Borrowing Basics.pptx

2
Objectives
• To analyze and evaluate sources and types
of credit.
• To understand the importance of a credit
score and read a credit report.
• To examine the components of the cost of
borrowing.
• To differentiate between debit and credit
cards.
• To evaluate the basic borrowing process.

3
Main Menu
• Credit Basics
• Borrowing Money
– Expert Tips & Advice Video
Segment

5
Credit
• Is the issue of money, goods or services to
an individual or entity with the expectation of
future payments
• Allows consumers to take possession of the
items with a promise to repay over a specific
period of time
• Plays a role in establishing good or bad
financial records
– good credit makes it easier to borrow money
while bad credit makes it harder

6
Sources of Credit
• Include the following:
– banks
– merchant banks
– peer-to-peer lending
– payday loans
– title loans

7
Banks
• Are trusted institutions where money is kept
secure
• Are the primary and largest sources for
borrowing and lending money
• Make money by lending money at higher
rate than the
lending amount

8
Merchant Banks
• Provide international banking
– large corporations typically use this type of
banking when dealing with finances overseas
• Are equipped to deal with international
trading
• Aid multinational corporations with their
financial transactions amongst different
countries
– multinational corporations include Walmart® and
Coca-Cola®

9
Peer-to-Peer Lending
• Is the process of borrowing money from an
individual or investor without a bank’s
consent
– also known as social lending or crowd lending
• Is used if an individual does not have a good
credit score or wants to avoid paying high
interest rates
• Is not considered legal in every state
– for example, peer-to-peer lending is illegal in
Ohio

10
Payday Loans
• Are usually short-term, high cost loans
typically for $500 or less and due on the
next payday or when income is received
• Are the most expensive type of loan due to
the high interest rates which are included
along with the money borrowed
• Can be referred to as a cash advance or
check advance loans

11
Title Loans
• Require the borrower to offer collateral as
securement provided to the lender
– in case lender does not receive the money back
• if the money is not repaid, lender has the ability
to sell the asset for the loan
• Should be the last resort for a loan, an asset
can be taken away if the loan is not repaid
Collateral: valuable asset the borrower offers to lender for
securement of the loan provided

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Types of Credit
– revolving credit
– installment credit
– collateralized credit
– unsecured credit

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Revolving Credit
• Involves a maximum amount being loaned
to the borrower by the creditor
– creditor has approved a set amount (credit limit)
and borrowers can access the credit whenever
they want and as often as they want
– in return, the borrower must pay the creditor, at
least, a minimum amount on the account’s
outstanding balance each month
• Examples include:
– credit cards
– home equity lines of credit

14
Installment Credit
• Allows the borrower to be loaned a certain
amount of money for a set period of time
• Requires the borrower to repay the money
by making a series of fixed or installment
payments
• Examples include:
– mortgages
– auto loans
– student loans
– personal loans

15
Collateralized Credit
• Is a loan guaranteed to be paid back by
putting a lien on an asset of the borrower
• Is issued when the borrower promises an
asset of equal or higher value for the loan
– for example, an individual’s vehicle or house
• Common examples include:
– car loans
– mortgages
– home equity loans
Lien: right to keep possession of property of another until a
debt owed by the person is discharged

16
Unsecured Credit
• Is issued and supported by a borrower’s
reliability, rather than value of an asset
– can be obtained without the use of property or
vehicle as a securement for the loan
• Generally requires borrowers to have a high
credit ratings to be approved
– for example, if an individual has a high credit
score and wants to borrow $100,000 from a
lender, the individual does not have to provide
the lender with a securement for the loan

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Credit Cards
• Provide a line of credit which can be
accessed with a card
• Allow consumers to borrow money from a
lending institution and pay back some or all
of it each month
• Have a maximum limit to how much can be
borrowed (credit limit)
• Usually requires a signature to complete the
transactions

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Debit Cards
• Draw money directly from the consumer’s
checking account when a purchase is made
• Issue a penalty when the account is
overdrawn
– it is important to keep a running balance in the
checking account to make sure to not
accidentally overdraw the account
• Usually requires a pin to complete the
transactions

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Impact of Credit Decisions
– monthly budget
– income statement
– net worth statement

