Chapter 25: The Basics of Credit

Credit Essentials

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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.

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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.

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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.

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Types of Credit

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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.

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