The Basics of CreditObjective: To explain the concept of consumer credit, including major types and their benefits/drawbacks.

What is credit? Credit is money that a lender makes

available to a borrower, with the understanding that the borrower will repay the money in the future. (Often with interest)

Interest is the price one pays for the right to use another party’s money.

Types of Credit1) Non-installment credit - credit that is

extended for a short term (30 days or less). The consumer borrows money at the time of

purchase and pays off the entire amount within a short time.

Used to encourage immediate purchases of specific items.

“30 days, same as cash” - if it is paid in the allotted time there is no interest.

This type of credit is good if you are expecting to receive money soon (Income Tax Refund).

Types of Credit2) Installment credit - credit that is extended but

allows the borrower more time to repay, usually requires the borrower to make monthly payments

Payment is split into principal and interests Principal is the total amount of money outstanding

on a loan. Installment loans span a few years Used for purchases such as furniture, car, or

boat loans. Makes purchasing these items MORE costly.

Math for Personal Finance Barbara borrowed $2300 to buy some furniture

and is paying 15 percent interest a year on the loan. The terms of the loan do not require her to pay off any of the loan balance during the first year. She only has to make interest payments. How much interest will she pay the first year is she does not reduce the principal of the loan?

Solution: $2300 x .15= $345 in interest the first

year.

Types of Credit3) Revolving Open-Ended Credit - borrow money up to

preset maximum amount. (Credit Cards) Credit limit - established based on the borrower’s

income level, debt level, and overall credit history. Can use revolving credit to make one purchase or

many You can repay entire amount borrowed at the end of

the month or spread the payments out over a longer time.

As you pay off the money borrowed in the past you can make additional purchases (as long as you do not exceed credit limit)

Higher interest rates than Installment Credit!

Cash versus Financing Why do you think someone might choose to borrow

money for 36 months rather than for a shorter period?

You buy a $3000 car and are going to finance the car at an interest rate of 12%

Cash purchase of car

$3,000

Total Paid$3,000

Interest Paid$0

Financed for 12 months 12 payments of : $266.55

$3,198.60 $198.60

Financed for 24 months 24 payments of : $141.22

$3,389.29 $389.29

Financed for 36 months 36 payments of : $99.64

$3,587.04 $587.04

Advantages of Using Credit Make large purchases sooner Simplifies finances (no need to carry

cash or checks) Established a good credit history (if you

use it wisely) The better your credit the lower your

interest rate, which makes your purchases cheaper when you use it.

Disadvantages of Using Credit Easier to get credit than pay it back Bad credit history can make borrowing more costly If you fail to make payments your purchases could

be repossessed Could lead to bankruptcy- a legal process where the

court takes over certain aspects of a person’s financial life.

Credit cards have high interest ( If you borrow $3000 on a credit card that charges

21% annual interest and only make the minimum payment every month it will take you almost 23 years to pay off the balance!)

Math for Personal Finance Sabrina charges $800 at the local sporting

goods store to buy some exercise equipment. The store offers no interest for 90 days if the balance is paid in full, or 24 percent annually if the balance is not paid in full prior to the 90 days. How much interest will she need to pay if she lets the account go for 91 days before paying the bill?

Solution: %2

12

%24

months48$800$302.

Credit Rights and Consumer Credit Laws THE EQUAL CREDIT OPPORTUNITY ACT-

prohibits discrimination in the granting of credit on the basis of such factors as race, skin color, religion, or sex.

THE FAIR CREDIT REPORTING ACT- sets up a procedure for correcting mistakes on your credit report.

Credit Rights and Consumer Credit Laws THE FAIR CREDIT BILLING ACT - sets up

procedures requiring creditors to promptly credit your payments and correct billing mistakes and allows you to withhold payments on defective goods.

TRUTH IN LENDING - gives you three days to change your mind about certain credit transactions that use your home as collateral. It also limits your risk on lost or stolen credit cards.