UNIT 3 To 5

Download as pdf or txt
Download as pdf or txt
You are on page 1of 10

UNIT THREE

DISCUSSING COSTS OF USING CREDIT


This unit will also assist you to customer attain the stated objective. Specifically, upon completion of this
learning guide line, you will be able to:
 Compare Fees, costs and profit
 Assess of non-interest bearing loan (consider Islamic Bank)
 Compare features fixed versus variable interest rates
 Discuss ways to compare advertised interest rate
The cost of credit is the money you pay in exchange for access to financing, like a personal loan or credit
card.
3.1 Comparing Fees, costs and profit
Cost of credit Definition
The cost of credit refers to the expenses charged to the borrower in a credit agreement. This may
include interest, commission, taxes, fees, and any other charges issued by the lender.

Calculating the cost of credit


Before you enter a car finance agreement (or any type of credit agreement), it's important to
understand how much the loan will cost. This need to consider the following factors.

Interest rate
Interest rate is rate a lender charges you to borrow money. It's typically expressed as an annual
percentage rate (APR), which refers to the yearly cost of interest on borrowed credit.
For example, if you borrow $3,000 over a 12-month contract with a 10% APR, you would pay
$300 in interest.

However, if you borrowed the same amount over the same period with a 15% APR, your cost of
interest would be $450. Your interest rate is calculated by the lender based on your individual
circumstances, including your credit rating and affordability. If you have an excellent credit
rating, you will likely be offered a much lower APR compared to someone with a poor or bad
credit rating. This is because a low credit score implies the individual is a greater risk to lend to.
To illustrate this, a business received a 3-month note with face value of Br 20,000. The notes
earn annual interest rate of 5%. Then the interest is computed as;
Interest = Br 20, 000 x 5% x 3/12= Br250
Had the note be a 90 days note, the interest is computed as;
Interest = Br 20, 000 x 90/360 x 5% = Br250
Loan amount
The amount you borrow can have a significant impact on your cost of credit. In most cases, the
more you borrow the greater cost of interest. Let's say you borrowed $10,000 over a 12-month
contract with a 10% APR. Your total cost of interest would $1,000. But if you were to borrow
$5,000 over the same period with the same APR, you would only pay $500 in interest, reducing
the cost of your loan by half.

Term length
Spreading your repayments over a longer period can be an effective way to reduce your monthly
cost. However, borrowing money over an extended term is usually more expensive in the long
run, as the cost of interest increases over time. So, while a shorter term length may mean your
monthly payments are a little higher, the overall cost of your loan could be considerably less.
Fees
These vary from lender to lender and can include anything from late payment charges to settlement fees.
Fees are a charge or payment for professional services a sum paid or charged for a privilege:

Fees and costs associated with different credit options may include:
 Account servicing fees: the receipt of company due to render of service by business or
individual. For example: individual is deposit of money in bank
 Credit purchase fees; is the amount fee that receive by individual for purchase when early
payment of product.
 Late payment fees: is the type of receive fee that receive by individual due to penalize of
payment.
 Loan establishment fees: - Also called 'application', 'up-front', 'start-up' or 'set-up' fees. An
establishment fee is a one-off payment when you start your loan. If you are not charged an
establishment fee, you may pay higher on going fees.
 Withdrawing from a foreign Automatic Teller Machine (i.e. the ATM of a lending
institution other than your owns. These types of payment that receive by company due to
receive of service charge of the bank.
Cost
A cost is an expenditure required to produce or sell a product or get an asset ready for normal use.
In other words, it’s the amount paid to manufacture a product, purchase inventory, sell
merchandise, or get equipment ready to use in a business process.
Profit is defined as the amount gained by selling a product, which should be more than the cost
price of the product. It is the gain amount from any kind of business activity. In short, if the
selling price (SP) of the product is more than the cost price (CP) of a product, then it is considered
as a gain or profit. It describes the financial benefit obtained if the revenue from the business
activity exceeds the taxes, expenses, and so on, which are involved in sustaining Profit Formula
if the selling price of the commodity is more than the cost price, then the business has gained its
profit. Therefore formula to calculate the profit is;
Profit = Selling Price – Cost Price
When the selling price lesser than the cost price, it is termed as loss business activities.