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Monthly Budget
• Helps organize money to set and reach
financial goals
• Can be based upon the following ideas or
goals of the budgeter:
– establishing an emergency fund
– paying bills on time to avoid late fees
– paying off any debt
– buying a house or vehicle
• Helps individuals understand how their
money is being allocated

21
Income Statements
• Are documents or spreadsheets outlining an
individual’s financial position at a given point
of time
• Typically include a breakdown of a person’s
total assets and liabilities
• Impact credit decisions
by showing how well an
individual is doing
financially

22
Net Worth Statements
• Provide a list of assets and debts owed
• Are essential when planning for long-term
financial success
• Include adding up all assets and liabilities,
then subtracting liabilities from assets
– assets are anything an individual owns which
has monetary value
– liabilities are obligations an individual has to pay
• mortgages
• student loans

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Credit Scores
• Are a number given to an individual which
indicates to the lender their ability to repay a
loan
• Can be obtained from multiple sources
– most commonly used are FICO and
VantageScore which range from 300 to 850
• each lender will set its own lending standards
however, in general, scores from 300 to 629 are
considered poor, 630 to 689 are considered fair,
690 to 719 are considered good and anything
over 720 is considered excellent

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Good Credit Scores
• Enhances a person’s ability to borrow
– lenders use a person’s credit score to evaluate
his or her risk as a borrower
• Help the borrower enjoy lower interest rates
– the higher the credit score, the lower the
interest rate might be
• Help the borrower gain access to better
financial deals
– a person might be able to refinance his or her
home loan or become eligible for better rewards
offered by a credit card

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Credit Worthiness
• Refers to an individual’s ability to repay a
borrowed amount
• Is reviewed by looking at five factors
– character
• how long an individual has been employed and if
bills are paid on time
– capacity
• evaluates income and household expenses
– capital
• equals how much is owned minus how much is
owed

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Credit Worthiness
• Is reviewed by looking at five factors
– collateral
• something tangible the borrower provides the
lender in the event of default
– condition
• current financial environment

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Credit Scores
• Are determined by the following:
– payment history
• whether bills or debts have been paid in the past
– credit utilization
• percentage of available credit which has been
borrowed
– length of credit history
• length of time each account has been open
– new credit
• new loans or credit accounts
– credit mix
• overall ability of how a borrower can handle all
types of credit

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Credit Reports
• Provide detailed information on how an
individual has used credit in the past,
including how much debt they have and
whether or not they have paid their bills on
time
• Are provided by three
credit bureaus in the
United States:
– Experian®
– Equifax®
– Transunion®

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Credit Reports
• Include the following information:
– personal information
• name, address, social security number
– credit history
• all open and closed credit accounts along with
records for repayments
– public records
• public records relating to finances such as
property liens or bankruptcy
– credit inquiries
• who has checked an individual’s credit in the
past two years

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Obtaining a Credit Report
• Involves the following:
– requesting a report from a credit report service
such as Equifax® or Experian®
– company sending the credit report which will
contain the credit score

31
Credit Reports
• Should be monitored regularly
– can be important tools for detecting identity theft
and fraud
• when someone uses another's personal
information to commit fraud, such as opening a
new credit account
– can help individuals catch signs of fraud and
take action to remedy the situation
– first step in correcting any inaccurate
information

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Credit Report Mistakes
• Can include the following:
– incorrect personal information
– outdated information
– incorrect payment status
• Can be disputed by contacting the credit
reporting agency
– disputes can be submitted online or by calling a
toll-free telephone number

33
Good Credit Management
• Is the practice of managing personal
finances
– tip: keep track of expenses and pay off debt fast
• Is an efficient indicator of identifying identity
theft
– tip: check credit report often to make sure
information is correct
• Can also catch mistakes made to credit
– tip: if a mistake occurs, make sure to report it
immediately

34
Consumer Credit Laws
• Are laws protecting consumer rights in credit
practices
• Include the following laws:
– Equal Credit Opportunity Act
– Fair Credit Reporting Act
– Truth in Lending Act

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Equal Credit Opportunity Act
• Prevents lenders from discriminating against
people or businesses based on non-
financial factors
• Claims a lender cannot discourage a
consumer from applying or discriminate
against a consumer based on factors such
as race, color, religion, marital status, age
(unless an applicant is too young to sign a
contract)

