Credit: Principles and Sources


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Credit: Principles and Sources

  1. 1. Chapter 9a Credit: Principles and Sources
  2. 2. Credit: Principles <ul><li>Three ways consumers can finance their purchases </li></ul><ul><li>i. Draw on their savings </li></ul><ul><li>Ii. Use present earning </li></ul><ul><li>Iii. Borrow against expected future income </li></ul>
  3. 3. Credit: Principles (cont.) <ul><li>Credit is an arrangement to receive cash, goods, or services now and pay later for them in the future </li></ul><ul><li>Or credit is an advance (or loan) of money with which to purchase goods and services </li></ul><ul><li>Or credit is an advance of goods & services in exchange for a promise to pay at a later date </li></ul><ul><li>Borrow money from a lender </li></ul><ul><li>A medium of exchange with limited acceptance </li></ul><ul><li>The use of money from future income </li></ul>
  4. 4. Credit: Principles (cont.) <ul><li>Consumer credit: </li></ul><ul><li>is the use of credit for personal needs, by individuals and families </li></ul><ul><li>credit granted to an individual especially to finance the purchase of consumer goods or for personal expenses </li></ul><ul><li>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 </li></ul>
  5. 5. Credit: Principles (cont.) <ul><li>The finance charge included all related costs – interest, processing fee </li></ul><ul><li>Have period of maturity, installment amount, repayment period and frequency of payment </li></ul><ul><li>The installment amount maybe fixed or varied depending on type of credit </li></ul><ul><li>The difference in rate of finance charge or maturity period affected the amount of finance charge and monthly installment </li></ul><ul><li>To reduce wastage of money, examine the finance charge & maturity period </li></ul>
  6. 6. Use & Misuse of Credit <ul><li>Before using any credit for major purchase, ask yourself some questions </li></ul><ul><li>Do I have cash for the down-payment? </li></ul><ul><li>Do I want to use my savings for this purchase? </li></ul><ul><li>Does the purchase fit my budget? </li></ul><ul><li>Could I use the credit I’ll need in some better way? </li></ul><ul><li>Can I postpone this purchase? </li></ul><ul><li>What are the opportunity costs of postponing the purchase? </li></ul><ul><li>What are the financial & psychological costs of using credit for the purchase? </li></ul>
  7. 7. Advantages of Credit <ul><li>Current use of goods & services </li></ul><ul><li>Permits purchase when funds are low </li></ul><ul><li>A cushion for financial emergencies </li></ul><ul><li>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 </li></ul><ul><li>Easier to return merchandise (hire-purchase) </li></ul><ul><li>Convenient when shopping – don’t have to bring along a big sum of cash </li></ul><ul><li>One payment a month (monthly payment) </li></ul>
  8. 8. Advantages of Credit (cont.) <ul><li>Safer than cash – no cash carried, thus does not attract thiefs </li></ul><ul><li>Have a record for the purchased item </li></ul><ul><li>Needed for hotel and car reservations and shopping online (credit card) </li></ul><ul><li>To take advantage of grace period in hirepurchase </li></ul><ul><li>May get rebates, airline miles, or other bonuses (credit card) </li></ul><ul><li>Indicates financial stability (as you are being granted credit by financial institution) </li></ul>
  9. 9. Disadvantages of Credit <ul><li>Tend to overspend </li></ul><ul><li>Can create long-term financial problems and slow progress toward financial goals </li></ul><ul><li>Potential loss of merchandise due to default payment </li></ul><ul><li>Ties up future income </li></ul><ul><li>Credit costs money; more costly than paying with cash </li></ul>
  10. 10. Alternative for Consumer Credit <ul><li>Not buying </li></ul><ul><li>Buy later when there is enough money </li></ul><ul><li>Use saving for purchasing </li></ul>
