Chapter 5 Introduction to Consumer Credit

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Chapter 5Introduction to Consumer Credit
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Kapoor Dlabay Hughes Ahmad
Prepared by Cyndi Hornby, Fanshawe College
? 2009 McGraw-Hill Ryerson Ltd.
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Learning Objectives - Chapter 5
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1. Define consumer credit and analyze its advantages
   and disadvantages.
2. Differentiate among various types of credit.
3. Assess your credit capacity and build your credit
   rating.
4. Describe the information creditors look for when
   you apply for credit.
5. Identify the steps you can take to avoid and
   correct credit mistakes.

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Learning Objective 1Define consumer credit
and analyze its advantages and disadvantages.
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What is Consumer Credit?
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• Credit is an arrangement to receive cash, goods
  or services now, and pay for them in the future.
• Consumer credit is the use of credit for personal
  needs, except a home mortgage.
• There are three ways consumers can finance
  current purchases.
• Take money from savings.
• Use present earnings.
• Borrow against expected future income.
• Trade-offs are involved in using credit.

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Credit Considerations
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• Before you use credit for a major purchase, ask
  yourself some questions.
• Could I pay cash or make a down payment?
• Do I want to use savings for this purchase?
• Does purchase fit with my goals and budget?
• Could I use the credit Ill need in some better
  way?
• Can I postpone this purchase?
• What are the opportunity costs of postponing this
  purchase?
• What are the dollar and psychological costs of
  using credit for this purchase?

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Advantages of Credit
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• Current use of goods and services.
• Permit purchase even when funds are low.
• Use for financial emergencies.
• Convenient when shopping.
• Safer than cash.
• Can take advantage of float time.
• May get rebates, airline miles or other bonuses.
• Demonstrates financial stability.

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Disadvantages of Consumer Credit
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• Purchases are more expensive.
• Temptation to overspend.
• Ties up future income.
• Possible financial difficulties.
• Damage to family relationships.
• Slows progress to future goals.

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Learning Objective 2Differentiate among
various types of credit.
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Types of Credit
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• Consumer Loan
• One time loan that the borrower pays back in a
  specified period of time with a pre-determined
  payment schedule
• Home mortgages, automobile or household
  furnishings
• Revolving Credit
• A line of credit in which loans are made on a
  continuous basis and the borrower is billed
  periodically for at least partial payment
• Department store or bank credit card

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Revolving Credit
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• Credit Limit
• The dollar amount, which may or may not be
  borrowed, that a lender makes available to a
  borrower
• Interest
• A periodic charge for the use of credit
• Personal Line of Credit
• A prearranged loan from a bank for a maximum
  specified amount

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Credit Cards
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• Nearly 83 of Canadian households carry one or
  more credit cards.
• One-third are convenience users. They pay their
  balance off in full each month.
• The other two-thirds are borrowers.
• Co-branding - linking a credit card with a
  business offering rebates on products and
  services.
• Smart cards have an imbedded computer chip.
• Debit cards are not credit cards.

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Protecting Yourself Against Credit Card Fraud
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• Sign new cards as soon as they arrive.
• Treat the cards like money - keep them secure.
• Shred anything with your account number on it.
• Dont give your number over the phone unless you
  initiate the call.
• Get your card and a receipt after every
  transaction and compare them to your bills when
  they arrive.
• Immediately report if lost or stolen.
• Notify issuer if you dont get your billing
  statement.
• Check your credit report every few years.

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Protecting Yourself Against Credit Card Fraud
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• If you make purchases online
• Use a secure browser
• Keep records of your online transactions
• Review monthly statements for errors and
  unauthorized purchases
• Read the policies of web sites you visit
• Keep your personal information private
• Give payment information only to businesses you
  know
• Never give your password to anyone online
• Do not download files sent to you by strangers

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Personal Lines of Credit
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• Revolving line of credit
• Interest rate linked to lenders prime rate
• Withdraw up to specified limit using debit card
  or cheques
• Repay minimum stated or more
• Secured with assets
• GICs or Home Equity

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Home Equity Loans
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• A loan based on the current market value of your
  home less the amount still owing on your mortgage
• Can borrow up to 85 of your equity
• Interest on loan is tax deductible if proceeds
  are being used for an investment (outside of
  registered plans)
• Usually set up as a revolving line of credit

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Consumer Loans
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• Mortgage Loans
• The biggest single debt most Canadians will incur
• Discussed in Chapter 7
• Car Loans
• Automobile is your second largest investment
• Financing at the Banks
• Required to make minimum down payment
• Balance financed in instalment loan at fixed or
  variable rate often with open prepayment clause
• Financing at the Dealer
• Affiliated with manufacturer or financial
  institution
• Significantly lower interest rates on some models
• Other incentives offered

