USING CREDIT
Credit is the privilege of using someone else's money for a period of time. That privilege is based on the belief that the person receiving credit will honor a promise to repay the amount owed at a future date. Two parties are involved in a credit transaction. Anyone who buys on credit or receives a loan is a debtor . The one who sells on credit or makes a loan is the creditor.
Although the credit system uses forms and legal documents, it also depends on trust between the debtor and creditor. This trust means that the creditor believes that the debtor will honor the promise to pay. Without that trust, the credit system could not operate.
Types of CreditBusinesses use trade credit. Trade credit occurs when a company receives goods from a supplier and pays for them later.
Businesses may secure long-term loans for land, equipment, and buildings. They may also borrow money for shorter periods, usually for 30 to 90 days, to meet short-term needs for cash.
Local, state, and federal governments often use credit to provide goods and services that benefit the public. Governments may use credit to buy items such as cars, aircraft, and police uniforms. They may also borrow funds to build highways, parks, and airports.
Most consumers use credit. You may use credit to buy expensive products that will last a long time. You may also use credit for convenience in making smaller purchases.
If you borrow money to use for some special purpose, you are using loan credit . Loans are available from several kinds of financial institutions. Loan credit usually involves a written contract. The borrower agrees to repay the loan in specified amounts, called installments , over a period of time.
If you charge a purchase at the time you buy the good or service, you are using sales credit . Most businesses offer sales credit. Sales credit involves the use of charge accounts and credit cards by consumers.
Charge AccountsA charge account represents a contract between the firm offering the account and the customer. Three types of charge accounts are generally available: regular, budget, and revolving.
Regular Accounts A regular charge account requires the buyer to make full payment within a stated period—usually 25 to 30 days. The seller may set a limit on the total amount that may be charged during that time. People use regular accounts for everyday needs and small purchases. Service providers, such as doctors, dentists, lawyers, and plumbers, commonly offer this type of credit.
Budget Accounts Some stores and utility companies offer budget charge accounts. This credit agreement requires that a customer make payments of a fixed amount over several months. One budget plan that businesses offer is the 90-day, three-payment plan. Under this plan, you pay for your purchase over a 90-day period, usually in three equal monthly payments.
With a utility company budget plan, the company makes an estimate for gas or electricity charges during a certain period, such as a year. You then agree to pay a certain amount each month to cover those charges. This plan avoids large payments during some times of the year. You pay the same amount each month.
Revolving Accounts The most popular form of sales credit is the revolving account. You may charge purchases at any time, but only part of the debt must be paid each month. Features of revolving credit include the following.
Credit is the privilege of using someone else's money for a period of time. That privilege is based on the belief that the person receiving credit will honor a promise to repay the amount owed at a future date. Two parties are involved in a credit transaction. Anyone who buys on credit or receives a loan is a debtor . The one who sells on credit or makes a loan is the creditor.
Although the credit system uses forms and legal documents, it also depends on trust between the debtor and creditor. This trust means that the creditor believes that the debtor will honor the promise to pay. Without that trust, the credit system could not operate.
Types of CreditBusinesses use trade credit. Trade credit occurs when a company receives goods from a supplier and pays for them later.
Businesses may secure long-term loans for land, equipment, and buildings. They may also borrow money for shorter periods, usually for 30 to 90 days, to meet short-term needs for cash.
Local, state, and federal governments often use credit to provide goods and services that benefit the public. Governments may use credit to buy items such as cars, aircraft, and police uniforms. They may also borrow funds to build highways, parks, and airports.
Most consumers use credit. You may use credit to buy expensive products that will last a long time. You may also use credit for convenience in making smaller purchases.
If you borrow money to use for some special purpose, you are using loan credit . Loans are available from several kinds of financial institutions. Loan credit usually involves a written contract. The borrower agrees to repay the loan in specified amounts, called installments , over a period of time.
If you charge a purchase at the time you buy the good or service, you are using sales credit . Most businesses offer sales credit. Sales credit involves the use of charge accounts and credit cards by consumers.
Charge AccountsA charge account represents a contract between the firm offering the account and the customer. Three types of charge accounts are generally available: regular, budget, and revolving.
Regular Accounts A regular charge account requires the buyer to make full payment within a stated period—usually 25 to 30 days. The seller may set a limit on the total amount that may be charged during that time. People use regular accounts for everyday needs and small purchases. Service providers, such as doctors, dentists, lawyers, and plumbers, commonly offer this type of credit.
Budget Accounts Some stores and utility companies offer budget charge accounts. This credit agreement requires that a customer make payments of a fixed amount over several months. One budget plan that businesses offer is the 90-day, three-payment plan. Under this plan, you pay for your purchase over a 90-day period, usually in three equal monthly payments.
With a utility company budget plan, the company makes an estimate for gas or electricity charges during a certain period, such as a year. You then agree to pay a certain amount each month to cover those charges. This plan avoids large payments during some times of the year. You pay the same amount each month.
Revolving Accounts The most popular form of sales credit is the revolving account. You may charge purchases at any time, but only part of the debt must be paid each month. Features of revolving credit include the following.
- A maximum amount may be owed at one time, called a credit limit .
- A payment is required once a month, but the total amount owed need not be paid at one time.
- A finance charge is added if the total amount owed is not paid. A finance charge is the total dollar cost of credit, including interest and all other charges. You must pay this additional amount for the convenience of using credit.
BENEFITS OF CREDITBoth businesses and consumers can benefit from credit use. The main advantages of credit for consumers include the following.
- Convenience Credit can make it easy for you to buy. You can shop without carrying much cash.
- Immediate Possession Credit allows you to have the item now. A family can buy a dishwasher on credit and begin using it at once.
- Savings Sometimes credit allows you to buy an item on sale at a good price. Some stores, especially department and furniture stores, send notices of special sales to credit customers.
- Credit Rating A person's reputation for paying bills on time is known as a credit rating . If you buy on credit and pay your bills on time, you gain a reputation for being dependable. In that way, you establish a favorable credit rating. A credit rating is valuable when you might need to borrow money or when you want to make a major purchase.
- Useful for Emergencies Access to credit can help in unexpected situations. Sometimes you may not have enough cash and have an urgent need for something. For example, your car might need repairs.
CREDIT CONCERNS
Buying on credit is convenient and can be beneficial. There are also some disadvantages if you are not careful.
Buying on credit is convenient and can be beneficial. There are also some disadvantages if you are not careful.
- Overbuying A common spending hazard of credit involves buying something that is more expensive than you can afford. Attractive store displays and advertisements invite you to make purchases. Buying on credit is convenient and can be beneficial. There are also some disadvantages if you are not careful.
Careless Buying If you become impatient or distracted in your shopping, you may not shop carefully. You may fail to make comparisons, causing you to buy at the wrong time or the wrong place. Credit can tempt you not to wait for a better price on an item you want now. - Higher Prices Stores that only accept cash may sell items at lower prices than stores that offer credit. Extending credit is expensive for stores. When customers do not pay as agreed, there are collection costs. Sometimes businesses must write off consumer debts as uncollectible. These increased costs often result in higher prices.
- Overuse of Credit Buying now and paying later may sound like a good idea. If too many payments need to be made later, the total amount due can become a problem. Consumers must keep records of the total amount owed so that they do not have monthly payments that exceed their ability to pay.
- Questions to AskBefore making a final decision about whether to buy on credit, think about these important questions.
- How will you benefit from this use of credit?
- Is this the best buy you can make or should you shop around?
- What will be the total cost of your purchase, including the finance charges?
- What would you save if you paid cash?
- Will the payments be too high for your income?