36
Fair Credit Reporting Act
• Defines how consumer credit information
can be collected and used
• Governs credit bureaus like Equifax®,
Experian® and TransUnion® along with other
consumer reporting agencies
• Allows consumers to review their credit
report upon request
– consumers can receive one free copy of their
credit reports each year from each credit bureau
• Provides consumers with the rights to
dispute errors on their credit reports

37
Truth in Lending Act
• Defines what information must be disclosed to
consumers who are being offered credit
products, such as personal credit cards and
loans
• Requires lenders to disclose:
– annual percentage rate (APR)
– finance charges, including application fees, late
fees and prepayment penalties
– amount financed
– payment schedule
– total repayment amount over the lifetime of the
loan

39
Borrowing Money
• Can become essential when making large
purchases such as a house or vehicle
• Usually involves paying interest for the
money borrowed
– interest is an amount of money charged by the
lender for borrowing money
• Is tricky and can result in poor financial
stability

40
Types of Loans
• Include but are not limited to:
– student loans
– mortgages
– auto loans
– payday loans

41
Student Loans
• Are offered to post-secondary students and
their families to help cover the cost of higher
education
• Have two main types:
– Federal student loans
• typically comes with
lower interest rates and
more borrower-friendly
repayment terms
– private student loans
• generally more expensive than Federal student
loans

42
Mortgages
• Are loans distributed by banks to allow
consumers to buy homes they cannot pay
for upfront
• Are tied to homes– a buyer can risk
foreclosure if they fall behind on payments
• Usually have the lowest interest rates of all
loans

43
Auto Loans
• Are loans people take out in order to
purchase vehicles
• Can help a person afford a vehicle, but
involves the risk of losing the car if
payments are missed
• May be distributed by a bank or by the car
dealership directly
– while loans from the dealership may be more
convenient, they often carry higher interest
rates and ultimately cost more overall

44
Payday Loans
• Are short-term, high-interest loans designed
to bridge the gap from one paycheck to the
next
• Are used predominantly by repeat borrowers
living paycheck to paycheck
• Should be repaid when the borrower
receives their next paycheck
– the government strongly discourages
consumers from taking out payday loans
because of their high costs and interest rates

45
Amortization
• Is the process of paying off a loan over time
with regular, equal payments
– monthly loan payments remain the same each
month
• Is most common with monthly payments on
loans
• Can be used to pay off many types of loans,
including:
– auto loans
– home loans
– personal loans

46
Amortized Loans
• Are calculated to completely pay off the
balance over a specific amount of time
– for example, a buyer will pay off a 30-year
mortgage after exactly 360 monthly payments
• Have payments which are applied toward
two parts─ interest costs and the principal
– interest costs are highest at the beginning of the
loan; as time goes on, more and more of each
payment goes towards the principal

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Amortization Table –
60 Month Loan Example
Month Balance
(Start)
Payment Principal Interest Balance
(End)
1 $20,000.00 $377.42 $294.09 $83.33 $19.705.91
2 $19,705.91 $377.42 $295.32 $82.11 $19,410.59
3 $19,410.59 $377.42 $296.55 $80.88 $19,114.04
--- --- --- --- --- ---
58 $1,122.90 $377.42 $372.75 $4.68 $750.16
59 $750.16 $377.42 $374.30 $3.13 $375.86
60 $375.86 $377.42 $374.29 $1.57 $0
* The table shows a $20,000 five-year auto loan with an interest rate of five percent

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Components of Borrowing Money
– annual percentage rate (APR)
– interest rate type (fixed interest or variable
interest)
– length of term
– grace period
– additional fees

49
Annual Percentage Rate (APR)
• Is the annual or yearly rate charged for
borrowing or earning through an investment
• Is the cost of a loan evaluated in terms of a
yearly percentage rate
– for example, if the loan has a 10 percent APR
rate, a borrower would pay $10 for every $100
borrowed annually

50
Fixed Interest
• Has the same interest rate throughout the
life of the loan
• Allows the individual to know how much
they will pay each month
– for example, if someone buys a $250,000
house, takes out a $200,000 mortgage with a
four percent fixed interest rate for 10 years, the
interest rate will stay the same every year

