Credit Essentials

Credit: The Promise to Pay

• Credit is an agreement to obtain money, goods, or services now in exchange for a promise to pay in the future.

  • When buying on credit, you are delaying the payment for an item.

• A creditor lends money or provides credit.

• A debtor borrows money or uses credit.

• Creditors charge a fee for using their money, which is called interest.

• The amount of interest to be paid is based on three factors.

  • One is the interest rate, which is a percentage of the total amount borrowed.

    • Interest rates vary from one provider to the next.

  • Another factor is the length of time of the loan.

    • The longer you take to pay it off, the more interest you will have to pay.

  • The other factor is the amount of the loan.

    • The larger the amount, the more interest that will be charged.

Who Uses Credit?

• The type of credit used by people for personal reasons is called consumer credit.

• Businesses often use credit for the same reasons that consumers do.

• Credit used by businesses is called commercial credit.

• When businesses borrow money, however, they often pass along the cost of interest to consumers by charging higher prices.

• The federal government uses credit to pay for many of the services and programs it provides to its citizens.

The Pros and Cons of Using Credit

• An important advantage of credit is that it is convenient.

  • You can shop and travel without carrying large amounts of cash.

• Buying on credit enables people to establish a credit rating.

  • A credit rating is a measure of a person’s ability and willingness to pay debts on time.

• Finally, credit contributes to the growth of our economy.

• Since credit is so convenient to use, it can also be easy to misuse.

• With credit, it is tempting for people to buy things that they cannot afford or do not need.

• Items also cost more when you use credit instead of cash because of the interest

• As credit card bills pile up, you might have trouble paying them.

• After a while, you may reach your credit limit, the point where you cannot charge any more.

Types of Credit

Sources of Credit

• Credit is available from many different sources.

  • These sources provide different types of loans for varying lengths of time.

• A charge account is credit provided by a store or company for customers to buy its products.

• Credit cards are like charge accounts, but some can be used in many different places.

  • There are three basic types of credit cards: single-purpose, multipurpose, and travel and entertainment.

    • Single-purpose cards can be used to buy goods or services only at the business that issued the card.

    • Multipurpose cards are also called bank credit cards because banks issue them

    • Holders of travel and entertainment cards must pay the full amount due each month.

      • They are accepted worldwide for expenses connected with travel, business, and entertainment, such as restaurant and hotel bills, car rentals, and airline tickets.

      • They often have an annual fee, which is higher than the fee for a multipurpose card.

• Financial institutions such as banks, savings and loans, and credit unions offer many types of loans.

• For single-payment loans, the debtor pays back this type of loan in one payment, including interest (at the end of the loan period).

• Student loans, car loans, and home improvement loans are types of installment loans, or loans repaid in regular payments over a period of time.

• A mortgage loan is a form of an installment loan, only it is written for a long period, such as 15 to 30 years.

  • It is used to purchase real estate, such as a home.

  • The home serves as collateral, which is something of value the bank can take if a borrower does not make the required loan payments.

• Many stores provide credit for their customers.

• Consumer finance companies specialize in loans to people who might not be able to get credit elsewhere.

• For people who have difficulty getting a loan, there are other options, although they are the most costly

  • Payday advance services offer short-term loans until payday.

    • However, they charge high fees and interest.

  • A pawnshop loan is based on the value of something you own that is left with a pawnbroker as security against money borrowed

    • You can later buy back your item.