AN ASSIGNMENT ON

CREDIT
SUBMITTED TO : Ms SurbhiSingh ASST. PROFESSOR

Submitted By Varade Dipal (03-326-2011) Patel Shivani (03-304-2011) Soni Amita (03-320-2011) Soni Nirmal (03-321-2011) Solanki Joshana (03-319-2011) Chhapiya Vina (03-2011)

ASPEE COLLEGE OF HOMESCIENCE AND NUTRITION SARDARKRUSHINAGAR DANTIWADA AGRICULTURAL UNIVERSITY S. K. NAGAR : 385506

Credit
The word credit is derived from the Latin word "credo" which means "\ believe." Fitzsimmons (1950) define credit as "purchasing power secured for use in the present through the belief others have in the borrowers willingness and ability to repay in the future." According to Donaldson (\961) consumer credit is the credit used by individuals to facilitate the process of consumption. It is utilized to purchase goods pay in future. Thus if we define credit it means supply of money, goods and services at present in exchange for the promises of payment in future. A feeling of trust is thus very important in the credit transactions. Credit is the method of getting money, goods or services in the present and paying for them in the future. At any given time use of credit increases purchasing power. Family should understand the nature and operation of credit since repayment of borrowed amount has to be made with the interest for its use. 6.1. NEED FOR CREDIT Under the impact of technological advancement and urbanization as we move for"vard in time from olden days to the present economic and social conditions have changed, which in turn have necessitated adjustment by families, societal change such as increased mobility and transfer of productive functions from the home have made the family of today more of a consuming unit than a producing unit. People in former times had almost no cash income they resorted to barter system to meet their household expenditure. Early in the development of trade it was found very inconvenient t chan J Ilwt ri I things by the process of barter. The use of money wa a reat impr v me~t over the barter system. With the industrialization and rapid advan ment in research and technology in the western world, tw dv I pm ot virtually forced a growing use of consumer credit. Firstly, with rapid in r a in m bility from rural to urban area consequent on account f advan m nt in transport and communication, people started crowdin int lar cities and became dependeT}t on monthly pay cheque or d ily wa c . A ontinuing

flow of money became therefore, essential for them. I it wa cut for a while they could not even get food to eat. Thu , whenev r there was shortage of money, credit was used and then credit be arne imperative that provision for such credit simply had to be made. Secondly, with raising con umption levels, even the ordinary middle class families of the capitalistic countries started buying consumer durables on credit basis which had become quite popular by then. Today especially in India also, credit purchase has become part of the spending plan of most offamilies. Almost all the household durables from refrigerator and electrical appliances to automobiles, houses etc. are financed through credit. It is said that availability of consumer credit has contributed much towards imprOVing the level.lIVIng. 6.2. IMPORTANCE OF CREDIT Credit is obtained by a person when he borrows money now with an understanding that he will repay it later. In case of consumer crt:dit the same thing happens, the consumer promises to pay later for goocs and services received today. Most families cannot buy costly items with cash; their large purchases require use of credit. Credit is important in the life of an average consumer because without it they cannot buy fridge, television, washing machine, car, house and other such expensive items. If they had to save enough to meet the entire purchase price in cash, such high-priced items could never been obtained in their life time. Credit facilitates the use of these items while you are paying for them. it helps people to enjoy a higher standard of living. Families use credit for various reasons. One of the reasons is to meet of cost of something one needs. Part of money could be taken as loan which can be repaid in easy installment for example loan to build a house. Credit helps to meet family emergencies such as operation costs, hospital bills, and so on. 6.3 Sometimes credit is taken to buy machines which can be used for production or in anticipation of future income, for example if you take loan for buying a sewing machine or for sending child abroad for further education. Credit is sometimes taken for sake of convenience, for example when you have

