Section 16-1What is Credit?

Chapter 16Credit in America

Development of CreditCredit- is money borrowed to by

something now, with the agreement to pay for it laterCredit is the most commonly used method of

purchase in our countryOver 80% of all purchases are made with

credit

Development of CreditIn the Past

The need for credit came about when we changed from a bartering and trading society to a currency exchange economy

Earliest form of credit was the account at the general storeStores rarely charged interestWas a convenience that the owners provided

customers they trusted and knewBecause of credit the economy grew quickly

as well as the standard of living

Development of CreditIn the Past cont.

Between 1920 & 1990 buying on credit became the American way of lifeNo longer was credit saved for emergencies

In the 90’s a record number of people filled for bankruptcyBecause of the overuse of credit as the main reason

Credit TodayMerchants today encourage credit to buy all kinds

of services and goodsSome transactions are difficult to make without a

credit cardSuch as reserving a hotel room or making an online

purchaseWe are no longer saying, “How can I get credit?”

But, “How can I wisely manage credit?”

The Vocabulary of CreditTerms commonly used to describe credit

are availability and its costWhen you borrow money or use credit you

are a borrower or debtorThe person or company loaning the money

is the creditorTo qualify for credit you must have the

ability to repayA job is one of the most important qualitiesAnother is capital- is property you possess

(bank accounts, investments, and other assets) that is worth more than your debts

The Vocabulary of CreditIn requests of large sums of credit,

creditors want more than just a promise from youCollateral- property pledged to assure

repayment of a loanIf you do not make your payments, the

creditor can seize the pledged propertyEx: You buy a new car on credit, the car is

the collateral, and you don’t make payments, the car can be repossessed- ownership would go back to the lending institution

The Vocabulary of CreditWhen the credit purchase is completed you

owe money to the creditor principal- (amount borrowed) plus interest for

the time you have the loan is called the balance due

You will make monthly payments until you repay the balance due in fullPayments include both principal and interest

Finance Charge- is the total dollar amount of all interest and fees you pay for the use of creditIt is the price you pay for the privilege of using

someone else's money

The Vocabulary of CreditCredit statements usually specify a minimum

payment- is the least amount you may pay that month under your credit agreement

All credit payments are due by a specific due dateYou will be given 10 to 20 days from the date you

receive a bill in which to payFailure to pay within the time allowed, you will be

accessed a late fee, which is added to the balance due

Expensive purchases you may be asked to sign a installment agreement- which is an agreement to make regular payments for a set period of timeThis is a secured loan- because the goods you

purchased with the loan serve as collateral for the money loaned

Advantages of Consumer CreditAdvantages of Credit

1. If used correctly can greatly expand your purchasing potential and raise your standard of living

Ex: allows you to purchase things you can buy with cash and pay for them over time

2. Making your payments on time then helps you establish a good credit record that will help you get loans in the future

3. Credit can also provide emergency fundsline of credit- which is a pre-established amount that can

be borrowed on demand with no collateralTo establish, simply fill out an application with a lender

Lenders examine your income and financial position and approve an amount that they believe you can repay

Advantages of Consumer CreditAdvantages Cont.

4. Credit is convenient5. You often get better service when they make a purchase

because they can withhold payment until a problem is resolved

6. Regular customers receive advance notices of sales and special offers not available to the public

7. Deferred billing- is a available to charge customers whereby purchases are not billed to the customer until later

8. The proof of purchase provided by a charge slip is usually more descriptive than a cash register receipt and helps in making adjustments when merchandise is returned

9. Carrying a credit card is safer than carrying cash

Disadvantages of Consumer CreditDisadvantages

1. Credit purchases may cost more than cash purchases

2. Merchants must pay the credit card company for using the card in transactions, and often pass the cost onto customers in the form of higher prices

3. An item purchased on credit and paid for over a period of time costs more because of finance charges

Ex: finance charge of 18% is 1.5% per month and on $1000 the finance charge would be $15 per month

The larger the balance and the longer you take to pay it off the greater the finance charges

Disadvantages of Consumer CreditDisadvantages Cont.