  11. 11. Consideration for Using Credit <ul><li>Comparing cost and benefit from using credit </li></ul><ul><li>Two types of cost involved </li></ul><ul><li>1. direct cost </li></ul><ul><li>- finance charge: interest & processing fee charged directly by the seller </li></ul><ul><li>- 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 </li></ul>
  12. 12. Consideration for Using Credit (cont.) <ul><li>indirect cost </li></ul><ul><li>less flexibility: have a payment schedule that restricted the monthly use of money for other expenses </li></ul><ul><li>high risk: in the case of hire-purchase of electrical goods or car, it may be repossessed by the seller </li></ul>
  13. 13. Consideration for Using Credit (cont.) <ul><ul><li>Benefit </li></ul></ul><ul><ul><ul><li>Borrower receives the service from those items immediately </li></ul></ul></ul><ul><ul><ul><li>Can take advantage of a sale price on an item providing the saving > total finance charge </li></ul></ul></ul><ul><ul><ul><li>Credit’s convenience aspects – no large sums of money to carry, single bill each month, record of purchases </li></ul></ul></ul>
  14. 14. Importance of Credit <ul><li>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 </li></ul><ul><li>People developed need for cash to help them meet financial emergencies for which they were unprepared </li></ul><ul><li>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 </li></ul>
  15. 15. Credit & Debt <ul><li>The term ‘credit’ refers to the ability to borrow money or to buy goods on time </li></ul><ul><li>Where it means the credit standing or the ability to use credit </li></ul><ul><li>A debt is incurred whenever an individual makes use of his credit standing </li></ul><ul><li>Consumers buy on credit means going into debt temporarily </li></ul>
  16. 16. Types of Credit <ul><li>Two basic types of consumer credit (based on method of payments) </li></ul><ul><li>Closed-end credit </li></ul><ul><ul><li>One-time loan repaid in equal payment in a specified period of time </li></ul></ul><ul><li>Open-end credit </li></ul><ul><ul><li>Continuous loan & billed periodically for at least partial payment </li></ul></ul>
  17. 17. Types of Credit (cont.) <ul><li>Closed-End Credit </li></ul><ul><li>Used for specific purpose & involves a specific amount </li></ul><ul><li>Mortgage loan (property – house, land, building) automobile loan (hire-purchase), installment loan for purchasing furniture & appliances (hire-purchase) </li></ul><ul><li>There is a contract or agreement </li></ul><ul><ul><li>Lists the repayment terms: number of payments, payment amount, cost of credit </li></ul></ul><ul><li>May require down-payment or trade-in; the balance repaid in equal weekly or monthly payments over a period of time </li></ul><ul><li>Seller holds title to the merchandise until completion of payment </li></ul>
  18. 18. Types of Credit (cont.) <ul><li>Open-end Credit </li></ul><ul><li>Bank credit card, departmental store credit card, overdraft bank </li></ul><ul><li>Credit card </li></ul><ul><ul><li>Credit not used for single purchase; can make any purchases & cash advance not exceeding the line of credit (credit limit) – maximum amount of credit made available to you </li></ul></ul><ul><ul><li>Pay interest (periodic charge) or other charges – late payment </li></ul></ul><ul><ul><li>Grace period of 20 to 25 days to pay a bill in full before charging any interests </li></ul></ul><ul><li>Overdraft bank – credit granted is deposited in current account </li></ul>
  19. 19. Types of Credit (cont.) <ul><li>Based on purpose for the credit & also method of payment </li></ul><ul><li>Public credit </li></ul><ul><li>Private credit </li></ul><ul><ul><li>Business credit </li></ul></ul><ul><ul><li>Consumer credit </li></ul></ul><ul><ul><ul><li>Retail credit </li></ul></ul></ul><ul><ul><ul><ul><li>Revolving credit </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Retail installment credit </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Service credit </li></ul></ul></ul></ul><ul><ul><ul><li>Cash credit </li></ul></ul></ul><ul><ul><ul><ul><li>Installment loan </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Single payment loan </li></ul></ul></ul></ul><ul><ul><ul><ul><li>General purpose credit card </li></ul></ul></ul></ul><ul><ul><ul><li>Retail estate credit </li></ul></ul></ul>
