Chapter 9aChapter 9a

Credit: Principles and Credit: Principles and SourcesSources

Credit: PrinciplesCredit: Principles

Three ways consumers can finance their purchases

i. Draw on their savingsIi. Use present earningIii. Borrow against expected future

income

Credit: Principles (cont.)Credit: Principles (cont.)

Credit is an arrangement to receive cash, goods, or services now and pay later for them in the future

Or credit is an advance (or loan) of money with which to purchase goods and services

Or credit is an advance of goods & services in exchange for a promise to pay at a later date

Borrow money from a lender A medium of exchange with limited acceptancewith limited acceptance The use of money from future income

Credit: Principles (cont.)Credit: Principles (cont.)

Consumer credit:Consumer credit: is the use of credit for personal needs, by

individuals and families credit granted to an individual especially credit granted to an individual especially

to finance the purchase of consumer goods to finance the purchase of consumer goods or for personal expenses or for personal expenses

Increase the current purchasing power but reducing future purchasing power. Overall, it reduced the purchasing power as finance charge are paid for the credit service

Credit: Principles (cont.)Credit: Principles (cont.) The finance charge included all related

costs – interest, processing fee Have period of maturity, installment

amount, repayment period and frequency of payment

The installment amount maybe fixed or varied depending on type of credit

The difference in rate of finance charge or maturity period affected the amount of finance charge and monthly installment

To reduce wastage of money, examine the finance charge & maturity period

Use & Misuse of CreditBefore using any credit for major purchase, ask yourself

some questions Do I have cash for the down-payment? Do I want to use my savings for this purchase? Does the purchase fit my budget? Could I use the credit I’ll need in some better way? Can I postpone this purchase? What are the opportunity costs of postponing the

purchase? What are the financial & psychological costs of using

credit for the purchase?

Advantages of Credit Current use of goods & services Permits purchase when funds are low A cushion for financial emergencies Take the opportunity of low prices during

sales, however have to determine whether the amount saved from low prices is more than the finance charges

Easier to return merchandise (hire-purchase)

Convenient when shopping – don’t have to bring along a big sum of cash

One payment a month (monthly payment)

Advantages of Credit (cont.)(cont.) Safer than cash – no cash carried, thus does

not attract thiefs Have a record for the purchased item Needed for hotel and car reservations and Needed for hotel and car reservations and

shopping online (credit card)shopping online (credit card) To take advantage of grace period in To take advantage of grace period in

hirepurchase hirepurchase May get rebates, airline miles, or other May get rebates, airline miles, or other

bonuses (credit card)bonuses (credit card) Indicates financial stability (as you are being Indicates financial stability (as you are being

granted credit by financial institution)granted credit by financial institution)

Disadvantages of CreditDisadvantages of Credit

Tend to overspend Can create long-term financial problems

and slow progress toward financial goals Potential loss of merchandise due to

default payment Ties up future income Credit costs money; more costly than

paying with cash

Alternative for Consumer Alternative for Consumer CreditCredit

Not buyingNot buying Buy later when there is enough moneyBuy later when there is enough money Use saving for purchasingUse saving for purchasing

Consideration for Using Credit

Comparing cost and benefit from using credit

Two types of cost involved1. direct cost- finance charge: interest & processing fee

charged directly by the seller- reduce purchasing power in the future:

paying the finance charges used-up some money that could be used for other expenses, thus limiting the expenses for other items

Consideration for Using Credit (cont.)

2. indirect cost - less flexibility: have a payment

schedule that restricted the monthly use of money for other expenses

- high risk: in the case of hire-purchase of electrical goods or car, it may be repossessed by the seller

Consideration for Using Credit (cont.)

