Chapter 6: Establishing Consumer Credit

Consumer credit is personal debt taken on to purchase goods and services.

 Although any type of personal loan could be labeled consumer credit, the term is more often
used to describe unsecured debt that is taken on to buy everyday goods and services.

 However, consumer debt can also include collateralized consumer loans like mortgage and car
loans.

Example:

 A credit card is one form of consumer credit.

 Home Credit Loan (mostly found in malls) catering. Offering customers shopping on
installments.

Credit

Credit contract agreement in which a borrower receives a sum of money or something of value and
repays the lender at a later date, generally with interest.

 Credit is generally defined as an agreement between a lender and a borrower.

 Credit also refers to an individual or business' creditworthiness or credit history.
 In accounting, a credit may either decrease assets or increase liabilities as well as decrease
expenses or increase revenue.

How Credit Works

In its first and most common-used definition, credit refers to an agreement to purchase a product or
service with the express promise to pay for it later. This is known as buying on credit.

The most common form of buying on credit today is via the use of credit cards. This introduces a
middleperson to the credit agreement: the bank that issued the card repays the merchant in full and
extends credit to the buyer, who may repay the bank over time.

The amount of money a consumer or business has available to borrow—or their creditworthiness—is also
called credit. For example, someone may say, "They have great credit, so they are not worried about
the bank rejecting their mortgage application."

Finally, in accounting, credit is an entry that records a decrease in assets or an increase in liability as
well as a decrease in expenses or an increase in revenue. So a credit increases net income on the
company's income statement, while a debit reduces net income.

Four Common Forms of Credit

 Revolving Credit
 This form of credit allows you to borrow money up to a certain amount.
 The lending institution sets a credit limit, or the most you can borrow.
 In revolving credit, the borrower revolves the balance by rolling from month to month until it is
paid in full.

 Charge Cards
 This form of credit is often mistaken to be the same as a revolving credit card.
  The major difference between a credit card and a charge card is the credit card can carry a
balance, whereas the charge card must be paid in full each month
 If the balance is not paid on time and in full, penalty fees will be added.
 Installment Credit
 Installment credit involves a set amount borrowed, a set monthly payment and a set timeframe
of repayment.
 Interest charges are pre-determined and calculated into the set monthly payments. Common
forms of installment credit agreements are home mortgages and auto loans.
 Installment credit is also typically secure.
 Secure credit requires security for the lender.
 The borrower must provide collateral, something of value pledge in order to guarantee loan
repayment.

 Non-Installment or Service Credit

 This form of credit allows the borrower to pay for a service, membership, etc. at a later date.
 Generally, payment is due the month following the service, and unpaid balances will incur a
fee, interest, and/or penalty charges.
 Continued non-payment will result in service cancellation and can be reported to the credit
bureau, affecting your credit score.
 Service or non-installment agreements are very common in our everyday life.
 Cell phone, gas and electricity, water and internet are all examples of service credit.

Personal Loan

A personal loan is an amount of money you can borrow to use for a variety of purposes.

 Personal loans can be offered by banks, credit unions, or online lenders. The money you borrow
must be repaid over time, typically with interest. Some lenders may also charge fees for
personal loans.
 Personal loans are loans that can cover a number of personal expenses.
 You can find personal loans through banks, credit unions, and online lenders.
 Personal loans can be secured, meaning you need collateral to borrow money, or unsecured,
with no collateral needed.
 Personal loans can vary greatly when it comes to their interest rates, fees, amounts, and
repayment terms.

Understanding a Personal Loan

A personal loan allows you to borrow money to pay for personal expenses and then repay those funds
over time. Personal loans are a type of installment debt that allows you to obtain a lump sum of
funding.

A personal loan is also different from a personal line of credit. The latter is not a lump sum amount;
instead, it works like a credit card. You have a credit line that you can spend money against and, as
you do so, your available credit is reduced. You can then free up available credit by making a payment
toward your credit line.

 Line of Credit (LOC) is a preset borrowing limit that can be tapped into at any time. The
borrower can take money out as needed until the limit is reached, and as money is repaid, it
can be borrowed again in the case of an open line of credit.
Types of Personal Loan

Unsecured Personal Loans

An unsecured loan is a loan that doesn't require any type of collateral.

 Instead of relying on a borrower's assets as security, lenders approve unsecured loans based on
a borrower’s creditworthiness.
 An unsecured loan is supported only by the borrower’s creditworthiness, rather than by any
collateral, such as property or other assets.
 Unsecured loans are riskier than secured loans for lenders, so they require higher credit scores
for approval.
 Credit cards, student loans, and personal loans are examples of unsecured loans.
 If a borrower defaults on an unsecured loan, the lender may commission a collection agency to
collect the debt or take the borrower to court.
 Lenders can decide whether or not to approve an unsecured loan based on a borrower's
creditworthiness, but laws protect borrowers from discriminatory lending practices.
 On the other hand, an unsecured personal loan doesn’t have a physical asset backing it, so if
you struggle to make payments, there’s no property the lender can take away from you.
 Your solid credit history, and possibly that of a co-signer, is what backs the loan.

Example:

unsecured loans include personal loans, student loans, and credit cards.

Secured Personal Loans

Secured loans are business or personal loans that require some type of collateral as a condition of
borrowing.

 A bank or lender can request collateral for large loans for which the money is being used to
purchase a specific asset or in cases where your credit scores aren’t sufficient to qualify for an
unsecured loan.

 Secured loans are loans that are secured by a specific form of collateral, including physical
assets such as property and vehicles or liquid assets such as cash. 
 Both personal loans and business loans can be secured, though a secured business loan may also
require a personal guarantee. 
 Banks, credit unions, and online lenders can offer secured personal and business loans to
qualified borrowers. 
 The interest rates, fees, and loan terms can vary widely for secured loans, depending on the
lender. 

Example:

Mortgage – A mortgage is a loan to pay for a home. Your monthly mortgage payments will consist of
the principal and interest, plus taxes and insurance.

Home Equity Line of Credit – A home equity loan or line of credit (HELOC) allows you to borrow
money using your home’s equity as collateral.
 Auto Loan – An auto loan is an auto financing option you can obtain through the dealer, a bank, or
credit union.

Sources/Resources

https://www.investopedia.com/

https://www.forbes.com/

https://www.greenpath.com/secured-or-unsecured-loans/

Prepared by:

Lesley Allen D. Kabigting, MBA

College of Business Administration
Guagua National Colleges