The Three C’s of Credit

• Objectives: – Students will be able to describe the “Three C’s of

Credit (Capacity, character, and collateral) and factors used to assess them.

– Students will be able to evaluate the riskiness of lending to an individual in each of the three categories (Capacity, character, and collateral)

– Students will be able to weigh the benefits and costs of approving a loan and make a decision to approve or deny the loan

FICO Score

• FICO – Named for the score’s developer, Fair Isaac Corporation.

• FICO score ranges from 350 to 850.• Scores between 675 – 850 are

considered good credit.• Scores less than 600 are

considered poor credit.

FICO Score

• You can buy your score from one of the three major credit reporting companies:– Equifax– Experian– TransUnion

How To Improve Your Score

Establish credit by obtaining some form of loan. Be punctual and CONSISTANT! Check credit report often. Keep debt in check. Avoid excessive inquiries. Keep accounts open. Keep a healthy mix (mortgage, credit card, a car loan,

and perhaps a retail card)

Credit Score Components

Source: myfico.com

35%

30%

15%

10% 10%Payment HistoryAmounts OwedLength of Credit HistoryNew CreditTypes of Credit Used

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Lesson 3: A Fresh Start

• PAYMENT HISTORY (35%)

– Number of accounts, number paid on time, number paid late

– Amounts past due on delinquent accounts

• AMOUNTS OWED (30%)

– Total amount owed on all accounts

– Number of accounts with balances

– Balances due on installment loans

– Revolving credit – credit utilization rate (amount owed / credit limits)

Credit Score Components

• LENGTH OF CREDIT HISTORY (15%)

– Average time since accounts opened

– Length of time accounts open by account type

– Date of last activity

• NEW CREDIT (10%)

– Number of recently opened accounts

– Length of time since last credit inquiry

– Re-establishment of positive credit history

– Length of time since new account opened

• TYPES OF CREDIT USED (10%)

– The mix of revolving debt and installment debt 7

Credit Score Components

Lesson 3: A Fresh Start

How Mistakes Affect Your Score

The 3 Cs of Credit• Capacity – Does the borrower have the capacity to

repay the loan?• Character – Will the borrower repay the loan?• Collateral – Is there a financial asset or piece of

property that a creditor can take if the borrower fails to repay the loan?

Debt-to-Income Ratio

Debt-to-income ratio measures the amount of debt you have compared to how much money you make.

30% or less: This is the ideal level of debt. 30% to 40%: Still credit worthy.41% to 49%: Hard to get credit at this level.50% or more: GET HELP!!!

Calculate Debt-to-Income RatioDebt:Monthly mortgage or rent ______Minimum monthly credit card payments ______Monthly car loan payment ______Other obligations ______Total monthly debt payments: ______

$850

$60$190

$75

$1,175

Calculate Debt-to-Income Ratio

Income:Monthly gross salary ______Other monthly income ______Total monthly income ______

Debt-to-Income Ratio:

Total debt ______ divided by total income ______

= ______

$1,175

$2,950 $90$3,040

$3,040

38.65%

Types of Credit

• Revolving credit

• Installment (or term) credit

• Noninstallment (or service) credit

• Credit conditions:

• Secured credit

• Unsecured credit

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Lesson 3: A Fresh Start

Revolving Credit

• Open ended

• Can be secured or unsecured

• Allows you to borrow at any time up to a limit set by creditor

• Offers flexible payments with a minimum payment required

• Minimum payment usually calculated as a percentage of the balance due

• Computes periodic finance charges on the unpaid balance

Examples: credit card, personal line of credit, home equity line of credit

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Lesson 3: A Fresh Start

Installment (or Term) Credit

• Close ended

• Can be secured or unsecured

• Allows you to borrow a specific amount for a specific purpose for a specific amount of time at a given interest rate

• Has the loan term, loan amount, number and dollar value of payments, and total finance charges agreed on at start of loan

• Typically has fixed number of payments of predetermined amount

Examples: home mortgage, car loan, student loan15

Lesson 3: A Fresh Start

Noninstallment (or Service) Credit

• Unsecured

• Paying for a service that you have already used

• Requires payment in full by a specified date

• Does not have interest

• Results in service fees or discontinuation of service if you fail to pay within specified time

• Examples: cell phone plan, utility bill

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Lesson 3: A Fresh Start

Examples of typical credit arrangements

Revolving

Installmen

t

Service

Secured

Unsecured

Credit cards

Student loans

Car loans

Cell phone contracts, utility bills

Home mortgages

Home equity line of credit

Personal line of credit

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TYPES OF CREDIT

Lesson 3: A Fresh Start

Activity!

• Create 10 groups• Get 12 “individual characteristic cards”

– One member from each group will randomly select one card for each characteristic

• Get a Loan Request from the teacher

Activity 9-14: Approve or Deny

• #1: Record the loan request• #2: Match the characteristics with the

corresponding C’s of credit that it falls under– “Capacity”: Annual Household Income, Years of Working at

Current Employer, Education, Monthly Debt Payments as % of Income

– “Character”: FICO Score, Years Living at Current Address, Criminal Record, and Length of Credit History

– “Collateral”: Short-Term Financial Assets, Long-Term Financial Assets, Equity in Home, & Market Value of Other Real Assets

Activity 9-14: Approve or Deny

• #3: Complete individually, then compare answers with group and come to an agreement if the measures of risk differ

• #4: Work together to decided whether to approve or deny for the loan and answer the questions.

• Discussion!