Week # 9 Consumer Credit and Credit Approval

Consumer Credit Overview

  • Topics Covered:

    • Debt in Canada

    • Lending Institutions

    • Types of Credit

    • Credit Terms & Features

    • Credit Approval Process

    • Credit Bureaus

Debt in Canada

  • Recent trend shows increased use of credit.

  • Canadian household debt has risen over the last 30-35 years.

  • By Q3 2024, household debt ratio was at 174.4%, meaning Canadians had $1.74 in debt for every dollar of income.

  • Consumer debt payments have become a larger portion of after-tax income.

Lending Institutions

  • Types of Institutions:

    • Banks

    • Trust companies

    • Credit unions

    • Finance companies

    • Retail stores

    • Finance-related companies (e.g., Oil, Gas)

    • Pawn shops

Understanding Consumer Credit

  • Definition: An arrangement for receiving cash, goods, or services and paying in the future.

  • Purpose: Suited for personal needs, excluding home mortgages.

  • Financing Options:

    • Use savings

    • Use current earnings

    • Borrow against expected future income

Impact of Debt on Cash Flow

  • Cash Flow Equation:

    • Gross Income

    • Minus Income Taxes = Net Income

    • Minus Expenses (including debt payments) = Deficit or Surplus

  • Focus on how debt affects disposable income and savings.

Financial Lifecycle & Debt Trends

  • Debt Variation Across Life Stages:

    • Younger, single: Medium debt

    • Young couples without children: Medium debt

    • Couples with dependent children: High debt

    • Older couples with independent children: Medium debt

    • Retired individuals typically have lower debt levels

Types of Credit

  • Categories:

    • Installment Loans: Specific amounts at fixed terms (e.g., car loans, mortgages).

    • Revolving Credit: Open-ended borrowing up to a limit (e.g., credit cards, lines of credit).

  • Loan Types:

    • Secured: Backed by assets (e.g., mortgages, HELOCs).

    • Unsecured: No collateral needed; relies on creditworthiness (e.g., credit cards, personal loans).

Understanding Secured and Unsecured Loans

  • Secured Loan:

    • Pledged personal property reduces lender risk leading to lower interest.

  • Unsecured Loan:

    • Based solely on the borrower’s creditworthiness without collateral (e.g., credit card).

Loan Payment Structures

  • Installment Loans: Lump sum with regular blended payments (interest + principal).

  • Revolving Credit: Continuous access to funds; interest only on borrowed amount.

Payday Loans

  • Known for high interest rates; used for very short-term funding (7-14 days).

Credit Approval Process: The 5 C's

  1. Character: Credit history and employment stability.

  2. Capacity: Current income compared to debt level (DTI, GDSR, TDSR).

  3. Capital: Financial assets the borrower possesses.

  4. Collateral: Assets pledged to secure the loan.

  5. Condition: Purpose and terms of the loan, along with market conditions.

Credit Ratios

  • Debt to Income Ratio (DTI): Total debt divided by gross annual income, indicating repayment capacity.

  • Gross Debt Service Ratio (GDSR): Stipulates maximum housing costs as a fraction of income, typically capped at 32%.

  • Total Debt Service Ratio (TDSR): Evaluates the share of income used for debt repayments, generally should not exceed 40%.

Credit Bureaus

  • Track individual credit histories and report them to lenders.

  • Major bureaus: TransUnion, Equifax Canada.

  • Reports include personal information, summary of accounts, payment history, and inquiries.

Improving Your Credit Score

  • Factors influencing score: Payment history, credit utilization, length of credit history, types of credit, and inquiries.

  • Steps to enhance score: Monitor payment history, use credit wisely, limit credit applications.

Final Notes

  • Lender Practices: Must disclose costs of borrowing and allow consumers a cooling-off period.

  • Next Tasks: Complete online quiz, study for upcoming tests on Mortgages and other types of credit.