BenefitBenefit- Borrower receives the service from those items Borrower receives the service from those items

immediatelyimmediately- Can take advantage of a sale price on an item Can take advantage of a sale price on an item

providing the saving > total finance chargeproviding the saving > total finance charge- Credit’s convenience aspects – no large sums of Credit’s convenience aspects – no large sums of

money to carry, single bill each month, record money to carry, single bill each month, record of purchases of purchases

Importance of Credit Whenever an immediate need for cash, goods or

services is met through the proper use of credit by consumers, the economy of the nation is strengthened & the level of living is raised

People developed need for cash to help them meet financial emergencies for which they were unprepared

People have used the installment plan (hire-purchase – credit) as a means of adjusting the high expenses & low expenses that develop in their spending patterns when they are not using the installment plan

Credit & Debt

The term ‘credit’ refers to the ability to borrow money or to buy goods on time

Where it means the credit standing or the ability to use credit

A debt is incurred whenever an individual makes use of his credit standing

Consumers buy on credit means going into debt temporarily

Types of CreditTypes of Credit

Two basic types of consumer credit (based Two basic types of consumer credit (based on method of payments)on method of payments)

Closed-end creditClosed-end credit One-time loan repaid in equal payment One-time loan repaid in equal payment

in a specified period of timein a specified period of time Open-end creditOpen-end credit

Continuous loan & billed periodically Continuous loan & billed periodically for at least partial payment for at least partial payment

Types of Credit (cont.)Types of Credit (cont.)Closed-End CreditClosed-End Credit Used for specific purpose & involves a specific amountUsed for specific purpose & involves a specific amount Mortgage loan (property – house, land, building) automobile Mortgage loan (property – house, land, building) automobile

loan (hire-purchase), installment loan for purchasing loan (hire-purchase), installment loan for purchasing furniture & appliances (hire-purchase)furniture & appliances (hire-purchase)

There is a contract or agreementThere is a contract or agreement Lists the repayment terms: number of payments, payment Lists the repayment terms: number of payments, payment

amount, cost of creditamount, cost of credit May require down-payment or trade-in; the balance repaid May require down-payment or trade-in; the balance repaid

in equal weekly or monthly payments over a period of time in equal weekly or monthly payments over a period of time Seller holds title to the merchandise until completion of Seller holds title to the merchandise until completion of

paymentpayment

Types of Credit (cont.)Types of Credit (cont.)Open-end CreditOpen-end Credit Bank credit card, departmental store credit card, overdraft bankBank credit card, departmental store credit card, overdraft bank Credit cardCredit card

Credit not used for single purchase; can make any purchases & Credit not used for single purchase; can make any purchases & cash advance not exceeding the line of credit (credit limit) – cash advance not exceeding the line of credit (credit limit) – maximum amount of credit made available to youmaximum amount of credit made available to you

Pay interest (periodic charge) or other charges – late paymentPay interest (periodic charge) or other charges – late payment Grace period of 20 to 25 days to pay a bill in full before Grace period of 20 to 25 days to pay a bill in full before

charging any interestscharging any interests Overdraft bank – credit granted is deposited in current accountOverdraft bank – credit granted is deposited in current account

Types of Credit (cont.)Types of Credit (cont.)Based on purpose for the credit & also method of paymentBased on purpose for the credit & also method of payment Public creditPublic credit Private creditPrivate credit

1.1. Business creditBusiness credit

2.2. Consumer creditConsumer credit

a)a) Retail creditRetail credit Revolving creditRevolving credit Retail installment creditRetail installment credit Service creditService credit

b)b) Cash creditCash credit Installment loanInstallment loan Single payment loanSingle payment loan General purpose credit cardGeneral purpose credit card

c)c) Retail estate creditRetail estate credit

Types of Credit (cont.)Types of Credit (cont.)

2a)2a) Retail CreditRetail Credit

Used by consumers to purchase final goods & services Used by consumers to purchase final goods & services

directly from sellers using revolving credit (open-end directly from sellers using revolving credit (open-end

credit), installment contract or service creditcredit), installment contract or service credit

Credit of the buyer is accepted by the seller who agrees Credit of the buyer is accepted by the seller who agrees

to wait for future payment; seller extend the credit to to wait for future payment; seller extend the credit to

buyer to facilitate purchase buyer to facilitate purchase

Types of Credit (cont.)Types of Credit (cont.)2a)2a) Retail CreditRetail Credit

i.i. Revolving creditRevolving credit Allows consumers to purchase a variety of items using Allows consumers to purchase a variety of items using

credit up to a predetermined amount. Seller issued specific credit up to a predetermined amount. Seller issued specific credit card to buyer that can be used to buy items from the credit card to buyer that can be used to buy items from the issuer. issuer.