an account at grains shop or with milk-man or when you buy things on installment basis. The family however, should think before taking credit. The cost of credit is always high. One has to pay more than what you would have to pay if you bought it in cash. The credit affects one psychologically. You may constantly worry if you take credit. Therefore credit should be taken only if it is going to be of some help. 6.3. WHY PEOPLE USE CREDIT The reasons why people use credit vary from family to family and frorri time to time for same family. Some of the common reasons are: 1. To meet needs and obligations. 2. To repay an accumulation of debts or bills. 3. To meet family emergencies. 4. For production purposes-to provide goods and services and 5. For convenience--Credit Cards, charge accounts etc. are used by families because of convenience. 6. To establish credit worthiness so that they can borrow m emergencies. 7. In anticipation of future income i.e., spending on trammg or education so that it would increase their income or if you expect to inherit. 8. To establish family as a buyer e.g., charge account. 9. To overcome the fear that they may not save and replace saving if they spend. 10. To enjoy consumer goods while paying for them. Taken for the following purposes. 11. To invest in human capital i. e., for education of children. 12. To save human resource such as saving human energy through buying labour saving equipment. 13. To improve standard of living. Household debts may be taken for the foHowing purposes: 1. For consumption of goods and services of the single-use type, such as, overdue charge accounts for food or doctor's services. 2. For buying more permanent consumption goods, such as clothing, the automobile, and the house purchased on installments, or the house owned with a

permanent mortgage debt. 3. For productive personal expenditures as education or surgi~al treatment expenditure that increase personal earning power. 4. For productive household equipment as labor-saving machinery or furnishing rooms for lodgers that increase use income or money-income. 5. For outside business purposes. 6. Debts for financial security (a) life insurance premiums or annuity payments due as charges on annual income but not debt in the ordinary sense; (b) investments bought on partial payments which if converted, as bonds, are similarly not to be regarded as debt in. the sense of credit. 6.4. BASIS OF CREDIT When a person desires to obtain credit the lender considers some aspects of the borrower on the basis of which the lender decides whether to give the credit or not and if it is to be given, then, on what terms and condition and what amount should be given. Today's credit is based on the" C's of credit." Fitzsimmons, in 1950, mentioned three C's of credit viz. character, collateral, capacity. Bigelow, in 1953, listed four C's of credit viz. character, capacity, collateral and capital. Donaldson (\961) considered three C's viz. character, capacity and capital. Nickell and Dorsey in 1967 added to the list 'Confidence,' which gives the sixth 'c.' Later, in 1976, Nickell, Rice and Tucker have considered "conditions" as the sixth 'c'. Nickell and Dorsey (1967) present the following diagram. Character. Character of the individual involves his attitude towards obligations and his regularity and promptness in handling financial affairs. ) , (Fitzsimmons, 1950). Character means willingness and determination to repay a loan as agreed (Bigelow, 1953; Donaldson, 196\). Character means intent or desire to repay (Nickell, Rice and Tucker, 1976). A person having good character will see very clearly how he can pay bill or repay the borrowed amount before incurs the debt. If loan is to be obtained from an institution, then, lending institution looks for certain things while checking the character of the applicant.

As stated by Nickell, Rice and Tucker, they are application behavior, accurate information on application, personal cha~cteristics as age, length of residence at one address, number of credit cards 'or accounts held by the person .. They also check credit history and prior credit experience with repayment such as past-due notices or law suits, absence of collection etc. If these are found to be satisfactory the individual is considered to be good character as far as credit is concerned. Family credit is based on the character of the man and his wife and quality of the family financial behavior (Nickelland Dorsey). Those who have good character will take care of the debts as soon as they receive money, unless there are unforeseen circumstances which prevent him to pay up the money immediately. But there are people who are notoriously slow payer although they have sizable income and capital. They are considered to be havinQ" poor character. Capacity. One should take credit only if one has capacity to repay the money. Capacity refers ability to repay bonowings (Fitzsimmons 1950; Nickell, Rice and Tucker, 1976) to meet the obligation when it is due (Bigelow, 1953). The capacity to repay loans depends on regularity of income and available margin of money over and above necessary expenditure. Aptly stated by Nickell and Dorsey, "The family's ability to repay depends on the capital fund which it has been accumulate on the family's earning power and on the managerial ability of women in the home." A person who is in good healthy has a steady position and profitable business is a better "credit risk" than the one who is unemployed. Capacity is measured by the money income (present and positive), cunent demands against that income, gifts/inheritance which mav be received and property which may be in the borrower's control. (Fit.:simmons, 1950). The lending institution looks for education, steady income, employment with good firm, when it assesses the capacity of the borrower. It sees the amount of income whether it is sufficient to meet normal needs. (Nickell, Rice and Tucker, 1976). It also considers the time since the person is on the job. In case of self employed person, they demand documents regarding paid income for the period of past 3 years.