51
Variable Interest
• Fluctuates over time as the market interest
rates change
• Tends to start out lower than fixed interest
rates, however, may increase or decrease
throughout the life of a loan
– for example, a credit card company may offer a
variable interest rate which is tied to a particular
interest rate such as the “prime rate”; the interest
rate is expressed as the prime rate plus a
particular percentage such as “prime rate + 5%”
this means the interest rate will change based on
the prime rate which is the market rate

52
Fixed vs. Variable Interest Rates
Fixed Interest Rate Variable Interest Rate
Description The interest rate and
payments are fixed for the
duration of the mortgage
term
The rate can rise and fall
depending on the market
interest rates
Pros The rate and payments
stay the same, which
makes budgeting easier
and provides stability
Historically, variable rates
have proven to be less
expensive over time
Cons Consumers might pay a
larger amount throughout
the entire mortgage term
It can be risky because a
significant increase in
market rate will increase
the interest rate

53
Length of Term
• Refers to the amount of time the borrower
has to pay back the amount loaned
• Varies depending on the loan and policies
provided by the lender
• Impacts the length of borrowing by
establishing an amount of time money can
be lent

54
Grace Period
• Is the gap between when the credit card’s
billing cycle closes and when the bill
becomes due
– if the balance is paid off during the grace period,
there will be no finance charges for the
purchases made

55
Additional Fees
• Include the following penalties:
– late payments
• charge made for a payment being late
– cash advance
• fee which is charged for a short-term cash loan
– prepayment penalties
• an agreement between the borrower and lender
which regulates the amount the borrower is
allowed to pay off and when it must be paid off
– these can be included by a lender in a loan to
ensure the lender does not miss out on collecting
any interest which could be incurred

56
Borrowing Costs
• Can be reduced in several ways, such as:
– putting down a higher down payment
– shopping around for a low interest rate
– shortening the length of term
– making a higher principal payment

57
Higher Down Payments
• Involve making a higher initial payment so
the amount borrowed is less
– down payment is a portion of the initial payment
made for a purchase
• Keep borrowing money at a minimum
– the higher the down payment, the lower the
amount of money which needs to borrowed
• Might result in lower interest rates and fewer
additional fees

58
Higher Down Payment
• Example includes the following:
– if a couple buys a $250,000 home and makes a
down payment of $100,000, they will only need
to borrow $150,000 from the bank
• in this case, loan amount and interest rate
decrease with a higher down payment

59
Interest Rates
• Are the rates charged by the lender for the
use of money
• Can make a huge difference when making a
major purchase
• Can be determined by:
– credit scores
– loan amount
– down payment
– loan term
– interest rate type (fixed or variable)

60
Length of Term
• Is also a determining factor of the borrowing
cost
– the faster a person pays off the principal, the
less interest they will have to pay
• for example, paying off a mortgage in 15 years
rather than 30 years can save a person a large
amount of interest
– an individual should assess his or her financial
ability when determining the length of term of a
loan

61
Principal
• Is the original sum of money borrowed in a
loan
– in the beginning of a loan, the principal is paid
off slowly as most of the payment is applied
toward paying interest
– toward the end of a loan, very little of the
payment will be applied toward interest, most of
it will go toward paying the principal down

62
Principal Payments
• Are the money which is agreed to be paid
back and only goes towards the principal of
the loan
– interest is calculated based upon the principal
• Will decrease within a loan as more money
will be left over after paying interest
• Include any remaining money which will be
applied to any interest due
– rest of payment will be applied to the principal
balance of the loan

63
Borrowing Process
• Involves the following steps:
– determining the amount to borrow
– selecting a right loan program
– applying for a loan
– processing the loan
– closing the loan

64
Determining the Amount to
Borrow
• Is the first step in the borrowing process
• Involves assessing how much money an
individual can afford to borrow
• Involves figuring out the debt-to-income ratio
– is calculated by dividing total monthly debt by
gross monthly income
• in the case of a mortgage, a rule of thumb states
a monthly mortgage payment should not exceed
one-third of the gross monthly income

65
Selecting the Right Loan Program
• Involves choosing which loan makes the
most sense for the financial situation
– in the case of a home loan, there are two basic
types of loans: fixed rate mortgage and
adjustable rate mortgage
– length of term also needs to be determined
according to the financial situation

66
Applying for a Loan
• Involves turning in necessary documents to
a loan officer, including:
– identification (state ID, possibly a social security
card)
– proof of income
– employer contact information
– most recent tax returns
– proof of assets which relate to ability to pay
– completed mortgage application
– information regarding all of the individuals bank
and credit accounts

67
Processing the Loan
• Involves determining whether the individual
has the ability and willingness to repay the
loan
• Involves assessing the following information
– credit check
– asset evaluation
– property appraisal

68
Closing the Loan
• Involves reviewing and signing the final
documents
– documents must be reviewed prior to signing in
order to make sure the interest rate and loan
terms are what has been promised
– verifying the name and address on the loan are
accurate
• May also involves paying several fees, such
as insurance, transfer charge, etc.

