Credit

What is Credit?

• When you borrow money

to purchase something
and promise to pay the
money back later, you are
using credit.
Terms you need to know:

• Principal: the amount of money

borrowed
• Finance charge: the interest charges
on the amount you owe (principal +
interest)
• Interest Rate: interest charged over
time for using credit, written as a
percent of the principal over one year.
 So, how much am I
paying?
• That depends on a lot of things:
• Amount of money borrowed (Principal)
• Length of time to pay back the principal
• The annual rate of interest (% extra
charged per year)
• Repayment schedule (how often payments
are made)
• Method used to calculate interest
 Example:
• $1000 installment loan at 9% interest

• Term of Loan: 24 months 36 months

• Monthly Payment $45.41 $31.52
• Total interest paid $90.00 $135.00
• Total Payment $1,090.00 $1,135.00

• Who is better off?

 Example (cont.)

• Even though the principal and the interest

rate were the same, the amount paid was
different.
• Why?
• Time! A shorter loan term (24 months)
had higher monthly payments, but paid
less overall (less time to accrue interest).
The longer loan (36 months) had lower
payments, but ended up paying more!
 Simple Interest
• The interest is only paid on the original
amount borrowed for the length of time
the borrower has use of the credit.

• Ex. I borrow $1000 at 5% and repaid

the loan in one payment at the end of
the year. Simple interest, 5% of $1000
for 1 year is $50.
$1000*.05=$50
$1000+$50=$1050
 Compound Interest
• Interest is calculated on the original
principal plus all interest accrued to
that point in time. Since interest is paid
on interest as well as the amount
borrowed, the effective interest rate is
greater than the nominal (stated)
interest rate.

• In English: Interest is charged on

interest, making Compound Interest
greater than Simple interest
 Example of Compound
Interest
I borrow $1000 at 5% interest for 1 years,
paying it back at the end of the year. Interest
is compounded semiannually (2X a year)
After 6months, $25 interest is charged. (5% of
$1000/2).
At the end of the year, the interest is
calculated on the principal ($1000) plus the
Interest already charged ($25), so the second
interest payment is $25.63 (5% of $1025/2)
The total interest paid is $50.63. ($25+$25.63)
vs. $50 in simple interest.
Compound interest is greater than simple
interest!
 Huh?

• Okay, let’s simplify: Simple interest is

calculated once- Principal times interest
rate.
• Compound interest is calculated again
and again, adding any extra interest.-
Principal + interest times interest rate.
The added difference makes compound
interest greater than simple. It may seem
like a little bit, but given time, it adds up!
Start of Year Principal amount Interest at 5% Principal at end of the year

- $100.00 $5.00 $105.00

1 $105.00 $5.25 $110.25
2 $110.25 $5.51 $115.76
3 $115.76 $5.79 $121.55
4 $121.55 $6.08 $127.63
5 $127.63 $6.38 $134.01
6 $134.01 $6.70 $140.71
7 $140.71 $7.04 $147.75
8 $147.75 $7.39 $155.14
9 $155.14 $7.76 $162.90
10 $162.90 $8.14 $171.04
11 $171.04 $8.55 $179.59
12 $179.59 $8.98 $188.57
13 $188.57 $9.43 $198.00
14 $198.00 $9.90 $207.90
15 $207.90 $10.39 $218.29
What do those numbers mean?
• They mean that over time, compound interest
grows and grows! If that chart was a savings
account, by doing nothing but leaving $100 in it
for a 15 years, your money DOUBLED! Now
imagine if you put in $1000, or $10,000! Or if it
had a higher interest rate, say 10%! Or if you
added $100 to the account every year! The
money earned would be even higher! By doing
very little, you can earn a lot of money over
time!
 Or…

• Or, if that $100 was on a loan or credit

card, your debt could grow and grow
until the interest you owe was more
than the original principal!
 Credit Score or Rate

