Introduction to

Credit
MODULE - 1
Learning Objectives
Define • Define credit.

Explain • Explain the basis for lending decisions.

Differentiate • Differentiate between a credit report and a credit score.

Detail • Detail the actions that will improve a credit score.

5.1 Define Credit

Credit: funds provided by a creditor to a borrower that will be

repaid by the borrower in the future with interest (Madura)

Credit is generally defined as a contractual agreement in which a

borrower receives something of value now and agrees to repay the
lender at a later date—generally with interest. (Investopedia)
Credit Versus Debt
Credit and debt are two different concepts.
◦ Credit is how we handle our financial life.
◦ It is your ability to borrow.
◦ Debt is what you acquire when you actually
borrow.
◦ It is a loan or obligation.
Who Uses Credit Scores? (1 of 2)
Traditionally, the financial services industry was the only
one to use credit scores (auto loans and mortgages).
• To determine the cost and terms of money borrowed

More recently, other industries have started using credit

scores:
• People with messy financial lives tend to lead messy lives.
 Other industries have started using
credit scores:
Who Uses ◦ Insurance companies
Credit Scores? ◦ Landlords
(2 of 2) ◦ Employers
◦ Dating sites
◦ Hospitals
 Lenders look at two factors before lending
money:
5.2 Explain the ◦ The ability to repay your loans
◦ If you have no income, no lender will
Basis for lend you money.
Lending ◦ The willingness to use your resources to
Decisions do so
◦ Not everyone who has money is
responsible with it.
 Take into account both your willingness and
your ability to repay your loans
◦ Character
The Five C s of ◦ A borrower’s willingness to pay bills on time
Credit (1 of 2) ◦ Capacity
◦ A borrower’s ability to pay bills
◦ Capital
◦ Assets owned by the borrower
The Five C s of Credit (2 of 2)
Collateral
• A specific asset of some value that the borrower pledges to the lender
• Can be taken away by the lender and sold to satisfy the debt, if the
borrower does not pay the loan

Conditions
• Economic conditions beyond the borrower’s control that could affect
the ability to repay the loan
 Bank versus Budget

What the bank The bank doesn’t

Approved Is Not approves is the
know everything
about you, such as
Afford maximum amount it is vacations, dining
out, shopping
willing to loan. habits.

You know the most

You are the boss of you can afford
your money. based on your
budget.
5.3 Differentiate
Between a Credit report Credit score
Credit Report Details a person’s credit history, A risk score assigned to an
specifically as it relates to the individual that indicates
and a Credit ability to pay financial debt creditworthiness and likelihood to
obligations repay a loan
Score A report from one of the credit All the information on a person’s
bureaus with financial and credit report run through a
demographic information about a complex algorithm to generate one
specific person number
Credit
Report
WHAT I S ON YOUR CR E DI T
R E P ORT?
Credit Reporting Agencies
Three largest and most used are
◦ Equifax,
◦ Experian, and
◦ Transunion.
Your three credit reports may look somewhat
different from each other because not all companies
report to all three major credit bureaus.
Easy to get access to each report for free by going to
www.annualcreditreport.com
 These services claim to monitor all three of
your credit reports and to
◦ notifying you monthly about activity,
◦ repair your poor credit, and
Credit ◦ restore your identity should it be stolen.
Monitoring They offer free services to get you to view their
Services website, then they offer other services, which
they charge for.
Some will sell your personal information to
third parties, who use it for marketing and sales
purposes.
What Makes up a Credit Score?

Credit scores are determined by Payment History – 35%

five main pieces of information:
◦ Payment history Amounts You Owe – 30%
◦ Amounts owed
Length of History – 15%
◦ Length of credit history
◦ New credit New Credit – 10%

◦ Types of credit Types of Credit – 10%

What makes up a credit score, by

percentage
 Fair Isaac and Company
(https://www.investopedia.com/terms/f/fico-fair-isaac.asp)

Produces the majority of credit scores used in lending and

other financial decisions

FICO Use data from the three major credit bureaus, with their own
proprietary algorithm, reduce the data to a three-digit score

Scores can range from a low of 300 to a high of 850.

Historically, a score of 760 or above has been considered the

best risk.
 There is no magic “fix” for a bad
5.4 Detail the credit score if the information on your
Actions That report is accurate.
Will Improve a
Credit Score Improving your score will take time
and discipline.
 The process of reviewing a customer’s
risk level by conducting a thorough
review of their credit worthiness along
The with other financial documents

Underwriting
Process (1 of 2) Evaluate how risky you
are as a borrower.
Underwriters go Decide if and how
through three steps in much they are willing
to lend.
reaching a decision: Determine the interest
rate.
 Use credit report and credit
score to determine worthiness
The
Underwriting
Process (2 of 2)
Lenders consider
how much available
each of the five Cs of
credit you have relative
credit and
to your income.
 Pay Pay your bills on time.

Pay down Pay down your debt.

Ten Tips to Help

Improve a Credit Pay down Pay down credit cards.
•Try to keep the balance on each to no more than 30% of your available credit.

Score (1 of 3)
Get a credit card, if you don’t have one already.
Get •Use it on occasion, and pay it off before the due date.

Get Get an installment loan, such as a car loan or personal loan.

 Check your credit report and get the
following errors fixed:
◦ Negative items older than 7 years (10
years for bankruptcy)
Ten Tips to Help ◦ Accounts handled by bankruptcy that still
Improve a Credit show as unpaid
Score (2 of 3) ◦ Incorrect credit limits reported as lower
than actual
◦ Late payments, collections, or accounts
listed as “settled,” “paid derogatory,” or
“paid charge-off,” if these are not correct
 Use your older credit cards.
Use • The length of older
accounts is important.

Ask to have late payments

Ask erased if you have been on
Ten Tips to Help time for several months.

Improve a Credit
Score (3 of 3) Dispute negative information
Dispute that is older than three
years.

Avoid closing unused

Avoid accounts.
Topic Review

In module 1, you learned

about the following:
◦ Credit versus debt
◦ The basis for lending
decisions
◦ Credit report versus
credit score
◦ Actions that help
improve a credit score

Financial Success Pyramid

Fin