4. When you use credit you tie up future income

You have committed to making payments, perhaps for several years

This situation can put a strain on your budget

5. Buying on credit can lead to overspending At the end of the month when the bills come in

you may be surprised at how much you spent

6. Using credit too much can result in debts so high that you can never pay them off and lead to bankruptcy

Section 16-2Types and Sources of Credit

Ch. 16 Credit in America

Types of Credit- Open-Ended Credit

1. Open-ended credit- is an agreement to lend the borrower an amount up to a stated limit and to allow borrowing up to that limit again, whenever the balance falls below the limit

Borrower usually has choice of repaying the entire balance within 30 days or repaying it over a number of months or years

Can be used over and over again as long as the balance owed doesn’t exceed the limit

2. Open 30-day accounts- is a agreement a consumer promises to pay the full balance owed each month

Ex: American Express and Diner’s Club cards There is no credit extended beyond the 30 daysUsually have high or no credit limits and are widely excepted

overseas

Types of Credit- Open-Ended Credit Cont.

4. Revolving Credit Accounts- a consumer has the option each month of paying in full or making payments at least as high as the stated minimum

Min. payment is based on the amount of balance dueEx: Visa, MasterCard, and Discover cards as well as retail

and gas station company cardsCredit Card Terms

Before selecting a card, learn which terms and conditions apply

1.Annual Percentage Rate (APR)- is the cost of credit expressed as a yearly percentage Truth-In-Lending law requires lenders to include all loan

costs in the APR Compare the APR of different lenders to find the best

deal Must be disclosed when you open an account and be

noted on each bill Usually a variable rate and can be high on credit cards

Credit Card Terms Cont.2. Free Period or Grace Period- allows you to

avoid the interest charge by paying your current balance in full before the due date shown on your billing statement

If no free period of 10-25 days the card issuer will impose an interest charge from the date you use your card or from the date each credit card transaction is posted

3. Annual Fees The fee can range form $15 to $35 or more and you

must pay it whether or not you use the card4. Transaction Fees and Late Fees

Credit card also may involve other types of costs Ex: if you use an access check, pay by phone, if you

go over your limit, or make your payment late

Credit Card Terms Cont.5. Method of Calculating the Finance Charge

This charge will vary, depending upon the method the card issuer used to figure your balance

The method used can make a difference, in how much of a finance charge you will pay

Types of Credit- Closed End CreditClosed end credit- is a loan for a specific amount that

must be repaid, in full, including all finance chares, by a stated due dateTypically used in purchasing expensive items, such as cars,

furniture or major appliancesDo not allow continuous borrowing or varying payment

amountsBorrower takes out a closed end loan for a particular

amount and then repays it with fixed payments or installments that include interest

Also called a installment loanA contract is signed explaining amount loaned, total finance

charge and amount of each paymentDown payment is required and item purchased is used as

collateral

Types of Credit- Service CreditService credit- is an agreement to have a

service performed now and pay for it laterEx: telephone and utility services are provided

for a month in advance, then you are billedexpect payment in full within a time limitUsually offer a budget plan, that allows you to

average bills to get lower monthly paymentsEx: doctors, lawyers, hospitals, dry cleaners,

and repair shopsTerms are set by individual businessesSome do not impose finance charges on

unpaid account balances but they do expect regular payments to be made until the bill is paid in full

Sources of Credit- Retail StoresRetail stores are stores that sell directly

to consumers, such as department stores, restaurants, and most service businessesMost offer their own credit cardsCan only use their credit cards in their storesConsumers using their cards often receive

discounts, advance notice of sales ,and other privileges not offered to cash customers

Most also accept credit cards issued by major credit card companies

Accepting credit cards helps retail stores attract customers, who like to buy on credit

