2006 mcgraw-hill ryerson ltd. kapoor dlabay hughes ahmad prepared by cyndi hornby, fanshawe college...

2006 McGraw-Hill Ryerson Ltd.

Kapoor Dlabay Hughes Ahmad

Prepared by Cyndi Hornby, Fanshawe College

Chapter 5Introduction to Consumer

Credit

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Learning Objectives - Chapter 5

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 # 1

Define consumer credit and analyze its advantages and disadvantages.

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What is Consumer Credit?

Credit is an arrangement to receive cash, goods or services now, and pay for them in the futureConsumer 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 savingsUse present earningsBorrow against future income

Trade-offs are involved in using credit

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Consumer credit is the amount of credit used by consumers to purchase non-investment goods or services that are consumed and whose value depreciates quickly

Includes automobiles, recreational vehicles (RVs), education, boat and trailer loans Excludes debts taken out to purchase real estate or margin on investment accounts


Common forms of consumer credit include

Credit cardsStore cardsMotor (auto) financePersonal loans (installment loans)Consumer lines of creditRetail loans (retail installment loans)Mortgages


The cost of credit is the additional amount, over and above the amount borrowed, that the borrower has to pay

Includes interest, arrangement fees and any other chargesSome costs are mandatory, required by the lender as a part of the credit agreementOther costs may be optional. The borrower chooses whether or not they are included as part of the agreement


Credit ConsiderationsBefore 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 I’ll 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

Current use of goods and servicesPermit purchase even when funds are lowUse for financial emergenciesConvenient when shoppingSafer than cashCan take advantage of float timeMay get rebates, airline miles or other bonusesDemonstrates financial stability

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Disadvantages of Consumer Credit

Purchases are more expensiveTemptation to overspendTies up future income.Possible financial difficultiesDamage to family relationshipsSlows progress to future goals

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Differentiate among various types of credit.

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Types of Credit5-9

Closed-End CreditFor a specific purpose and amount.•Payments of equal amounts•Mortgage, automobile and installment loans

Open-End CreditUse as needed until reaching line of credit. You pay interest and finance charges if you do not pay the bill in full when dueDepartment store or bank credit card, overdraft protection, bank line of credit, home equity loan


Open-End Credit5-10

Credit LimitThe dollar amount which may or may not be borrowed that lender makes available to a borrower

InterestA periodic charge for use of credit

Personal Line of CreditA prearranged loan from a bank for a maximum specified amount


Credit Cards

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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MasterCard


Credit Card in VietnamAccording to Visa International, only 88,000 of 85mil people in Vietnam (1%) are using Visa credit cards with the transaction turnover of $115millions Meanwhile, the percentages of populations using Visa cards are much higher in other countries

68.5% in Singapore10.6% in Thailand20.3% in Malaysia


ANZ and HSBC are well known as banks that issue international credit cardsBoth the banks have high technology and a lot of experience in international and domestic credit cards


Domestic banks also issue credit cards

For example, Vietcombank began issuing MasterCard in 1996After 10 years of development, the international card market now has 10 banks-issuers, including Vietcombank, ACB, ANZ, Eximbank, EAB and HSBC

There are three main brand name cards

Visa, MasterCard and American Express


Protecting Yourself Against Credit Card Fraud

Sign new cards as soon as they arrive.Treat the cards like money - keep them secure.Shred anything with your account number on it.Don’t 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.

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Immediately report if lost or stolen.Notify issuer if you don’t get your billing statementCheck your credit report every few yearsIf you make purchases online;

use a secure browserkeep records of your online transactions

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If you make your purchases online;review monthly statements for errors and unauthorized purchasesread the policies of sites you visitkeep your personal information privategive payment information only to businesses you know and trustNever give your password to anyone onlineDo not download files from strangers

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Personal Lines of Credit

Revolving line of creditInterest rate linked to lender’s prime rateWithdraw up to specified limit using debit card or chequesRepay minimum stated or moreSecured with assets

GIC’s or home equity

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Line of creditAny credit source extended to a government, business or individual by a bank or other financial institution

A line of credit may take several formsOverdraft protectionDemand loanSpecial purposeExport packing creditTerm loan Discounting, purchase of commercial bills


The lender determines a line of credit based largely on the individual's credit worthiness and income potentialMost people encounter a line of credit when dealing with credit cards or home equity loans


Home Equity LoansA loan based on the current market value of your home less the amount still owing on your mortgageCan borrow up to 85% of your equityInterest 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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Home Equity Loans vs. Second Mortgage

Similar to a 2nd mortgage, a home equity line of credit establishes a maximum amount of money a homeowner can borrowIn a second mortgage, the bank lends the entire amount of money and the borrower makes regular payments based on the balance dueA line of credit arrangement allows the homeowner to borrow smaller amounts of money to pay off contractors or bills without incurring a large debt up front


Closed End CreditMortgage and Mortgage Loans

Mortgage• A contract to buy a real estate, plan• A pledge of property to secure payment

of a debt

Mortgage Loans• A debt• Loans to value is 80% at max• Ex:

– Home Mortgage– Plant Mortgage


Closed End CreditCAR LOAN

Automobile is your second largest investmentFinancing Sources1. Financing at the Dealer

– Affiliated with manufacturer or financial institution

– Significantly lower interest rates on some models

– Other incentives offered (no down payment, no late charge….)

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Car Loan2. Leasing

Closed-end lease• You can buy vehicle at lease end or

return it to company

Open-end leas• You are responsible for residual value of

vehicle at lease end

Vehicle owned by leasing company, you pay maintenance, repairs, insuranceMay have mileage restrictions

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3. Paying CashAdvantages:• Least expensive • Avoids interest charges• Used by people with limited/poor credit line

Disadvantages:• Investment returns higher than cost to

borrow– Using saving money to buy or borrowing– Using saving money to buy or investing

• Automobile depreciations– 15-20% on the first year– 50% after three years



Assess your credit capacity and building your credit rating.

