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.