Credit and the 5 Cs of Credit

What is credit?
Credit
Trust given to another person for future
payment of a loan, credit card balance, etc.
Creditor
A person or company to whom a debt is owed.

When to use credit

WHEN TO USE CREDIT
Can you describe a situation when it is a good

time to use credit and when it is NOT a good

time to use credit?

Questions to ask before using credit

1. Do I need it or do I want it?

2. How much am I actually going to pay for
the item? (time payments incur
interest)
3. Where am I getting the $$ to pay for it?
4. What reward can I receive by using
card? (airline miles, etc. )

Questions to ask when applying for credit?

1. What is the annual percentage rate

2.
3.
4.
5.
6.

(APR)?
What is the annual fee?
When are payments due?
What is the minimum payment required
each month?
Is there a grace period?
What is the credit limit?

THE FIVE Cs OF CREDIT

C = Capital
C = Collateral
C = Conditions
C = Character
C = Capacity

Capital
Banks want to see that you have a financial

commitment; that you have put yourself at risk.

Have you paid off debts? (ie. Car loans)

Collateral
How much cash/wealth/ property do you
have that could cover debts if you fail to pay?
Most collateral is in the form of real estate, your
bank accounts, and parents promise to provide
support.

Conditions
What is your current economic condition?

Are you sensitive to economic downturns. The bank

wants to know that you are good at managing
expenses.

Character
Banks want to put their money with clients who have

the best credentials and references. The way you

take responsibility, your timeliness in
fulfilling obligations - that's character.

Capacity
What is your borrowing history and track

record of repayment. How much debt can you

handle? Will you be able to honor the obligation
and repay the debt?

Measure of Credit Worthiness: Debt to Income Ratio

DTI is the percentage of a consumer's monthly gross

income that goes toward paying debts.

In order to qualify for a mortgage for which the lender

requires a debt-to-income ratio of 28/36:

Yearly Gross Income = $45,000 / Divided by 12 =
$3,750 per month income.

$3,750 Monthly Income x .28 = $1,050 allowed for housing

expense.
$3,750 Monthly Income x .36 = $1,350 allowed for housing
expense plus recurring debt.

COSTS OF CREDIT
How much can credit cost? If you make only the
minimum payment for an item, here are some
examples of what you might actually pay and how long
it will take you to pay it.

Slide 4 Costs of Credit

Lesson Reference: Credit, Activity 5 Handout 2