Non-Interest Bearing Loan (Consider Islamic Bank)


A non-interest bearing note is a debt for which there is no documented requirement for the
borrower to pay the lender any rate of interest. Non-interest bearing loan means no interest
shall be charged to any outstanding amount of the loan lend.
A non-interest bearing note is a debt for which there is no documented requirement for the
borrower to pay the lender any rate of interest. If such a note were to be resold to a third party,
the debt would be sold at a discount to its face value, so that the third party purchaser would
eventually realize a gain when it was redeemed by the borrower at its face value.

If a non interest bearing note is a bond, the issuer is selling the bond at a deep discount and
committing to pay back the face value of the bond on its maturity date. This approach allows the
issuer to avoid making periodic interest payments on the bond. Instead, all cash payment
obligations by the issuer are concentrated at the maturity date of the bond.

This is the difference between the face value of the note and its discounted present value.
Calculate the present value of the note, discounted based on the market rate of interest. The
same approach is used by the issuer of the note, except that interest expense is recorded, and the
value of a note payable liability account is gradually increased until such time as the debt is paid
off at its face value.

Example: Non-Interest Bearing Loan


Operator agrees to make a non-interest bearing loan to Owner in an amount equal to five hundred
thousand dollars ($500,000) in cash subject to the conditions set forth below of which $150,000
has already paid. The balance $350,000 shall due and payable on satisfaction of all condition.
Features of Fixed Versus Variable Interest Rates
Definition of Fixed and Variable interest rate
 Interest rate is charged by a bank and is the cost to borrow money.
 A fixed interest rate loan is a loan where the interest rate on the loan remains the same for the
life of the loan.
 A fixed interest rate means that the interest rate that you will be charged over the term of
your loan will not change, no matter how high or how low the market may drive interest
rates. Your payment will remain the same on your last payment as it was on your first
payment.

Variable interest Rate


 A variable interest rate is a rate on a loan or security that fluctuates over time
 A variable interest rate loan is a loan in which the interest rate charged on the outstanding
balance varies as market interest rates change. As a result, your payments will vary as well (as
long as your payments are blended with principal and interest).
 A variable interest rate means that the interest you are charged changes as whatever index
your loan is based on changes.

Which One is best?


 Fixed tend to be better, as you have a predicted amount in mind, because they have fixed
interest rates. So fixed interest rates may be more interesting.
 Variable rates are often lower in the beginning and can save you money, but they can change
at any time so your monthly payments are less predictable and you may lose money in the
long run.

Compare Advertised Interest Rates and the Effects of Fees


Ways to compare promoted interest rate

 An interest rate is charged by a bank and is the cost to borrow money.


 A comparison rate includes the interest rate plus certain fees specific to the actual loan
product.
 The purpose of a comparison rate is to give you an indication of the real cost of your
borrowings over the life of your loan so that comparisons can be more easily made. You see,
sometimes you may be offered a special discount or an attractive start up rate for a fixed
period at the beginning of your loan agreement and once the fixed period has expired the rates
may increase. So the rate you pay at the outset doesn't actually tell you the annual percentage
interest rate that you may have to pay in the future.
 A comparison rate is a tool to help consumers identify the true cost of a loan. It is a rate which
includes both the interest rate and fees and charges relating to a loan.
For example, a bank’s advertised interest rate may be 5.49% and its comparison rate 6.75%.

Reason of Advertised interest rates


1. Credit score is less than excellent
Unless your credit score is near perfect, a low (or even good) score will be the biggest reason you
aren’t offered the lowest advertised interest rate. Other aspects of your financial life, such as a
high debt-to-income ratio or unstable employment history with inconsistent income, can
prevent you from getting the advertised interest rate. Ultimately, anything that makes a lender
feels you’re a higher risk.