Sources of Credit- Credit Card Companies.Visa, MasterCard, American Express, and

DiscoverThese are all purpose cards are generally accepted

nationwide and even internationallyYou can get an all purpose credit card through your

financial institutions or from various organizationsAffinity cars- are cards sponsored by professional

organizations, college alumni associations, and some members of the travel industryIssuer often donates a portion of the annual fees or charges

to the sponsoring organization, or qualifies you for free travel or other bonuses

When you have an all purpose credit card, you have an automatic line of credit up to the limit of the card

Sources of Credit- Credit Card Companies Cont.Cash advance- is money borrowed against

the credit card limitYou are taking out a cash loan from your line

of credit rather than making a purchase with itYou can access this money at a teller

machine, at a customer service desk in your bank, or by writing an access check against the credit card account

Access checks- look like regular checks that are supplied by the credit card company You must then pay back the cash advance in the

same way you pay for credit purchases

Sources of Credit- Banks and Credit UnionsIn addition to credit cards, banks and credit unions

make closed end loans to individuals and companiesLoan money to consumers for specific purchases such

as a home car or vacation Interest on closed end loans tends to be lower than on

credit cardsCredit unions make loans to their members only

Interest rates are generally lower than those charged by banks because credit unions are nonprofit and are organized for the benefit of members

Credit union are more willing t make loans because the members who are borrowing also have a stake in the success of the credit union

Sources of Credit- Finance CompaniesOften called small loan companiesusually charge high interest rates for the use of their

moneyReason for the high interest rates is the willingness to

loan money to people that are turned away from banks and credit unions

Are second only to banks in the volume of credit extended

Two types of finance companies1. Consumer finance company- makes mostly consumer

loans to consumers buying durablesDurables- items expected to last several years (cars,

refrigerators, stereos)Non durable goods - items consumed in a few days or months

(food products)Household Finance and Beneficial Finance are two examples

Sources of Credit- Finance Companies Cont.

2. Sales finance company- makes loans through authorized representatives

Manufacturer related companies Ex: (GMAC) finances General Motors automobiles

dealers and their customers Both types of finance companies borrow

money from banks and lend it to consumers at higher rates

Take more risks than banks and will do more to protect themselves

If you do not make your payments when due, you can expect a call from someone at the finance company, who will want an explanation

Will keep in contact with you till you make your payment

High interest rates also protect them

Sources of Credit- Finance Companies Cont.Uniform Small Loan Law- permits loans of up

to $5000 and allows interest rates of up to 42%Growth of finance companies is due to the efforts

to eliminate loan sharksLoan sharks- unlicensed lenders who charge

illegally high interest ratesUsury Laws- set max. interest rates that may be

charged for loansDon’t exist in all statesIn states where they don’t exist, companies can

charge as much as people will payWhen an emergency or other extreme need arises

consumers often feel forced to pay higher rates to get the money they need

Sources of Credit- PawnbrokersPawnbroker- is a legal business that makes high

interest loans based on the value of personal possessions pledged as collateralAccept possessions that are readily salable (guns,

camera, jewelry, radios, TV’s and coins)Customer brings in an item of value to be appraised,

then a pawnbroker makes a loan for considerable less than the appraised value of the itemSome pawnshops give only 10-25% of the value of the

article most give no more than 50-60%You receive a receipt and certain length of time from

two weeks to six months to redeem the item by paying back the loan plus interest

If you don’t pay it back, the pawnbroker then sells the item and keeps the proceeds

Sources of Credit- Private LendersMost common source of cash loans is the

private lenderInclude your parents, other relatives, and

friendsMay or may not charge interest

Other Sources of Consumer CreditLife insurance policies can be used as an alternate

source of consumer creditSome policies build a cash value and policy holders can

borrow at low interest rates against the value of their policyThe loan doesn’t have to be repaid, but interest will be

charged and the reduce the value of the life insurance policy

Certificate of Deposit from a bank can be borrowed againstWhich means the certificate is used as collateral and the

interest rate charged is usually only 2 to 5% above the rate you are receiving on the CD

If you cash in the CD before maturity you incur a penalty if you borrow money using the CD as collateral you get a moderate rate of interest on the loan, and keep the CD’s full value