• Your credit score is how well you pay off

your credit and other bills.
• Pay on time, don’t carry much debt,
your score is good.
• Pay late, owe a lot, default on loans,
your credit score is poor.
 Good/Bad/No Credit
• Good credit score gets more credit and
lower interest rates
• Bad credit score limits amount of credit and
gets higher interest rates.
• No credit: If you have not credit history (no
bills, loans or credit cards) banks and credit
card companies do not know if you will pay
back your loans. It is like bad credit. It is
important to establish good credit early to
build up a good credit score.
 Credit Cards
• How they work:
1. Merchant passes card through
machine, gets approval from the
credit company for the amount
2. When you sign the paper, you
agree to pay the amount
3. Merchant deposits receipt in bank
who credits their account and bills
the credit company.
How a Credit Card works
cont.
4. Credit card company pays the
merchant’s bank account and debits
the issuer’s account
5. Issuer of your card bills you for the
purchase, which you pay.
 Paying Credit Cards

• Credit cards charge interest on money

owed, compounded monthly. Often,
credit cards can charge interest rates
around 20-30%, which can add up over
time.

• Add up a lot!
 Extra Costs of Credit
Cards
• Annual Fees- once a year charge for using the card
• Finance charge or fee- This fee is charged when
cardholders do not pay off their credit card balance.
• EX:
Balance Payment Interest
• Month 1 ₱11,000 ₱5,000 ₱6,000 x 3.5% =
₱6,210
• Month 2 ₱6,210 ₱3,000 ₱3,210 x 3.5% =
₱3,322.35
• Month 3 ₱3,322.35 ₱3,000 ₱322.35 x 3.5% =
₱333.63
 Extra Costs of Credit
Cards
• Late payment fee- A late payment fee is charged
to the cardholder when the minimum payment is
not settled within the due date.
• Cash advance fee- Cash advance is a means of
withdrawing cash from an ATM with a credit
card which will be restricted according to your
credit limit.
• Balance transfer fee- A balance transfer fee is
charged when you move debt from one credit
card to another. 
 Extra Costs of Credit
Cards
• Foreign transaction fee- A foreign
transaction fee is a charge added on
purchases made outside the issuing
country of your credit card (for our case,
the Philippines). 3.525% int. as service
charge on Visa/Master card
• Over-limit fee- An over-limit fee is charged
when your card’s balance exceeds your
credit limit.
 Are Credit Cards Bad?

• No, they aren’t bad. Credit is useful if

you do not want to carry large amounts
of cash. They also allow you to make a
purchase you may not have the money
to pay for at that time.
• Just make sure you pay off your debt
quickly. Don’t owe so much that you are
paying more than you can afford.
 But…
• If you get carried away, run up your bills
and only pay the minimum, a card with a
high interest rate will take YEARS to pay
off. So you could be paying for something
you bought years ago, and paying more
than it originally cost!
• And, if you max out your credit, you can’t
buy what you may really need.
• Finally, having a lot of debt and missing
payments hurts your credit score, making
it harder to get more credit when you
need it!
Installment Loans
 Installment Loan

• A form of credit where the money is

borrowed all at once
• Payment is made on a regular schedule
for a set amount
• Ex. Auto Loan, Mortgage (home loan),
Student Loan
 Secured vs. Unsecured
Loans
• Secured Loans: security or collateral is
used to guarantee the loan. If you fail to
repay loan, the lender keeps the security.
Collateral ex. Home, property, valuables.
• Unsecured Loan: made solely on the
person’s promise to repay the loan. Less
money available without the collateral.
Poor credit score, less likely to get an
unsecured loan.
Auto Loan vs. Auto Lease
 Loan

• Loan: Bank gives you money to buy car.

