Credit/Truth-in Lending

AuthorJeffrey Wilson
Pages311-315

Page 311

Background

Credit is money granted by a creditor or lender to a debtor or borrower, who defers payment of the debt. In exchange for the credit, the lender gets back the money, usually paid on a monthly basis, plus finance charges or interest. Entities within the credit industry, including banks, mortgage lenders, and credit card companies, earn billions of dollars per year from these charges and the interest received from outstanding balances.

The government regulates the credit industry due the potential for abuse by those who issue credit. Without government regulation, creditors could attempt to confuse debtors regarding the terms of credit or could deny credit on improper grounds, such as the race or gender of the potential debtor. Identity theft, which occurs when one person uses another's personal identification to commit fraud or other crimes, has become a major problem in the United States due to the continually increasing use of the Internet. Legislatures, including Congress, have enacted statutes in recent years that are designed to protect the credit histories of those who may be the victims of identity theft.

Types of Credit
Same-as-Cash Credit

Same-as-cash, or noninstallment, credit is the simplest form of credit. Same as cash credit is usually due after a very short term, such as a 30-day period. Same-as-cash credit enables consumers to take possession of property today and pay for it within a set amount of time. Many department stores offer non-installment credit; however, many same-as-cash plans can convert to high interest credit if the customer does not pay in full on the due date.

Installment Credit

With installment, closed-end credit, a creditor loans a particular amount of money, usually the amount of the purchase price of the goods. The full amount of the principal and interest must be paid within a pre-determined time period. Failure on the part of the debtor to pay within this time period may mean that the debtor must return the goods to the creditor.

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Revolving Credit

Revolving, open-end credit is found with most credit cards. Under agreement with the lender, an amount of credit is extended to the consumer. An outside limit is established, depending upon the consumer's credit history and ability to handle the debt repayment. The financial institution gives the consumer a credit card with a credit limit, and the consumer can choose how much of the available credit to use at any given time. Usually the consumer makes monthly payments. Revolving credit requires active management by the consumer. The consumer can decide to pay off the entire outstanding debt when the statement is present, pay off more than the required minimum payment, or simply make the minimum required payment.

Interest

Interest is the compensation paid by a debtor to a creditor for the use of the creditor's money. Over time, due to inflation, the value of money decreases. Interest on credit can be either simple or compound. Simple interest is interest charged only on the principal amount borrowed. Simple interest does not add the interest charge back to the outstanding loan during the length of the loan. Thus, simple interest charges are less than compound interest charges. Compound interest is interest charged not only on the principal, but on the interest accrued during the length of the loan. Compound interest is more expensive to the consumer because interest is charged on top of interest.

The amount of interest that can be charged is limited and regulated by state laws. The percentage interest rate allowed varies from state to state, depending on the type of credit being extended. A fixed interest rate does not change throughout the duration of the extension of credit. Under a variable rate loan, the finance charge is determined by an index, such as the "prime rate" published nationally each quarter for short-term loans charged by banks. This allows the lender to charge an interest rate that reflects current market conditions. Regardless of whether the interest rate charged is fixed or variable, the rate may not exceed the permissible rate set by state usury laws.

Truth In Lending Act

The Truth in Lending Act is a federal law which sets minimum standards for the information which a creditor must provide in an installment credit contract. The amount being financed, the amount of the required minimum monthly payment, the total number of monthly payments, and the annual percentage rate (APR) must all be provided to the consumer prior to entering into a...

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