2. Shopping for a vacation home


Mortgage loans aren’t created equal, and it’s not just your information that affects the rate the
lender quotes. The property you want to purchase can also impact the rate and the terms of your
loan.
3. Lender doesn’t want to get competitive
Did you receive a quote for an interest rate from a large, corporate bank and get a little bit of
sticker shock when the numbers came back much higher than you expected? Remember that
lenders make profits from the interest they charge on money they let people borrow. If, for
whatever reason, an institution or lender.
UNIT 4
DISCUSSING THE EFFECTIVE USE OF CONSUMER CREDIT
This unit will also assist you to customer attain the stated objective. Specifically, upon completion of this
learning guide line, you will be able to:
 Discuss ways to avoid excessive or unmanageable debt
 Discuss strategy to minimize fees on credit
 Discuss importance of meeting minimum payments on credit cards
 Discuss ways to avoid credit card fraud
Discussing Ways of avoid Excessive or Unmanageable Debt
4.1.1 Definition Unmanageable Debt
Unmanageable debt generally means having more debt payments than you can keep up with and a
monthly basis. It means the total of your monthly expenses and debt payments exceeds your monthly net
income. Having unmanageable debt is difficult, but there are options to simplify your struggles if your debt
hasn't gotten completely out of control.

4.1.2 Ways of avoid unmanageable debt


There are Five ways avoid unavoidable risk
With a little dedication and prior planning, it is possible to reduce your debts on your own. Why
pay debt counselors and consolidation agencies fees for things you can do yourself? Credit.com
shows you the tricks of the trade and the fastest way to reduce your debts on your own.
Step 1: Evaluate Your Debts
Collect all of your financial documents and print out your free annual credit reports. This is an
important step toward debt recovery and one that people are often scared to take. On a piece of
paper, write down the balances, interest rates, and monthly amount due for each of your debts.
Include your auto loans, personal loans, payday loans, credit cards, and other debts.
Step 2: Look at Your Budget

After you have collected the information about your debts, you should take a look at your
monthly budget. Write down your monthly income after taxes and subtract your rent/ mortgage
payment from this amount and other monthly expenses such as childcare, student loan payments,
insurance, utilities, and groceries. Once you have subtracted all of your expenses, calculate how
much you have left to pay off your debts.

Step 3: Make a Plan


To create a plan for reducing your debts. Use your information from Step 1 and 2 to fill in the following
chart. Subtract your minimum debt payments (Step 1) and monthly expenses (Step 2) from your monthly
income after taxes. The remaining amount should be used to pay off the debt with the highest interest rate
and the highest balance.

Step 4: Start Negotiations


While to contact your creditors and lenders. You may be able to lower your interest rates or
negotiate a reduced settlement on some debts by speaking with the customer service department.
Step 5: Follow-Through Your Debt Reduction Plan
Do your best to meet your repayment goals each month. It’s okay if the amount you put toward your most
expensive debt each month varies. Just try to consistently put as much as possible toward your debts.
Signing up for an automated payment system.

4.2 Strategies to Minimize Fees on Credit


Strategies to minimize fees on credit
 Savings and credit facilities with the one institution where account servicing fees can be
cancelled out
 Knowing how many free transactions come with the card
 Paying the minimum monthly installment on time.
Basically, there are seven Strategies to Minimize Fees on Credit
1. Your accounts stay out of collections.
Pay on time and you can avoid dealing with debt collectors.
2. Enjoy a lower interest rate.
Credit card issuers are allowed to increase your interest rate if you’re more than 60 days late on
your credit card payment.
3. Avoid late fees.
Thanks to technology, you might be charged a late fee just minutes after your credit card payment
is due.
4. Improve your credit score.
Thirty-five percent (35%) of your credit score is based on whether your credit card payments are
made on time.
5. Get lower insurance rates.
Insurance companies increasingly use your credit score to determine your insurance rate. When
late credit card payments lower your credit score, your insurance rates could subsequently
increase.
6. Keep your monthly payments low.
When you make a late credit card payment, your next minimum payment will be more than
double what it would have been had you not missed a payment. That's because your next credit
card payment will include two minimum payments and a late fee. If you have trouble making
your credit card payment, putting it off won’t make it easier to pay. Instead, the opposite happens.
7. Keep your credit card in good standing.
You risk having your credit cards cancelled when you miss your credit card payment, an action
that could hurt your credit score, especially if you have a credit card balance.

