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Borrowing Basics.pptx
- 2. 2 Objectives • To analyzeand 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. 3 Main Menu • CreditBasics • Borrowing Money – Expert Tips & Advice Video Segment
- 5. 5 Credit • Is theissue 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. 6 Sources of Credit •Include the following: – banks – merchant banks – peer-to-peer lending – payday loans – title loans
- 7. 7 Banks • Are trustedinstitutions 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. 8 Merchant Banks • Provideinternational 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. 9 Peer-to-Peer Lending • Isthe 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. 10 Payday Loans • Areusually 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. 11 Title Loans • Requirethe 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
- 12. 12 Types of Credit •Include the following: – revolving credit – installment credit – collateralized credit – unsecured credit
- 13. 13 Revolving Credit • Involvesa 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. 14 Installment Credit • Allowsthe 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. 15 Collateralized Credit • Isa 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. 16 Unsecured Credit • Isissued 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
- 17. 17 Credit Cards • Providea 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
- 18. 18 Debit Cards • Drawmoney 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
- 19. 19 Impact of CreditDecisions • Include the following: – monthly budget – income statement – net worth statement
- 20. 20 Monthly Budget • Helpsorganize 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. 21 Income Statements • Aredocuments 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. 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
- 23. 23 Credit Scores • Area 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
- 24. 24 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
- 25. 25 Credit Worthiness • Refersto 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
- 26. 26 Credit Worthiness • Isreviewed by looking at five factors – collateral • something tangible the borrower provides the lender in the event of default – condition • current financial environment
- 27. 27 Credit Scores • Aredetermined 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
- 28. 28 Credit Reports • Providedetailed 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®
- 29. 29 Credit Reports • Includethe 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
- 30. 30 Obtaining a CreditReport • 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. 31 Credit Reports • Shouldbe 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
- 32. 32 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. 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. 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
- 35. 35 Equal Credit OpportunityAct • 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. 36 Fair Credit ReportingAct • 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. 37 Truth in LendingAct • 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. 39 Borrowing Money • Canbecome 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. 40 Types of Loans •Include but are not limited to: – student loans – mortgages – auto loans – payday loans
- 41. 41 Student Loans • Areoffered 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. 42 Mortgages • Are loansdistributed 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. 43 Auto Loans • Areloans 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. 44 Payday Loans • Areshort-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. 45 Amortization • Is theprocess 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. 46 Amortized Loans • Arecalculated 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
- 47. 47 Amortization Table – 60Month 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
- 48. 48 Components of BorrowingMoney • Include the following: – annual percentage rate (APR) – interest rate type (fixed interest or variable interest) – length of term – grace period – additional fees
- 49. 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. 50 Fixed Interest • Hasthe 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. 51 Variable Interest • Fluctuatesover 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. 52 Fixed vs. VariableInterest 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. 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. 54 Grace Period • Isthe 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. 55 Additional Fees • Includethe 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. 56 Borrowing Costs • Canbe 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. 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. 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. 59 Interest Rates • Arethe 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. 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. 61 Principal • Is theoriginal 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. 62 Principal Payments • Arethe 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. 63 Borrowing Process • Involvesthe following steps: – determining the amount to borrow – selecting a right loan program – applying for a loan – processing the loan – closing the loan
- 64. 64 Determining the Amountto 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. 65 Selecting the RightLoan 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. 66 Applying for aLoan • 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. 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. 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. 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. 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. 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. 72 Debt Problems • Canbe overwhelming • Can be solved by implementing the following strategies: – identifying the cause – implementing a cure – seeking professional help
- 73. 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. 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. 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. 76 Teacher Instructions: Show theExpert Tips & Advice video segment
- 77. 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. 78 References • https://bettermoneyhabits.bankofamerica.com/en/personal- banking/difference-between-debit-and-credit • 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://bettermoneyhabits.bankofamerica.com/en/personal- banking/difference-between-debit-and-credit • https://www.thebalance.com/how-amortization-works-315522
- 79. 79 Acknowledgements Assistant Brand Manager CarolineHuang-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