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Car Loans
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• Leasing
• Closed-end lease you can buy vehicle at lease
  end or return it to company
• Open-end lease you are responsible for residual
  value of vehicle at lease end
• Vehicle owned by leasing company, you pay
  maintenance, repairs, insurance
• May have mileage restrictions
• Paying Cash
• Avoids interest charges
• However, investment returns may be higher than
  cost to borrow

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Learning Objective 3Assess your credit
capacity and building your credit rating.
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Measuring Your Credit Capacity
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• Before you take out a loan, ask yourself...
• Can you afford the loan?
• What do you plan to give up in order to make the
  payment?
• First learn how to make an accurate
• and sensible family or individual
• budget

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Credit Capacity Indicators
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Not including housing
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Co-Signing a Loan
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• Guaranteeing a debt
• If borrower doesnt pay the debt you will have to
  
• Including fees and collection costs
• Statistics show that 3 out of 4 co-signors have
  to pay
• If you do co-sign a loan
• Be sure you can afford to pay
• Liability can keep you from getting other credit
• Could lose the property you pledge as security
• Understand provincial laws
• Request copy of all over due notices

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Build and Maintain Your Credit Rating
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• Your credit experiences, or lack of, is a major
  consideration for the creditor
• A good credit rating is a valuable asset
• use credit with discretion
• limit borrowing to your capacity to repay
• abide by the terms of the lending contracts

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Your Credit File
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• The Credit Bureau is a reporting agency that
  collects credit and other information about
  consumers and sells the date to creditors to help
  in evaluating applications.
• Your Credit file includes
• Your employer and position
• Former address and employer
• Spouses name, social insurance number and
  employer
• Public records and information
• Cheques returned for insufficient funds

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Credit Bureau Regulation
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• Most provinces have legislation to protect
• consumer privacy
• right not to suffer from false credit or personal
  information
• Others may only view your file if written consent
  has been given
• First bankruptcy remains on your file 7 years,
  second bankruptcy results in both on your record
  for 14 years
• Errors in your credit file should be corrected
  immediately

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Credit Scoring
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• Used to assess the credit risk of prospective
  borrowers
• Data in credit report is summarized in a credit
  score
• Helps to predict creditworthiness
• Higher the score the better
• A strong credit score will help you get
• credit faster and at a more
• advantageous rate

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Credit Scoring
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• The following categories are weighted
• Payment history
• Length of credit history
• Amounts owed
• Types of credit used
• Number of recent applications for credit
• Improve your score by managing your debt
  responsibly

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Learning Objective 4Describe the information
creditors look for when you apply for credit.
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What Creditors Look For 5 Cs
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• Character Borrowers attitude towards credit
  obligations
• Capacity Borrowers financial ability to meet
  credit obligations
• Capital Borrowers assets or net worth
• Collateral Valuable assets that is pledged to
  ensure loan payments
• Conditions the general economic conditions that
  can affect borrowers ability to repay a loan

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If You Are Denied Credit?
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• Ask questions if application for credit is denied
• If based on your credit report ask
• what specific information on credit report lead
  to denial?
• Check with credit bureau to find out what
  information has been reported and investigate and
  correct any inaccurate or incomplete information

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Learning Objective 5Identify the steps you
can take to avoid and correct credit mistakes.
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Avoiding Correcting Credit Mistakes
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• To correct mistakes or misunderstandings in your
  credit accounts
• contact creditor first to correct error
• If your identity has been stolen
• contact the fraud department of major credit
  bureaus
• contact creditors for accounts that have been
  tampered with or opened fraudulently
• file a police report
• close all bank accounts immediately and cancel
  credit cards

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Summary of Learning Objectives
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• Define consumer credit and analyze its advantages
  and disadvantages
• Is borrowing money to obtain goods and services
  for personal needs
• Advantages include
• Purchase goods when you need them and pay for
  them gradually
• Ability to deal with financial emergencies
• Convenience in shopping
• Establishment of credit rating
• Disadvantages include
• Credit costs money
• Encourages overspending
• Ties up future income

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Summary of Learning Objectives
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• Differentiate among various types of credit
• Closed end (installment) credit
• Pay back one time loan in a stated period of time
  and with a specified number of payments
• Open end (revolving) credit
• Take loans on a continuous basis and is billed
  for partial payments periodically
• Assess your credit capacity and build your credit
  rating
• Debt payment to income ratio
• Debt to equity ratio
• Creditor seeks information from credit bureaus

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Summary of Learning Objectives
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• Describe the information creditors look for when
  you apply for credit
• Character
• Capacity
• Capital
• Collateral
• Conditions

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Summary of Learning Objectives
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• Identify the steps you can take to avoid and
  correct credit mistakes
• If billing error occurs notify creditor in
  writing within 60 days
• If your dispute is not settled place your version
  in your credit file
• Can withhold payment for defective goods or
  services as long as you attempt to solve dispute
  with merchant