Wise Use of Credit

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Course 1: Financial Basics

Lesson A: Wise Use of Credit

Credit is money that is available to consumers for purchasing goods and/or services. It is extended to consumers on the premise that the money will be repaid with interest. Credit is a financial tool that can establish credibility and if used correctly, can increase your purchasing power.

The Three C’s of Credit

Lenders evaluate credit and loan applications based on the Three C’s of Credit. These refer to Character, Capital, and Capacity.

Character
Are you likely to repay the loan?

Capital
Do you have something of value that can be pledged to repay the loan should income become unavailable?

Capacity
Do you have the financial means to repay the loan?

Types of Credit

Unsecured Credit is extended based upon a consumer’s ability to repay the loan. There is no collateral needed for this type of credit so it often carries a higher interest rate.

Secured Credit is any purchase backed by collateral. Some item of equal or greater value is pledged to the lender. If the consumer fails to repay the loan, the lender can repossess and sell the item torecover monies owed.

Installment Credit is a loan that must be repaid over a specific period of time. Some examples ofthis type of credit are car loans and mortgages. Installment loans can be secured or unsecured.

Non- Installment Credit is repaid by a specified date usually without an interest charge. A utility bill is an example of this type of credit.


Most credit card accounts would be considered unsecured. Revolving credit accounts can be used for purchases until the credit limit is reached. There is a specified minimum payment due each month on the remaining balance. If a consumer wants to “free up” some of the available credit, they would have to pay the remaining balance down below the established credit limit.

Types of Loans

There are several loans available to consumers today. Each loan has its own characteristics. Some are listed below:

• Business Loans
• Personal Loans
• Real Estate Loans
• Debt Consolidation Loans
• Lines of Credit
• Interim Financing
• Service Loans
• Life Insurance Loans
• Margin Loans
• Retirement Loans
• Government Guaranteed Student Loans
• Government Guaranteed FHA Home Mortgage Loans
• Government Guaranteed Small Business Administration Loans
• Mortgages

 

How Much Loan can I afford?
The 20-10 Rule

The 20 refers to: Do not borrow more than 20% of your yearly net (after taxes) income.

The 10 refers to: Your monthly payments should not exceed 10% of your monthly net (after taxes) income.

Advantages and Disadvantages of Credit

Advantages

• Increased Purchasing Power
• Decreased use of cash
• Creates record of purchases
• More convenient than writing checks

Disadvantages

• Items cost more (interest and fees)
• Increases impulse spending

Exercise

Using the Three C’s of Credit complete the following questionnaire to determine if you are likely to be approved for a loan.

CLICK HERE FOR A PRINTABLE VERSION OF THIS FORM

Character

Have you established credit in the past?
Have you paid your bills on time?
Do you have a good credit score? If so, what is it?
Can you provide character references?
Have you been at your residence for more than a year?
How long have you been at your present job?

Capital

Do you own property?
Do you have a savings account?
Do you have investments to use as collateral?

Capacity

Do you have a steady Job?
What is your annual (yearly) net (after taxes) salary?
What is your monthly net income?
What are your current monthly living expenses?
What is the total amount of your debts?
Do you have any dependents? If so, how many?

Review your answers and using your judgment, determine if you would approve yourself for a loan.If you determine that you are eligible, calculate how much you can afford to borrow using the 20-10 Rule.

Quiz
CLICK HERE FOR A PRINTABLE VERSION OF THIS FORM

1.	Your home can be used as collateral for a secured loan.	True/False
2.	The Three C’s of Credit refer to Capital, Character, and Collateral.	True/False
3.	A mortgage is an example of non-installment credit.	True/False
4.	Unsecured credit carries a higher interest rate because there is more risk involved.	True/False
5.	One of the disadvantages of using credit is it may increase impulse spending.	True/False
6.	A credit card is an example of unsecured debt.	True/False
7.	Capacity refers to a consumer’s ability to repay a loan.	True/False
8.	In the 20-10 rule the 20 refers to the percentage that your monthly payments should not exceed.	True/False
9.	Secured credit is backed by collateral.	True/False
10.	Installment credit is paid over a specific period of time and usually without interest.	True/False

 

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