2022-03-02

Consumer
Credit / Credit
Approval

Agenda
• Debt in Canada
• Financial Life cycle
• Lending institutions
• Types of Credit
• Credit terms
• Credit features
• Credit approval process
• Credit Bureaus
• Credit Ratios
https://globalnews.ca/video/8587978/consumer-matters-more-
canadians-struggling-with-debt-as-pandemic-lingers 2

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Source: https://quotes2remember.com/quotes/1278

Questions to consider……….
• Do I have the cash I need for the down payment?
• Do I want to use my savings for this purchase?
• Does the purchase fit my budget?
• Could I use the credit I need for this purchase in some better way?
• Could I postpone the purchase?
• What are the opportunity costs of postponing the purchase ?
• What is the $ cost and psychological cost of using credit?

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What Is Consumer Credit?

• Credit is an arrangement to receive cash, goods or services now,

and pay for them in the future.
• Consumer credit is the use of credit for personal needs (except a
home mortgage)by individuals and families.
• There are three ways consumers can finance current purchases
• Take money from savings
• Use present earnings
• Borrow against expected future income

Credit in Canada

• Trend in Canada toward increased use of credit

• Consumer debt payments much larger part of after-tax income
• Household debt ratio is at 177.15%, in Q3 2021-Statistics Canada
• Canadians have $1.77 in debt for every dollar they make

https://betterdwelling.com/canadian-household-debt-is-
surging-and-previous-quarter-revised-3-points-higher/

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Consumer Debt in Canada

Consumer Debt Report –2022 https://nomoredebts.org/consumer-debt-report-2022
Credit counselling society
Jan 2022 https://globalnews.ca/news/8515875/canada-debt-
confidence-report-2022/

Jan 2022 https://www.globenewswire.com/news-

release/2022/01/17/2367671/0/en/Canadians-
Confidence-in-Personal-Finances-Debt-Repayment-Abilities-
Reaches-Lowest-Level-Ever-Recorded.html

Dec 2021 https://financialpost.com/executive/executive-

summary/posthaste-canadians-are-carrying-less-debt-but-
financial-worries-are-still-keeping-them-up-at-night

How debt affects individual Cash Flow

Gross Income
- Income Taxes
Net Income (Take Home Pay, After Tax Income)
- Expenses:
Debt Payments increase
other expenses
= Deficit or Surplus
Net Income Available for Saving

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Source:
Personal
Finance for
Canadians,
Elliott J.
Currie

1. Younger, single → medium debt

2. Younger, couple no children → medium
debt
Increased debt
3. Couple, dependent children → high debt
Family Life 4. Single, dependent children → high debt
Cycle categories 5. Older couple, children independent or
nearly so → medium debt
6. Older couple, single → Low
7. Couple, retired → Low
8. Single, retired → Low

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Gilles Bernier and Chris Robinson, Personal Financial Management,, Institute of Canadian Bankers, 1986. Second edition 1987, pp. 540. First French edition, 1987.

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Xiao, Jing Jian & Yao, Rui.

(2014). Consumer debt
delinquency by family lifecycle
categories. The International
Journal of Bank Marketing. 32.
10.1108/IJBM-02-2013-0007.

A hypothesized case: risk of debt delinquency over lifecycle among credit card debt holders

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Lending institutions
• Banks
• Trust companies
• Credit unions
• Finance companies
• Department stores
• Oil & gas companies
• Pawn shops

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Types of Credit

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Types of Credit
Consumer loans Revolving
/Installment loans Credit

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CONSUMER LOANS REVOLVING CREDIT

• Home mortgages • Credit cards issued by

• Automobile loans banks (Visa) or stores
• Other consumer (Canadian Tire Triangle)
installment loans • Charge cards or travel and
• Demand loans entertainment cards
(American express , Diners
clubs)
• Lines of credit
• Overdraft protection
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Installment Loans
• Receive Lump Sum
• Repay in Blended payments
• Regular monthly payments of principal and interest
• Declining (principal) balance

• Examples: Car Loan, Investment Loan

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Revolving Credit

• Approved for a particular limit

• Keep “reusing” the approved limit amount
• Payments dependent on $$ outstanding

• Examples: Line of Credit, Credit Cards

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What is a Secured Loan?