Capital. Capital is the money and seCUrities owned by family investment in house, land, shares, jewellery etc. are the capital assets which increases a family's credit worthiness. Capital shows the net worth of the family. It is determined by the difference between what one "owns" and what one "owes" (Bigelow, 1953). To some degree this denotes the financial ability of the borrower to pay up the debts. If a person refuses to pay a debt, a lien may be secured against his property and it may be sold to satisfy the debt. Financial standing of an individual or family in the community is also considered as capital (Nickell, Rice and Tucker, J 976). The lending institution looks for the account of the borrower in one or more of local banks when it tries to check the capital of the borrower. It sees the savings accounts, the assets it owns such as a house and automobiles. It also sees the liquidity of the capital, in case the lender has to exercise control over the borrower's assets. Collateral. Collateral is the assets pledged as security for a loan or credit sale (Nickell, Rice and Tucker, 1976). Collateral consists of specific units of capital which can be pledged as security for a given loan. Collateral is any holdings that can be used by the individual or family to uarante reoavment on a loan. (F't7J:mmnnfO 19C;()) Tn r::l<;p th~ borrower is unable to repay the debts, the lender can sell the collateral to recover the money. Any property that a family owns, which has a sale value, may be used as collateral if it is acceptable to lender. House, automobile, jewelry, stocks, bonds even furniture equipment, LIC Policies, etc. can be offered as security for a loan. Sometimes one's wages are the payment directly from the borrower's employer. In rural India, some of the very poor labour as security and a way of repayment of debt from the landlords. The lender sees the liquidity and resale value of the collateral before accepting it as security. Confidence. Based on the degree which the borrower processes the "four c's,"

the lender reposes confidence in the borrower that the borrower will return the money. As Nickell, Rice and Tucker (1976) say, "Confidence of the lender is faith built on the borrower's character (desire to pay) and his capacity, collateral and capital (ability to pay)." Conditions. Conditions are the current national and local economic conditions that limit or expand available money and confidence in job security, (Nickell, Rice and Tucker, 1976). Giving due considerations to all these factors, the lender gives credit to the borrower. The basis for family credit is presented in the following schematic diagram: I. Character of family Leader (Interest in repayment) + 2. Occupational Returns Managerial ability Capital accumulation (Source. Nickell and Dorsey, 1967) The first and second part both should be good. If either of these two factors breaks down, confidence is lessened and credit is affected. lffamily, which has strong interest in repaying the debt and has the ability to repay it finds it easy to secure credit on very good terms and conditions. Confidence Credit 6.5. CLASSIFICATION OF CREDIT 6.5.1. There are Two Kinds of Credit The commercial credit which are loans taken for the purpose of business and the other one is consumer credit whlcn are loans taKen oy consumers to meet their personal needs. This credit may not always be in form of cash. For example, if you want to buy a washing machine you can take a cash loan and buy it or you can pay for it in installments. When you pay your grocery bill at the end of the month you are using credit. (Ability to Pay)

6.5.2. Bigelow (1953) Classifies Credit (i) On the basis of WilY of getting credit, i. e.; Trade credit vs. Money credit. (ii) On the basis of payment of credit i.e., lump sum vs. installment payment. (iii) On the basis of length of time of credit i.e., longtime vs. short time credit. Trade Credit vs. Money Credit. There are two principal ways in which a family may secure credit. It may use trade credit that is it may buy goods and pay for them at some time in the future. The individual who sells the goods extends the trade credit to his customers. Or the family may use money credit, that is r11ay borrow money from an organization making a business of lending money, and pay cash for the goods it buys. In either case the family assumes an obligation to pay a certain sum of money at a given time. Lump Sum vs. Installment Payment. There are 1wo ways in which a family may pay off the obligations it assumes. One is to repay the entire amount of a loan one time. This is technically known as lump-sum liquidation. The other is to repay the loan a little at a time in a series of payment. This is piecemeal liquidation, or what is ordinarilY known as installment payment. Retail stores and commercial banks ordinarily assume that the obligations of their customer will be settled at a definite time in a single payment. Stores selling good on the installment plan, and industrial banks and personal finance companies assume that their customers will settle their obligations in a series of small payments. Families with generous incomes and families receiving moderate incomes in large increments at irregular intervals ordinarily find it to their advantage to settle their obligations in a single payment, when they receive their incomes. Families with small but regular incomes find it more convenient to pay on the installment plan, for they can use their small margin above current necessities to pay a little at a time towards upon the loan. However, it costs more to collect obligations in a series of payments than to collect the same amount in