Monthly statement is sent to customer that lists previous Monthly statement is sent to customer that lists previous purchases & amounts duepurchases & amounts due

Can pay the entire outstanding balance up to 25 days grace Can pay the entire outstanding balance up to 25 days grace period without finance chargesperiod without finance charges

Can pay a minimum payment but outstanding balance will Can pay a minimum payment but outstanding balance will be charged with interest in the next bill be charged with interest in the next bill

Types of Credit (cont.)Types of Credit (cont.)2a)2a) ii.ii. Retail installment credit (closed-end)Retail installment credit (closed-end) To purchase a large item & pay in a series of fixed & To purchase a large item & pay in a series of fixed &

regular payments over a long period of timeregular payments over a long period of time A single contract for each item purchased, finance charges A single contract for each item purchased, finance charges

& provisions for nonpayment specifically outlined in the & provisions for nonpayment specifically outlined in the agreementagreement

Hire-purchase of electrical goods & furnitureHire-purchase of electrical goods & furniture

2a)2a) iii. Service creditiii. Service credit Service provider agree to wait for payment from customerService provider agree to wait for payment from customer Doctors, plumbers who offer services & utilities Doctors, plumbers who offer services & utilities

(telephone, electricity) provider will send a bill later for (telephone, electricity) provider will send a bill later for the paymentthe payment

Types of Credit (cont.)Types of Credit (cont.)

2b)2b) Cash creditCash credit A borrower obtain fund from a lender in exchange A borrower obtain fund from a lender in exchange

for an agreement to repay fund later, with interest for an agreement to repay fund later, with interest chargescharges

Lender provides cash that will be used by borrowerLender provides cash that will be used by borrower

i.i. Installment loanInstallment loan A series of fixed, regular payments are made to A series of fixed, regular payments are made to

repay funds over a period of timerepay funds over a period of time Required to provide evidence of income & Required to provide evidence of income &

financial securityfinancial security Personal loan, hire-purchase carPersonal loan, hire-purchase car

Types of Credit (cont.)Types of Credit (cont.)

2b) Cash credit2b) Cash credit

ii.ii. Single payment loanSingle payment loan Usually short-term loanUsually short-term loan Funds are given for a year or less with the Funds are given for a year or less with the

agreement to repay it in one payment at the agreement to repay it in one payment at the end of the periodend of the period

Eg. Loan from pawn-brokers Eg. Loan from pawn-brokers

Types of Credit (cont.)Types of Credit (cont.)

2b)2b) Cash creditCash credit

iii.iii. General purpose credit cardGeneral purpose credit card Revolving credit where a borrower pay purchases using Revolving credit where a borrower pay purchases using

credit card credit card Can be used for a variety of purchasesCan be used for a variety of purchases Master card, visa cardMaster card, visa card Itemized monthly statement shows specific charges, Itemized monthly statement shows specific charges,

purchases, cash advances, paymentpurchases, cash advances, payment May pay full amount each month without chargesMay pay full amount each month without charges May pay minimum payment, with the finance charges May pay minimum payment, with the finance charges

collected in the following month’s bill collected in the following month’s bill

Types of Credit (cont.)Types of Credit (cont.)

2c) Real estate credit2c) Real estate credit Funds being extended to borrower with a loan that Funds being extended to borrower with a loan that

uses real property as security or collateral for the uses real property as security or collateral for the loanloan

To purchase or improve a homeTo purchase or improve a home Interest on this loan can be deducted from taxable Interest on this loan can be deducted from taxable

incomeincome