• Personal property or financial assets pledged to support the loan
• Reduces the lender risk →lowers the interest rate

• Examples:
• Installment loan: car, house (mortgage)
• Demand loan: financial assets
• Line of Credit: financial assets, house

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Mortgage

• A long-term loan on a specific property

• Secured by the property (land and building)
• Contract with specific terms and clauses
• Most households, mortgage the largest debt

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Unsecured Loan
• No specific property held against the credit
• Based on creditworthiness of the borrower
• Determined through credit assessment

• Examples:
• Overdraft on a bank account
• Debt Consolidation Loan
• Credit Card
• Line of Credit

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Credit Terms/ Terms of a Loan

• Principal =Amount of money borrowed
• Payments: weekly, bi-weekly, twice a month, monthly
• Open: Can prepay or pay off the loan any time

• Interest rate
• Fixed percentage over term of loan, Variable (Prime rate + x%)
• Much lower than credit cards
• Determined by degree of risk with individual borrower

• Prime rate = rate the bank offers their best customers

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Types of Credit Cards

• Financial institution
• TD, Scotia Bank, CIBC etc.
• Major retailer
• Triangle Mastercard (Canadian Tire)
• PC Financial World Elite Mastercard (Superstore and Loblaw stores )
• Amazon.ca rewards master card (for the online shopper)

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Overdraft Protection

• Personal accounts overdrawn to a set limit

• Overdraft amount becomes a loan subject to interest rates
• Very expensive form of credit
• Unsecured

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Demand Loan

• Receive Lump Sum

• Types
• Bridge loan
• Payday loan

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Bridge Loan

• Receive Lump Sum

• Monthly pay interest only
• Repay full principal on specific future date
• Often secured by financial assets

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Payday Loan
• Small loans for short periods of time (7 to 14 days)
• Lender advances a percentage of the next pay cheque
• Repayment date is the next payday
• Very high interest rate borrowing
• Moneymart.ca (https://www.moneymart.ca/loans/cash-advance)

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Comparing the cost of a payday loan with a line of

credit, overdraft protection on a chequing account
and a cash advance on a credit card (Based on a
$300 loan for 14 days)

https://www.canada.ca/en/financial-consumer-agency/services/loans/payday-loans.html
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Line of Credit

• Higher income borrowers

• Like a credit card
• Use up to the approved limit, again and again
• Interest only on amount used
• Unsecured: no collateral
• Secured: with $$ or home

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Home Equity Line of Credit

• Special kind of second mortgage loan

• Line of Credit
• lower interest rate
• secured by principal residence (home)
• Second charge on the property
• Only for people who have a high portion of equity in their home
AND good income

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Investment Loans
• Goal is to increase family’s net worth by earning a higher rate of
return than the interest rate
• Borrowing magnifies after-tax return
• Borrowing also magnifies risk
• Structured properly, can reduce total tax burden for a high-income
family.
• Investment loans are secured by the assets you buy, and usually
require additional collateral

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What Information is Required

for Credit Approval?

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Credit Approval: 5 C’s

1. Character & Credit history: conduct and employment stability
2. Capacity to repay: Current income & level of borrowing GDSR &
TDSR
3. Capital owned by client: Net Worth (assets & liabilities)
4. Collateral: security that borrower can supply
5. Condition : Purpose of the loan and prevailing interest rates

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Measuring Debt Capacity (Credit ratios)

• Debt Ratio: yearly trends
• GDSR: mortgage approval
• TDSR
• Assessment of housing expenses and debt repayment
• New loan approval

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Debt Ratio
Total Liabilities
Debt Ratio =
Total Assets

• Percentage of assets financed by borrowing.

