Chapter 25: The Basics of Credit

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.