69
Good Borrowing Habits
• Include:
– using credit carefully
– finding the best interest rate and terms
– finding a reputable lender
– taking repayment responsibilities seriously
– clearing debts as quickly as possible
– reviewing debt periodically

70
Bad Borrowing Habits
• Include:
– spending more than can be earned
– borrowing for a luxury when basic necessities
cannot be afforded
– delaying monthly payments
– failing to budget
– ignoring credit reports

71
Bad Borrowing Habits
• Can result in:
– low credit score
• bad habits such as missing payments and using
up available credit can negatively impact a score
– loss of property
• in the case of a secured loan, assets could be
taken if too many payments are missed
– bankruptcy
• legal status of a person which cannot repay
debts to creditors; can result in major damages
on a credit profile

72
Debt Problems
• Can be overwhelming
• Can be solved by implementing the
following strategies:
– identifying the cause
– implementing a cure
– seeking professional help

73
Identifying the Cause
• Is the first step in getting out of debts
• Involves getting to the root of the problem
and understanding what need to be
overcome
• Might be:
– insufficient income
– excessive debt
– bad spending habits

74
Implementing the Cure
• Involves adopting new habits which help get
rid of debt
• Might involve:
– making a realistic budget with spending limits
for each category
– tracking daily spending
– learning how to curb emotional spending
• when facing any unplanned buying decision,
always require a “calming” period of time
• reduce exposure to advertising
• find alternatives which bring enjoyment to life,
such as exercising, listening to music, etc.

75
Seeking Professional Help
• Can be a great solution when a person
becomes overwhelmed with debt
• May prevent a person from filing bankruptcy
• Involves looking for a financial planner or
debt counselor
– a professional financial counselor will look at the
monthly bills, expenses, debts and income and
help set up a budget; in addition, he or she can
negotiate better terms, lower monthly payments
and lower interest rates

76
Teacher Instructions:
Show the Expert Tips & Advice video segment

77
References
• https://study.com/academy/lesson/consumer-credit-types-
differences.html
• http://www.experian.com/blogs/news/2012/12/14/check-credit-reports/
• https://www.creditcards.com/credit-card-news/help/5-parts-
components-fico-credit-score-6000.php
• https://www.accountingcoach.com
• https://www.mymoney.gov/borrow/Pages/borrow.aspx
• https://www.thebalance.com
• https://bettermoneyhabits.bankofamerica.com/en/personal-
banking/difference-between-debit-and-credit
• https://blog.equifax.com/credit/the-top-four-reasons-your-credit-score-
is-important/
• https://www.experian.com/blogs/ask-experian/credit-education/report-
basics/
• https://www.consumerfinance.gov/about-us/blog/7-factors-determine-
your-mortgage-interest-rate/

78
References
• https://www.thebalance.com/consumer-credit-laws-you-should-be-
familiar-with-4068374
• https://www.nationaldebtrelief.com/4-ways-can-deal-overwhelming-
debt-problems/
• https://financialmentor.com/financial-advice/how-to-get-out-of-
debt/9458
• https://www.cstonemortgage.com/loan-process
• https://www.thebalance.com/how-amortization-works-315522

79
Acknowledgements
Assistant Brand Manager
Caroline Huang-Loggains
Brand Manager
Amy Hogan
Production Coordinator
Erin Metzler
Director of Brand Management
Megan O’Quinn
Videography/Post Production
Holley Baker
Jake Saye
Quality Control Director
Angela Dehls
Collaborator
Jennifer Wilson, MS
Assistant Director
Faculty Instructor
Texas Tech University
V.P. of Brand Management
Clayton Franklin
Executive Producer
Gordon W. Davis, Ph.D.
CEV Multimedia, Ltd.
© MMXIX

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