Forms of Credit

1
Forms of Credit

• Using and Earning Credit

2
Learning Goal

• To be able to recognize the main types of credit,
  and the process for earning credit.

3
What is Credit?

• When goods, services, or money is received in
  exchange for a promise to pay in the future, with
  interest.
• Lender- the person or organization who has the
  ability to provide the individual with a loan.
• Borrower- the person or organization that is
  receiving the money from the lender.

4
How do you get Credit?

• When a lender is considering granting credit to
  the borrower, they need to believe the borrower
  has the ability and the willingness to pay them
  back.

• How do they decide whether or not to give you a
  loan?

5
The 5 Cs of Credit

• C - a persons honesty and reliability,
  determined by their history of repaying bills on
  time.
• C - an evaluation of a persons net worth.
• C - the income a person has to be able to repay
  the loan. Based on job status and how many other
  loans they may have.
• C - property which can be seized (taken) if a
  person does not repay the loan.
• C - the general state of the economy.

6
Credit Basics

• Types and Sources

7
Credit Basics

• Close-ended credit
• A one time loan
• Borrower must repay the amount in a specified
  number of equal payments that includes interest

8
Credit Basics

• Open-ended credit
• Credit as a loan with a certain limit on amount
  of money you can borrow for a variety of goods
  and services

9
Credit Basics

• Open-ended credit
• Monthly payment may include
• Cost of goods and services purchased
• Interest charges (periodic rate APR/12) on
  current and unpaid balance
• Finance charges (if paid after grace period)
• Other fees Late charge, cash advance, overlimit,
  additional credit

10
Credit Basics

• Sources of Consumer Credit
• Commercial Banks
• Consumer Finance Companies
• Credit Unions
• Life Insurance Companies
• Federal Savings Banks

11
Credit Basics

• Consumer Finance Companies

• Commercial Banks

• Customers with established credit
• Makes secured loans
• Lower interest rates
• Prefers larger loans

• Customers without established credit
• Makes unsecured loans
• Much higher interest rates
• Prefers smaller loans

12
Credit Basics

• Consumer Finance Companies

• Commercial Banks

• Rates vary according to
• Type of credit
• Time period
• Customer credit history
• Several days to process

• Rates vary according to
• Size of loan balance
• Process quickly (usually same day)

13
Forms of Credit

• Using and Earning Credit

14
Types of Credit

• Installment Loan (close-ended credit)
• A one time loan which the borrower must repay the
  amount in a specified number of equal payments.
• Ex Car Loan (10,000 at 9 for 48 Months)
• Payment 249/month
• After 4 Years, the car costs you about 12,000

15
Types of Credit

• Student Loans (close-ended credit)
• An Installment Loan from the government to help
  pay for college.
• No payments until out of school!
• Interest rates usually lower at banks.
• People pay on these loans for a very long time!

16
Types of Credit

• Credit Cards (open-ended credit)
• Standing line of credit to use at any time.
• Credit Limit the maximum you are allowed to
  borrow.
• APR (Annual Percentage Rate) The total interest
  you will be charged each year. (1 27)
• Finance Charge The amount you are charged above
  your principal each month.
• Minimum Payment Usually 2 or 10 each month.

17
Types of Credit

• Mortgage (close ended credit)
• An Installment loan for the purchase of a house
• Most Mortgages are for 30 years
• Payment includes
• Principal (goes up each month)
• Interest (goes down each month)
• City Taxes (Usually about 1.5 of cost per year)
• Mortgage Insurance (About 475 per year)
• PMI (If you put less than 20 down - usually
  between 50 and 80 per month until 20 paid)

18
Credit Definitions

• Annual Percentage Rate
• Credit Bureaus
• Credit File

• Line of Credit
• Minimum MonthlyPayment
• Credit
• Grace Period
• Finance Charge
• Credit Rating

19
Credit Definitions

• Creditor A person or organization which extends
  credit to others.
• Loan Officer A person who helps borrowers
  acquire loans from banks or other institutions.
• Co-Signer The party responsible for payment of
  a note if the borrower does not pay as promised.

20
CREDIT CARDS

• Features, Payments, and Debt

21
4 Methods Credit Cards Calculate Interest

• Average daily balance
• Two-cycle average daily balance
• Previous balance method
• Adjusted daily balance

22
Credit Card Interest Methods

• Average daily balance Most common method
• At the beginning of each day a balance
  (subtracting refunds and payments) is calculated
• At the end of the month these balances are
  averaged together and divided by the number of
  days in the billing cycle

23
Credit Card Interest Methods

• Average daily balance Most common method
• Example Average daily balance 100, APR 15,
  days in billing cycle 30
• ADB APR days in billing cycle/days in
  year(100 .15 30)/365 1.23

24
Credit Card Interest Methods

• Average daily balance Most common method
• Example 500 balance with APR of 11.9
• Average Daily Balance APR Days In Billing
  Cycle / Days In Year500 .119 25 / 365
  4.08
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25
Credit Card Interest Methods

• Two cycle average daily balance
• Previous months balance is averaged
• Current months balance is averaged
• Finance charges are calculated on the average of
  the two balances averaged together

26
Credit Card Interest Methods

• Two cycle average daily balance
• Example
• Two-Cycle Average Daily Balance APR Days In
  Billing Cycle / Days In Year750 .119 25 /
  365 6.11

27
Credit Card Interest Methods

• Previous balance
• The amount you owed at the end of the previous
  billing period.
• Payments, credits and new purchases during the
  current billing period are not included.
• Some creditors also exclude unpaid finance
  charges.

28
Credit Card Interest Methods

• Adjusted balance
• Your balance is determined by subtracting
  payments or credits received during the current
  billing period from the balance at the end of the
  previous billing period.
• Purchases made during the billing period are not
  included.
• This method gives you until the end of the
  billing cycle to pay a portion of your balance to
  avoid the interest charges on that amount.

29
Mortgages

• Features Costs

30
What is a Mortgage(Repeated Slide)

• Mortgage (close ended credit)
• An Installment loan for the purchase of a house
• Most Mortgages are for 30 years
• Payment includes
• Principal (goes up each month)
• Interest (goes down each month)
• City Taxes (Usually about 1.5 of cost per year)
• Mortgage Insurance (About 475 per year)
• PMI (If you put less than 20 down - usually
  between 50 and 80 per month until 20 paid)

31
How much does a Mortgage Cost?

• 100,000 Loan at 6, with 2 down payment
• Payment (including interest) 600
• City Taxes (1.5 x 100,000 / 12) 125
• PMI 80
• Mortgage Insurance (475 / 12) 40
• TOTAL MONTHLY PAYMENT 845