (due) date is at least 14 days from statement date. If you pay account in full by due date, you will not usually owe interest.

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Many stores provide revolving charge to their customers

Users may earn points, bonuses, rebates or get special unadvertised specials

Examples: Kohls, Sears, Best Buy, Belk

Installment loan - contract issued by the seller that requires payments at specified times such as bi-weekly or monthly until loan is paid in full

Used for: Student, mortgage, automobile loans

Ex: Buy furniture – pay monthly to Rooms To Go Furniture StoreEx: borrowing $1000 from a bank and agreeing to make

payments $105 for 10 months.

Specialize in loans to people with poor credit ratings

Cost of credit is higher than other institutions

Short-term loan “Borrow Until Payday” Loan

◦ Cost is extremely high◦ includes flat fees, high interest rate

You get cash ahead of getting your paycheck.Secured Loan- secured by promise of paycheck

A short term loan◦ Give up an asset (ring, watch)◦ Pawnshop gives you cash

Usually less than 50% of value◦ You can get property back

Time limit Pay amount & interest charged

◦ Pawn shop can sell your item

Secured Loan

◦ Cash Value Insurance –whole life Provides both

savings and death benefits

◦ You cannot borrow against term life insurance policies…no cash value

*Secured Loan-collateral is $ in cash value

Can legally borrow from them but not recommended since the purpose is to have money when you retire

*Secured Loan- collateral is $ in retirement plan

Small Business Administration (SBA)◦ Offers a number of financial, technical, and

management programs to help businesses◦ Loan funds available ◦ Info available at local Community colleges

Consumers

Businesses

Government◦ Local◦ State◦ Federal

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Federal government - uses credit to pay for:◦ Public services and programs provided for its citizens◦ Examples-military, foreign aid, roads, courts, prisons◦ Loan sources include: Federal savings bonds, treasury bills,

bonds, notes

State & local governments-use credit to pay for:◦ highways, water systems, public housing , and stadiums,

airports◦ Loan sources : municipal bonds, school bonds

• Municipal Bonds– State and local governments use to finance

projects• Savings Bonds

– Sold by federal government– T-bills, T-notes, T-bonds

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Bonds – written promise to repay a loan with interest on a specific date

Buyer of the bond is the creditor

• Corporate Bonds– Usually used to finance

buildings and equipment– Blue chip companies vs. junk

bonds– Part of investment portfolio

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Bond is an investment for creditor

Marty borrowed $450 for 12 months from First Federal Bank to buy a bike at 8% APR.

1. Who is the creditor?2. Who is the debtor?3. What is the interest rate?4. What does APR stand for?5. How much will his monthly payment be?

“Creditors have better memories than debtors.” -Benjamin Franklin

Do you agree or disagree with this quote and why?

Convenience◦ Shop without carrying cash

Immediate Possession◦ Allows possession of goods or services now◦ Especially BIG TICKET ITEMS

Homes, business expansion◦ Buy now, pay later

Emergencies◦ Helps in case of a serious situation

Establishing favorable credit rating Keeping business separate from

personal expenses Earning rewards/points Minimizing record-keeping and receipts Keeping track of what employees are

spending Saving Money –Buy item when it is on

sale without cash Growth of the Economy-Buying goods &

services helps stimulate the economy

Theft of customer records/databases

Overbuying by employees

Overusing Credit

Credit Fees - Interest paid on balance

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Bad Credit Rating◦ Higher interest rates in future◦ Inability to get loan in future

Repossession/Foreclosure◦ Loss of property because of

failure to repay loan

Bankruptcy◦ Can’t qualify for credit for

seven years

Using someone else’s money has a cost.

Interest is the cost of using someone else’s money.

Factors for computing interest include:◦ Principal, P = Amount of the loan◦ Interest Rate, R = Percent of interest charged or earned.◦ Time, T = Length of time for which interest will be charged,

usually expressed in years or parts of a year.

Formula for computing simple interest:I = P x R x T

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How is time determined for a loan for each of the following lengths?◦ Years – multiply by # of years◦ Months – ex 2/12◦ Days 24/365

How is the maturity date calculated?◦ Months-the maturity date is the same day of the month that the

loan was made.◦ Days-Determine the day the loan was made, and then count the

exact number of days of maturity.

How is a decreasing loan payment calculated?◦ Interest is calculated on the amount of the loan that is unpaid.

What is disclosed in APR? % cost of credit, service fees

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1. Credit Application2. Documentation3. Processing4. Underwriting5. Closing 6. Funding

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Form used to provide information needed by a lender to make a decision about granting credit (approving a loan).

Fill out completely, accurately, & honestly Requires signature of applicant, which indicates

provided information is true

Credit decision must be based on your ability to repay a loan, Other discrimination is illegal.

Provide the following information:◦ Salary, Employer, ◦ Outstanding Credit (Debt), Credit References◦ Assets, Checking and Savings Accounts, Stock

Portfolio, etc.

◦ Disclose every piece of information about your financial background to obtain loan

◦ Be honest!

