Credit Management

Credit Management

5.01 Understand credit management.Credit ManagementMain Types of CreditCredit: An agreement to obtain money, goods or services now in exchange for a promise to pay in the futureMain Types of CreditCharge AccountsCredit CardsInstallment CreditConsumer Loans

Charge AccountsA charge account represents a contract between creditors and debtors. Charge accounts allow debtors (customers) to receive goods or services from suppliers (creditor) and pay for them at a later date.ExamplesRegular AccountsBudget AccountsRevolving Accounts

Charge AccountsRegular AccountsRequires the buyer to make a full payment within a stated periodUsed for everyday needs and small purchases Example: charge account with an electrician who re-wired a houseBudget AccountsRequires that a customer make payments of a fixed amount over several monthsExample: A charge account with Progress Energy utility company

Charge Accounts

Revolving AccountsMost popular form of sales creditCharge purchases at any time, but only part of the debt must be paid each monthA credit limit is set for the maximum amount to be spentPayments are required once a month, but it doesnt have to be the FULL paymentA finance charge is added if the total bill is not paid (total dollar amount spent plus interest)Credit CardsCredit cards allow debtors (customers) to receive goods and services from suppliers (creditor) using credit cards and pay for them later.Types of credit cardsBankA bank will pay the business (taking liability for payment)Customers are required to pay a fee for using the credit cardExamplesMasterCard, VISA

Credit CardsTravel/EntertainmentPay a yearly membership feeExpected to pay the full balance each monthExamples: American Express, Diners ClubOil CompanyExamples: BP Oil, ExxonRetail StoreCards offered by a particular storeExamples: Belk, Kohls

Installment CreditInstallment sales credit is a contract issued by the seller that requires intermittent payments at specified times such as bi-weekly or monthly.Customers are required to make a down payment which is a portion of the entire purchase.Most often used for furniture and household appliancesExamples:Rooms to Go Furniture

Consumer Loans

A consumer loan is when a buyer agrees to make monthly payments in specific amounts over a period of time.The loaner receives money up front and agrees to pay the price back in full plus interestThe lender needs some assurance that the loaner will pay the money back.Promissory noteCollateral (property used as security)CosignerBusiness Advantages for using CreditEstablishing a favorable credit ratingKeeping business separate from personal expensesMinimizing record-keeping and receiptsKeeping track of what employees are spendingEarning rewards

Business Disadvantages for Using Credit

Experiencing theft of customer records/databasesOverbuying by employeesOverusing credit

Cost of CreditInterest (I)The cost of using someone elses moneyPrincipal (P)Amount of the loanInterest Rate (R)Percent of interest charged or earnedTime (T)The length of time for which the interest will be chargedExpressed in years

Cost of CreditSimple InterestI=P*R*TTime in YearsMultiply by the number of yearsTime in MonthsDivide the number of months by 12Time in DaysDivide the number of days by 360

Cost of CreditInstallment Interest: When a loan is repaid in partial paymentsCalculation:Calculate out how much interest you oweI = P x R x TCalculate the total cost of the loanTotal Cost = P + IDetermine the number of paymentsBased on how often you are required to make paymentsGenerally, you make monthly payments# payments = # years * 12[because there are 12 months/yr]Calculate your paymentsPayments = Total Cost / # of payments

Cost of CreditDecreasing Loan PaymentsInterest is calculated on the amount that is unpaid at the end of each monthCalculation:Interest is calculated on the amount of the loan that is unpaid.Interest = Unpaid Balance * Interest rateRemember: The amount of interest is based on the portion of the year.1 month is 1/12th of a yearInterest Rate for 1 month = Annual Interest Rate / 12Monthly Payment = Interest + Loan Repayment

Cost of CreditMaturity DateThe date on which a loan must be repaidMonthsThe maturity date is the same day of the month that the loan was madeExample: One month loan on January 15 will be due on February 15DaysDetermine the day the loan was made, and then count the exact number of days of maturityExample: A 90-day loan made on March 4 will be due on June 2

Cost of CreditAnnual Percentage Rate (APR)A disclosure required by law on all credit agreementsStates the percentage cost of credit on a yearly basisAlso includes service fees