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Measuring Your Credit Capacity

Before you take out a loan, ask yourself...Can you afford the loan?• Ability to make principal and interest

payments• Extra money after covering up the loan

What do you plan to give up in order to make the payment?• Saving or investing money

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Credit CapacityThe maximum amount of debt a person or entity can be expected to assume and repay based on financial abilityBased on a formula that factors existing debt payments and net income to arrive at a percent of net income that is available for debt repayment


Credit Capacity Indicators

*Not including housing

Debt Payments-to-Income Ratio

monthly payments*

net monthly income

should not exceed 20%

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Ex: Monthly credit payments are $760 and net income is $3,800Debt-payments ratio• $760/$3,800 = 0.20 = 20%


Credit Capacity Indicators

Debt To Equity Ratio

total liabilities

net worth*= Should be < 1

*Excluding home value

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Ex:Long-term debt of $3,000 and owner’s equity of $12,000The debt/equity ratio• 3000 / 12000 = 0.25

If the ratio is greater than 1, the majority of assets are financed through debtIf it is smaller than 1, assets are primarily financed through equity


Co-Signing a LoanYou are considered as a co-debtor or co-owner of the loanGuaranteeing a debt

If borrower doesn’t pay the debt you will have to Including fees and collection costs

Statistics show that 3 out of 4 co-signors have to pay

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If you do co-sign a loanBe sure you can afford to pay

• Cover the debt of others when they default

Liability can keep you from getting other credit

• Credit line will be affected

Could lose the property you pledge as security

• Lost of automobile or furniture

Understand provincial laws• Rights as a co-singer

Request copy of all over due notices


Build and Maintain Your Credit Rating

Your credit experiences, or lack of, is a major consideration for the creditora good credit rating is a valuable asset

use credit with discretionlimit borrowing to your capacity to repayabide by the terms of the lending contracts

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Your Credit FileThe 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 positionFormer address and employerSpouses name, social insurance number

and employerPublic records and informationCheques returned for insufficient funds

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Credit BureausEquifax Canada• www.equifax.ca

Trans Union Canada• www.tuc.ca

Experian• www.experiance.com

Others


Credit Bureau RegulationMost provinces have legislation to protect

Consumer privacyRight not to suffer from false credit or personal information

Others may only view your file if written consent has been givenFirst bankruptcy remains on your file 7 years, second bankruptcy is permanentErrors in your credit file should be corrected immediately

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Credit Bureaus in VietnamThe State Bank of Vietnam's Credit information center, established in 1999, remains the country's sole credit bureau

The credit bureau targets small- and medium-size enterprises (SMEs) and individuals


Vietnam's first private credit information company (PCB) officially began providing services in 2010 with more than 20 banks committing to supply information

The company was established by the Private Credit Bureau Investment Joint Stock Company (PCB)

Total charter capital of 50 billion VND (2.7 million USD) was contributed by 11 Vietnamese commercial banks: ACB, ABBank, Vietinbank, BIDV, Southeast Asia Bank, Techcombank, Vietcombank, SB, VIB, Vietbank and VPBank


Vietnam has a population of more than 86 million and over 480,000 SMEsOnly 5% of the population and 30% of the SMEs have engaged in credit transactions with banks

A low rate in the region, as the rates in Thailand and Malaysia are 70 to 80%


Credit Scoring

Used by lenders to assess the risk of prospective borrower’sData is credit report is summarized in a credit score

Helps to predict creditworthinessHigher the score the better

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Credit Scoring

The following categories are weighted

Payment historyLength of credit historyAmounts owedTypes of credit usedNumber of recent applications for credit

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Improve your scoreManaging your debt responsiblyPay your debt on timeAvoid over spending on credit limitAvoid certain types of creditNot applying for too many credit cards at the same time



Describe the information creditors look for when you apply for credit.

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What Creditors Look For: 5 C’sCharacter – Borrower’s attitude towards credit obligationsCapacity – Borrower’s financial ability to meet credit obligationsCapital – Borrower’s assets or net worthCollateral – Valuable assets that is pledged to ensure loan paymentsConditions – the general economic conditions that can affect borrower’s ability to repay a loan

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If you are denied credit?

Ask questions if application for credit is deniedIf 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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Identify the steps you can take to avoid and correct credit mistakes.

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Avoiding & Correcting Credit Mistakes

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 bureauscontact creditors for accounts that have been opened fraudulentlyfile a police reportclose all bank accounts immediately and cancel credit cards

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Summary of Learning ObjectivesDefine consumer credit and analyze its advantages and disadvantages

Is borrowing money to obtain goods and services for personal needsAdvantages 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 ObjectivesDifferentiate 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 ratioDebt to equity ratioCreditor seeks information from credit bureaus

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Summary of Learning Objectives

Describe the information creditors look for when you apply for credit

CharacterCapacityCapitalCollateralConditions

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Summary of Learning Objectives

Identify the steps you can take to avoid and correct credit mistakes

If billing error occurs notify creditor in writing within 60 daysIf your dispute is not settled place your version in your credit fileCan withhold payment for defective goods or services as long as you attempt to solve dispute with merchant

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2006 mcgraw-hill ryerson ltd. kapoor dlabay hughes ahmad prepared by cyndi hornby, fanshawe college...

Documents

credit agreement

cost of credit

credit considerations

credit capacity

credit rating

visa credit cards

international credit

domestic credit cards