4.3 Importance of Meeting Minimum Payments on Credit Cards

The important minimum payment credit card is:


1) Save money
When you only cover the minimum every month, you end up paying more in interest. The
minimum payment exists to ensure that interest fees are covered, with only a small amount going
toward the actual balance.
2) Get to debt-free faster
The more you pay, the quicker you’ll be debt-free.
3) Raise your credit score
The ratio of your balances to your credit limits is called “credit utilization.” This making the total
minimum payment each month means you avoid a late payment fee and ensures you can keep
using your card.

4.4. Ways to Avoid Credit Card Fraud

 Personal Identification Number (PIN) to anyone


 Selecting a PIN only the card holder would know
 Signing the back of the credit card.
UNIT 5
MANAGE PERSONAL CREDIT RATING AND HISTORY
This unit will also assist you to customer attain the stated objective. Specifically, upon completion of this
learning guide line, you will be able to:
 Discuss role of credit reference agencies
 Discuss purpose and use of credit reference reports
 Discuss implications of establishing a poor credit history
 Discuss methods of obtaining own credit reference file

Discussing Role of Credit Reference Agency


5.1.1 Definition of Credit Reference
Credit reference agency is to collect information over the last six years from public bodies and
lenders. This information is then used to create your credit report which can be viewed by lenders
to help them make decisions on applications.
Credit reference agencies act like data libraries, receiving information from your lenders and the
public bodies (such as the electoral register).

Need Credit References


Credit references are requested when an individual requests to borrow money from a lender or to
use a service.
 Loan applications.
When an individual or business applies for a loan, lenders require a credit reference whether or
not the applicant will pay back the money that has been borrowed from the lender.
 Rental applications.
Property-owners (landlord) request credit references to determine if rental applicants will make
timely payments.
 Utility services such as electricity, gas, cable, or phone services. Companies that provide
these services may require a credit reference prior to activating accounts to determine whether
or not you have a history of making timely and appropriate payments for similar services.
Role of Credit Reference Agency
1. To provides to review the information before making any applications for credit,
2. To check the information being provided by their lenders is correct.
3. Help lenders to make more confident decisions.
5.2. Purpose and Use of Credit Reference Reports
A credit report is a summary of your credit history, including the types of credit accounts you’ve
had, your payment history and certain other information such as your credit limits. Credit reports
established and maintained by credit reference agencies which record all negative events (i.e.
defaults) listed by creditors against debtors.
Purpose of Credit reference
 It is used documents that describe your credit history background and creditworthiness to
potential lenders.
 Credit reports are a gold mine of information about consumers. They contain your Social
Security number, date of birth, current and previous addresses, telephone numbers (including
unlisted numbers), credit payment status, employment information and even legal
information.
5.3 Implications of Establishing a Poor Credit History
The Implications of establishing a poor credit history may include:
 Higher interest rate penalties: it is refers to the amount of interest rate is higher.
 Inability to obtain finance in the future: it implies that poor obtain of fiancé of business.
 May disadvantage applications for rental accommodation
 Necessity to obtain guarantor in future loans.

5.4 Methods of Obtaining own Credit Reference Report


Methods of obtaining own credit reference file may include: Writing, emailing or telephoning the
relevant agency requesting a copy of your file, having provided relevant details to identify self.
 Asset documentation
These documents are issued by the financial institution that manages an individual’s assets like
savings accounts, retirement funds, stocks and bonds.
 Financier support documentation
This type of documentation is similar to asset documentation; however, instead of illustrating the
assets of an individual, it highlights the assets of a business entity. For example, those who
financially support a business can provide documentation that illustrates its access to capital.
Business owners applying for loans or services that require credit references can ask their
investors to furnish statements that showcase the amount of capital available to the business.
Financier support documents are considered highly effective credit references.
 Character references
While these types of credit references are not as effective as credit reports, asset documentation,
and financier support, they can be useful. Character references are documents issued by reliable
resources such as past landlords, previous employers, and utility companies that an individual has
had accounts.

You might also like