• Usually decreases over time.
• Young clients have higher percentage, older clients usually have lower
percentages.
• To evaluate, calculate the ratio for a number of years and examine the trend

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Mortgage Approval :Gross Debt Service Ratio

GDSR=
𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 𝑃𝑎𝑦𝑚𝑒𝑛𝑡𝑠 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 𝑎𝑛𝑑 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 + 𝑃𝑟𝑜𝑝𝑒𝑟𝑡𝑦 𝑇𝑎𝑥𝑒𝑠+ 𝐻𝑒𝑎𝑡𝑖𝑛𝑔 𝐶𝑜𝑠𝑡𝑠
𝐺𝑟𝑜𝑠𝑠 𝐼𝑛𝑐𝑜𝑚𝑒
PITH

New mortgage approval GDSR maximum 32% of gross annual income (depends
on the lender). The lower the ratio the better.

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Total Debt Service Ratio

𝑃𝐼𝑇𝐻+ 𝑜𝑡ℎ𝑒𝑟 𝑑𝑒𝑏𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠
TDSR = 𝐺𝑟𝑜𝑠𝑠 𝐼𝑛𝑐𝑜𝑚𝑒

• Used to evaluate current housing and debt repayment level

• TDSR should not exceed 40% of gross income
• Also used to approve new loans. For new loans, the TDSR is recalculated
including the new loan repayment.
• For approval, the TDSR should not exceed 40%

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Credit Bureau
• Document credit payment history of individuals
• Sell credit history reports to subscribers, FIs and other businesses
• Primary credit bureaus: TransUnion, Equifax Canada
• Tracks credit inquiries and credit payments
• Anyone with credit cards, a mortgage, has rented, paid utilities
and phone bills, has a file at a credit bureau
• Bankruptcy stays on file for 7 years.

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Credit Bureau Reports

• Personal information
• Summary of accounts & repayment history
• Bank information regarding accounts that were closed for derogatory
reasons
• Public information regarding bankruptcies, judgments, and loan security
• Names of creditors who have made inquiries
• Creditor contacts

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Sample credit report ………

https://www.canada.ca/en/financial-consumer-
agency/services/credit-reports-score/sample-credit-score-
transunion.html

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Credit Score
• A rating that indicates a person’s creditworthiness
• Creditors rely on this score to help determine whether or not
to extend a loan
• Can affect the interest rate on the new loan
• Score affected by many factors
• Payment history, credit utilization, length of relationship with
creditors, types of credit established, recent credit inquiries

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Assessing Credit Score

• A low credit score is normally due to either missed payments or
carrying an excessive amount of debt
• Poor credit history remains on credit bureau reports for three to
ten years
• Bankruptcy on reports for six to seven years
• Improve credit score immediately by catching up on late
payments, making at least the minimum payments on time and
reducing debt

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“How to Build a Good Credit Rating”

https://www.canada.ca/en/financial-consumer-
agency/services/credit-reports-score/improve-credit-score.html

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Credit Approval Process

• Credit file: information on your financial and work history, kept by
companies that act as recorders for lenders.
• Credit scoring: Many credit granters use the information in
models that assign points to various indicators of likelihood of
repayment. If you score high enough you get the credit.
• The better your credit history/score, either the more likely you get
credit, or the better the rate.

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Credit Approval

• Lenders have computer programs that “score” the credit

applications
• Determine whether the credit applicant is:

Good risk

Bad risk

Uncertain risk
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Applicant Risk
Good risk : Get the credit

Bad risk : Do not get the credit

Uncertain risk : May need to

provide security or co-signer

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Co-Signer

• Required if borrower has poor/weak credit rating

• I.e. considered High risk
• Lender may require another person to sign loan agreement
• Co-signer agrees to repay outstanding balance if borrower fails to
do so

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Credit Regulation
• Lenders required to disclose costs of credit
• Consumers have time to change their minds about contracts
signed in their homes
• “cooling off” period
• Many provinces prohibit issuing unsolicited credit cards
• Most lenders press for payment rather than engage in
repossession

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Consumer Credit Queries ????

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