Over the next 3 to 5 years you pay back
the principal and interest. The car is the
collateral on the loan. When you are
done, you own the car.
 Lease

• Lease: Payments are made for the right

to use the car. At the end of the period,
the bank takes the car. A lease is like
renting the car for a long period of time.
Often there are stipulations about
mileage and condition for the lease.
 Loan
• Making Payments on a $18,000 car

• $2,500 Down Payment

• $1,260 Sales Tax
• $20,126 paid remaining principle + interest
($559/monthx 36 months)

• $23,886 TOTAL PAYMENT

Minus resale value
 Lease
• Making Payments on a $18,000 car

• $400 Lease Fee

• $317 Prepayment Fee
• $11,412 Monthly Payments ($317x36)

• $12,129 TOTAL PAYMENT

But no CAR!
 Which is better, Loan or
Lease?
Loan (Advantages) • Lease (Advantages)
You keep the car! • Pay less initially
Drive it for years to • Pay less monthly
come without
making a payment! • Pay less overall

But… (Disadvantages) But…(Disadvantages)

• Pay more initially No car once the lease

runs out. You have to
• Pay more monthly lease or buy another
• Pay more overall car. May cost more
in the long run.
 The cost of taking longer to
repay
The term of your loan determines final cost
3 different auto loans for $13,500 at 12.5%

# of 36 48 60
payments (3 years) (4 years) (5 years)
Amount per $451.62 $358.82 $303.72
payment
Total Paid $16,258.32 $17,223.36 $18,223.20

Interest $2,758.32 $3,723.36 $4,723.20

Paid
Buying a House
 Mortgage

• Def.: a long term loan to buy a house or

other property.
• The house and land it sits on are
collateral for the loan. If the borrower
doesn’t make payments, the lender can
take the home through foreclosure.
• Most mortgages require a cash down
payment of 5%,10%,or 20%
 Escrow

• Def.: monthly payment on property which

includes the mortgage and other costs.
• Principal: amount borrowed
• Interest: interest owed on the principal
• Real Estate Taxes: taxes assessed on property
by county, city/town and school district.
• Property Insurance: insurance coverage against
theft, fire and natural disasters.
 Closing Costs

• When the final purchase of a home

occurs, called a closing, the costs can
reach thousands of dollars for taxes,
fees, insurance and lawyer fees.
 How much for a house?

• On a 30 year, $150,000 mortgage with a

fixed interest rate of 7.5%, a homeowner
who keeps the loan full term (30 years)
will pay $377,000!
$150,000 for the home
$227,575.83 in interest on the loan!
 So why buy a home?

• Equity: The value of your home to be

used as collateral for other loans. As you
pay for your home, you build equity. This
can be used to get a home equity loan or
home equity line of credit to make more
purchases: cars, vacation homes, pay for
college, etc.
 Benefits of a good interest
rate:
Home Down Mortgage 6% rate 8% rate 10% rate
Price Payment

$80,000 $8,000 $72,000 $432/ $528/ $632/

month month month

$140,000 $15,000 $125,000 $749/ $917/ $1,097/

month month month

$240,000 $40,000 $200,000 $1,199/ $1,468/ $1,755/

month month month
 Length of Mortgage

• Most mortgages are offered as 15 or 30

year mortgages. The length of time
determines how much is paid per month
and how much is paid overall for the
house.
 Adv/Disadv of 30 year
mortgage
• Adv.
• Lower monthly payments than 15 year
• Stretches money; buyer can afford a larger
house because of the lower payment
• Dis.
• Builds equity at a slow rate
• Overall interest paid is much higher than 15
yr.
• Tend to have higher interest rates than 15 yr.
 Adv/Disadv of 15yr.
mortgage
• Adv.
• Build equity much faster
• Overall interest is less than 30yr. mortgages
• Interest rates tend to be lower
• Dis
• Monthly payments are higher than 30yr.
Mortgages
• Buyers restricted to a smaller home because
of high monthly payments
 Effect of term on a $100,000
mortgage
• Monthly payment 15 year $956
at 8% interest mortgage
30 year $734
mortgage

15 year $172,080
mortgage

• Total payment at 30 year $264,240

8% interest mortgage