Creditor will collect and verify necessary documentation for the extension of credit.◦ Examples: Bank statements, credit card

statements, past W-2’s, etc.◦ Verify using phone, mail, documents

Credit data make 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

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Information provided by Credit Bureaus ◦ 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

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Lender builds loan file Evaluates credit worthiness Creditors examine factors

about potential debtors when deciding whether to grant them credit◦ The C’s of Credit Worthiness

Capacity ◦ How much debt can comfortably be handled?◦ Considers current income and debt levels

Character◦ Honesty to pay debt when due◦ Earned by paying bills on time and being a

trustworthy, reliable, stable person financially◦ References – people you have borrowed from in

the past who indicate you paid on time Capital (money)

◦ How much you have beyond what you owe◦ Current available assets that could be used to

repay debt if income was unavailable

Review loan info for soundness, creditworthiness

Make decision about granting credit Consumer Reporting Agencies

◦ Company that compiles and keeps records on consumer payment habits.

◦ Used to evaluate creditworthiness Examples: Equifax, Experian, and TransUnion

Representative explains terms of credit-usually loan officer

Attorney may be present at closing, especially real property

Debtor/creditor sign contract Contract is binding on signing parties

KWYS – know what you’re signing

READ and UNDERSTAND BEFORE signing any contract

Contract – legally binding agreement between two parties

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Creditor issues money/funds to the debtor for the item purchased

Example: mortgage company pays seller in full, debtor then pays mortgage company monthly installments to repay the loan

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– Legally 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

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Printed monthly once credit is granted and purchases are made on credit (also online)◦ Includes summary of transactions completed

during the billing period What kind of information may be found on the

statement of account? Balance due Amounts charged during the billing period Amounts paid during the billing period Current balance Minimum amount of next payment Late fees, interest charges

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Steps in Order:1.___credit application

2.___documentation

3.___processing4.___underwriting5.___closing

6.___funding

Description of Activity A. loan officer builds a loan file B. borrower completes form info for

lender to review C. creditor issues money to the

debtor D. debtor/creditor sign contract E. creditor collects and verifies

information F. loan officer reviews loan for

creditworthiness

Fair Credit Opportunity Act requires that credit denial cannot be based on sex, family, religion, etc.

Loan decision must be based on ability to pay back loan.

http://www.youtube.com/watch?v=1u4NpD_sZy0

Credit Bureau◦ An agency that collects information & calculates a

score/rating on how promptly people/businesses pay their bills

◦ Information retrieved from banks, finance companies, landlords, retail stores, utility companies, stores, credit card companies

Corporations: Standard & Poors, Fitch Rating, Moody’s

Individuals: Equifax, Experian, TransUnion

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Open a checking or savings account

Apply for a local department store charge card

Apply for a multipurpose credit card

Take out a small loan from local bank

PAY ALL LOANS, BILLS, AND CREDIT CARDS ON TIME!!!

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Nick wants to buy a four wheeler. It costs $2500. He has $500 for a down payment. He qualifies for a bank loan for $2000 @ 5% simple interest. The bank sets up payment terms of monthly installment for 2 years beginning on the 10th of next month.

Questions What is Nick’s

principle? What is the interest

rate? What is the time? When is maturity

date? How many payments

will Nick make? How much interest

will Nick pay in 2 years?

What is the total cost of the 4-wheeler?

Use Interest formula to calculate Nick’s finance cost.

I= Interest (finance charges/fees) P= Principle R= Rate (APR % charged) T= Time (year or portion of year)

I=P*R*T I=2000*5%*2 I=$200 What is the total cost to Nick for purchasing

the four wheeler? $2500 + 200 interest paid=$2700

What would happen to the interest fees if Nick paid off the loan in 6 months?

I=2000*5%*6/12 (6 out of 12 months) I=$50

Protect rights of credit applicants & rights of credit users from fraudulent & unfair practices

Truth in Lending Law (TILA) requires lenders to reveal the cost of credit (APR & $ amount of finance charge) & terms before signing an application or contract

Federal Trade Commission (FTC) enforces laws on credit

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allows credit applications be judged on financial responsibility of credit applicants.

Cannot discriminate based on gender, age, ethnicity, or religion

Credit can be denied due to these areas of responsibility: Income too low Other large debts compared to income Poor payment record in past

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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.

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prohibits deceptive, harassing, and unfair practices for collecting debt from debtors.

Collectors:◦ Must identify themselves◦ Cannot tell others about debt◦ Cannot harass debtor

Consumer Credit Reporting Reform Act◦ requires that credit reporting agency must be

able to prove that credit information they provide is accurate.

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Amendment to the Truth in Lending Act Institutes fair and transparent practices of

providing credit

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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.

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Debt repayment planIs 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, one on one with debtor.

BankruptcyMay be used by

debtors to reduce debt or amount owed to creditors. Legal process in which some or all of the assets of a debtor are distributed among the creditors because the debtor is unable to pay his or her debts.

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Chapter 7 (Liquidation)List assets and

liabilities

Most of the debtor’s assets are sold to pay off creditors (liquidation)

Cannot release debt on alimony, child support, taxes, fines, educational loans, or court fees

Chapter 13 Propose a plan for

using future earnings and assets to eliminate debts over a period of time

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Reorganization of debt, re-negotiating terms of debt to stay in business

For Businesses Only

Creditors often accept terms to get partial payment, or an extended period to get paid, rather than not get repaid at all!

Chapter 11 bankruptcy reorganization: what is it and how does it work

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