Previous Balance MethodCharges interest based on the amount of debt carried over from the previous billing cycle to the new billing cycle.I = Previous Balance * Interest RateAdjusted Balance MethodInterest is calculated at the end of the month once all the transactions have been posted.I = (Balance Payments) * Interest RateAverage Daily Balance MethodInterest is calculated based on the average daily balance for the billing cycle.I = (Total Daily Balance/# Days in Billing Cycle) * Interest RateCost of CreditThree Cs of CreditCharacterHonesty to pay a debt when it is due.How past debt obligations were handledCapacityRefers to a persons ability to pay a debt when it is dueCapitalCurrent available assets that could be used to repay debt if income was to become unavailable

Credit Application

A form on which you provide information needed by a lender to make a decision about granting credit.Credit referencesbusinesses or individuals who are able and willing to provide information about your creditworthinessShould be filled out completely, accurately, and honestly.Requires signature of applicant, which indicates provided information is true.

Documenting Credit DataCredit data makes up the information that applicants provide on credit applicationsDocumentation of credit data may be verified by:Employers (former and current)Type of data: Employment dates and salaryFinancial institutionsType of data: Saving or checking accountsPersonal referencesType of data: Manner how personal business is conducted

Credit Documents

Credit ContractsKWYS Know what youre signingCredit contracts are legal binding documents that allow debtors to use credit to obtain goods and services. Debtors should know the content of the credit contract before signing such as:Amount of finance chargesRepairs covered Add-on featuresReduction of finance charge if contract paid in full prior to ending dateReceive the copy of the contractRepossession conditionsCredit DocumentsStatement of Account: The BillA record of the transactions completed during the billing periodStatement includesBalance that was due from last statementAmounts charged during the monthAmounts credited to your account for payments or for returned itemsThe current balance (old balance + finance charges +purchases payments)The minimum payment due

Credit BureausA company that gathers information on credit users (credit reporting agency)Credit bureaus sell lenders credit information about credit users such as debt records, payment history, and if any action has been taken to collect overdue bills.Credit bureaus create a credit report to show the debts an individual owes, how often the individual uses credit, and whether the individual will pay their debts on timeEqiufax TransUnionExperian

Credit RegulationsTruth-in-Lending Law (1968)Requires lenders to reveal the cost of credit (APR and finance charge) and terms before signing an application or contractProtects consumers against unauthorized use of credit cards

Equal Credit Opportunity Act (1974)Prohibits creditors from denying a person credit because of age, race, sex, or marital statusAllows credit applications be judged on financial responsibility of credit applicants. The three areas of responsibilities are low income, large debts, and a poor payment record.

25Credit RegulationsFair Credit Billing Act (1975)Requires creditors to correct billing mistakes promptly.

Fair Credit Reporting Act (1970)Allows individuals to scrutinize any information shared by credit reporting agencies with potential creditors and employers.Individuals also may correct any incorrect credit information.

Credit RegulationsConsumer Credit Reporting Reform Act (1996)Requires that the credit reporting agency must be able to prove that credit information they provide is accurate.

Fair Debt Collections Act (1977)Prohibits deceptive, harassing, and unfair practices for collecting debt from debtors.

Credit RegulationsCredit Card Accountability, Responsibility, and Disclosure Act (2009)An amendment to the Truth in Lending ActThe act institutes fair and transparent practices of providing credit.

Credit RegulationsSome practices are instituted by the CARD Act are:Inform customers of increase of cost of credit not less than 45 days prior to effective date.Provides information about how long it would take to pay off a loan if minimum payments are paid.Protects potential credit consumers under the age of 21, who must have a cosigner with a means to repay debt of the consumer.

Credit AssistanceDebt repayment planAn agreement between a creditor and debtor that allows the debtor to pay off a debt with more manageable payment planCredit CounselingProvides information on actions to take in order to manage debt (reduce spending and eliminate credit difficulties)BankruptcyThe legal process of reducing or eliminating an amount owedOnly should be used for extreme situationsStays on your credit record for 10 years