  20. 20. Types of Credit (cont.) <ul><li>2a) Retail Credit </li></ul><ul><li>Used by consumers to purchase final goods & services directly from sellers using revolving credit (open-end credit), installment contract or service credit </li></ul><ul><li>Credit of the buyer is accepted by the seller who agrees to wait for future payment; seller extend the credit to buyer to facilitate purchase </li></ul>
  21. 21. Types of Credit (cont.) <ul><li>2a) Retail Credit </li></ul><ul><li>Revolving credit </li></ul><ul><ul><li>Allows consumers to purchase a variety of items using credit up to a predetermined amount. Seller issued specific credit card to buyer that can be used to buy items from the issuer. </li></ul></ul><ul><ul><li>Monthly statement is sent to customer that lists previous purchases & amounts due </li></ul></ul><ul><ul><li>Can pay the entire outstanding balance up to 25 days grace period without finance charges </li></ul></ul><ul><ul><li>Can pay a minimum payment but outstanding balance will be charged with interest in the next bill </li></ul></ul>
  22. 22. Types of Credit (cont.) <ul><li>2a) ii. Retail installment credit (closed-end) </li></ul><ul><li>To purchase a large item & pay in a series of fixed & regular payments over a long period of time </li></ul><ul><li>A single contract for each item purchased, finance charges & provisions for nonpayment specifically outlined in the agreement </li></ul><ul><li>Hire-purchase of electrical goods & furniture </li></ul><ul><li>2a) iii. Service credit </li></ul><ul><li>Service provider agree to wait for payment from customer </li></ul><ul><li>Doctors, plumbers who offer services & utilities (telephone, electricity) provider will send a bill later for the payment </li></ul>
  23. 23. Types of Credit (cont.) <ul><li>2b) Cash credit </li></ul><ul><ul><li>A borrower obtain fund from a lender in exchange for an agreement to repay fund later, with interest charges </li></ul></ul><ul><ul><li>Lender provides cash that will be used by borrower </li></ul></ul><ul><ul><li>Installment loan </li></ul></ul><ul><ul><ul><li>A series of fixed, regular payments are made to repay funds over a period of time </li></ul></ul></ul><ul><ul><ul><li>Required to provide evidence of income & financial security </li></ul></ul></ul><ul><ul><ul><li>Personal loan, hire-purchase car </li></ul></ul></ul>
  24. 24. Types of Credit (cont.) <ul><li>2b) Cash credit </li></ul><ul><ul><li>ii. Single payment loan </li></ul></ul><ul><ul><ul><li>Usually short-term loan </li></ul></ul></ul><ul><ul><ul><li>Funds are given for a year or less with the agreement to repay it in one payment at the end of the period </li></ul></ul></ul><ul><ul><ul><li>Eg. Loan from pawn-brokers </li></ul></ul></ul>
  25. 25. Types of Credit (cont.) <ul><ul><li>2b) Cash credit </li></ul></ul><ul><ul><li>iii. General purpose credit card </li></ul></ul><ul><ul><li>Revolving credit where a borrower pay purchases using credit card </li></ul></ul><ul><ul><li>Can be used for a variety of purchases </li></ul></ul><ul><ul><li>Master card, visa card </li></ul></ul><ul><ul><li>Itemized monthly statement shows specific charges, purchases, cash advances, payment </li></ul></ul><ul><ul><li>May pay full amount each month without charges </li></ul></ul><ul><ul><li>May pay minimum payment, with the finance charges collected in the following month’s bill </li></ul></ul>
  26. 26. Types of Credit (cont.) <ul><li>2c) Real estate credit </li></ul><ul><ul><li>Funds being extended to borrower with a loan that uses real property as security or collateral for the loan </li></ul></ul><ul><ul><li>To purchase or improve a home </li></ul></ul><ul><ul><li>Interest on this loan can be deducted from taxable income </li></ul></ul>
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