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Credit Management
5.01 Understand Credit Management
Topics:
• 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
• What is Credit?
• What are the different types of Consumer Credit?
• What are some Advantages/Disadvantages to using
Credit?
• How do you establish credit?
• What are Loan Sources
• How do you ‘Shop’ for Credit?
• What is Good Credit?
• What is a Credit Report
• What are some signs of a debt problem?
• What is Bankruptcy?
Main Types of Credit
Main Types of Credit
• Consumer Credit
• A debt that someone incurs for the purpose of purchasing a
good or service. This includes purchases made on credit cards,
lines of credit and some loans.
• Consumer Debt
• Commercial Credit
• Pre-approved amount of money issued by a bank to a
company that can be accessed by the borrowing company at
any time to help meet various financial obligations.
• Commercial credit is commonly used to fund common day-today operations and is often paid back once funds become
available.
• May be called “Commercial Line of Credit”
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 Credit
• Charge Accounts
• Credit Cards
• Installment Credit
• Consumer Loans
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 Accounts
• Regular Accounts
• Requires the buyer to make a full payment
within a stated period
• Used for everyday needs and small purchases
• Example: charge account with an electrician
who re-wired a house
• Budget Accounts
• Requires that a customer make payments of a
fixed amount over several months
• Example: A charge account with Progress
Energy 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
• 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
• Examples
• MasterCard, VISA
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
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
• Aaron’s
Consumer Loans
• A Consumer Loan is when a buyer
agrees to make monthly payments in
specific amounts over a period of time.
• Example –
• Student Loans, Automobile Loans, Home
Loans, etc.
• Borrowing $1,000 from a bank and
agreeing to make $100 payments for a
period of time.
Consumer Loans
Two Parties:
• The borrower receives money up front and agrees
to pay the price back in full plus interest
• The lender needs some assurance that the
borrower will pay the money back.
• Promissory note
• Collateral (property used as security)
• Cosigner
Consumer Loans
• Promissory Note
• A written promise to repay based on a debtor’s
excellent credit history.
Guarantees that ‘someone’ will repay the loan:
• Collateral
• An item promised to the lender if the borrower
does not pay back the loan.
• Cosigner
• A person who agrees to pay back the loan if the
borrower fails to.
Advantages &
Disadvantages of
using credit
Business Advantages for using
Credit
• Establishing a favorable credit rating
• Keeping business separate from
personal expenses
• Minimizing record-keeping and receipts
• Keeping track of what employees are
spending
• Earning rewards
Business Disadvantages for Using
Credit
•Experiencing theft of
customer records/databases
•Overbuying by employees
•Overusing credit
Cost of Credit
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 Interest
• I=P*R*T
• Time in Years
• Multiply by the number of years
• Time in Months
• Divide the number of months by 12
• Time in Days
• Divide the number of days by 360
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
• Installment Interest: When a loan is
repaid in partial payments
Calculation:
• Calculate out how much Interest you owe
•I=PxRxT
• Calculate the Total Cost of the loan
• Total Cost = P + I
Cost of Credit
Calculation:
• 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
Cost of Credit
• Decreasing Loan Payments
• Interest is calculated on the amount that is
unpaid at the end of each month
• Calculation:
• 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 / 12
• Monthly Payment = Interest + Loan Repayment
Cost of Credit
• Annual Percentage Rate (APR)
• A disclosure required by law on all credit
agreements
• States the percentage cost of credit on a
yearly basis
• Also includes service fees
Factors & Documents
Three C’s of Credit
• Character
• Honesty to pay a debt when it is due.
• How past debt obligations were handled
• Capacity
• Refers to a person’s ability to pay a debt when
it is due
• How much debt can a person handle
• Capital
• Current available assets that could be used to
repay debt if income was to become
unavailable
Credit Application
• A form on which you provide information
needed by a lender to make a decision about
granting credit.
• Credit references  businesses 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.
Creditworthiness:
• An assessment of the likelihood that
a borrower will default on their debt
obligations.
• Based Upon:
• History of Repayment
• Credit Score
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
What is a Credit Bureau?
• A company that gathers information on
credit users (credit reporting agency)
• 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
• 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.
• 3 Main Credit Bureaus
• Equifax
• TransUnion
• Experian
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.
Credit Documents
Credit Contracts
• 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 &
Assistance
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
Credit Regulations
• 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.
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
Act
• The 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)
Credit Assistance
• 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
• Chapter 7 – must sell certain personal belongings,
use proceeds to repay debts
• Chapter 13 – can retain most personal property, but
must propose a repayment plan, go to credit
counseling, receive financial management
education, and be employed