a single sum. There is always the risk family must use to make its installment payments. As a result, installment . payment contract usually carry a higher rate of interest than loans to be liquidated in lump sum. Long Time vs. Short-Time Credit. If credit is to be of maximum value to a family, the family must be able to buy when its need is greatest, and be allowed to pay when its income is most easily available. As a result, families want to borrow for varying lengths of time. Ordinarily credit granted for a year or less is considered to be shorttime credit. Credit granted for one to five years is called intermediate credit. Credit granted for more than five years is considered long-time credit. In connection with customer's credit, however any obligation running more than one year is considered to be a long time obi igation. Because of the personal nature of the character and capacity of family credit, there is a very definite relationship between the length of time credit is extended and the risk which is involved. It is unwise to grant credit to a family for as long a time as is safe in lending to a wellestablished corporate enterprise. Because of the uncertainties of family life, it is equally unwise for any family to assume many obligations running over a period of years. 6.5.3. Classification y Fitzsimmons Fitzsimmons (I950) also classifies credit on the basis of time for' which the borrower uses it. Short-term credit is that allowed for ninety days or less. Charge accounts are in this class. Emergency borrowing should fall here. Some of the less-expensive items of household equipment and furnishings brought on installment mu'st be paid for in ninety days. Some forms 'of production credit come under this classification. Money borrowed to pay for a stock of festival goods may be sec Ired on short time. Intermediate credit is that allowed for the more than ninety days and up to five years. Installment purchases of such things as' automobiles, electric ranges and teleVision sets would come under this classification. Some homes might be

bought with credit allowances of five years. Credit for financing many farming operations would come in this class. So would borrowing used to initiate various small businesses, such as that of neighborhood grocers, druggists, and petrol pump operators. Long-terms or long-time credit is one that is extended for more than five years. For consumption purposes the mnst common use of such a credit is in the purch,ase of a home. Borrowing to meet the expense cases bills for the hospital and a doctor might require long-time credit. A emergency expenditure, however, which was difficult for the family to repay might be burdensome. Since this is for a service, rather than' an item of wealth, there is no continuous enjoyment of it by family members. The burden of payment becomes more oppressive as the time required for its completion increases. 6.5.4. Classification Suggested by Nickell and Dorsey The credit commonly having some place in family finance is classified by Nickell and Dorsey (1967) according to use into these major ktnds: Investment credit represents long,.term credit, usually for the development of large-scale projects of industry. It enters into family finance, as the name implies, as a form of income yielding property or investment for the family capital fund. The two major examples are: (I) the family's purchase of bond, which are loans to growing government or industrial enterprises and (2) mortgages, which are loans made on real estate. Mortgages also enter as part of the financing of home ownership in providing housing for the family. Commercial credit is a form of short-term credit used in financing small business enterprises or the movement of good between manufactures and retailer, such credit is used for firms. with relatively short periods to turnover of goods. Commercial credit enters into family finance indirectly as it affects the price paid for commodities purchased. Consumer credit is that used for the purchase of commodities and services for satisfying wants as they occur day by day. It enters directly into family finance. It is the type of indebtedness most frequently used and requires careful planning to be liquidated so that eventual insolvency

will not occur.

6.5.5. Classification Suggested by Gross and Crandall These authors opine that the consumers have two choices for the obtaining the credit. (a) Merchandise or R~tail Credit and (b) Cash Credit. (a) Merchandise or Retail Credit. In merchandise credit the consumer selects an item ~nd arranges for its payment in install~ent. Such dealing can be done with the shop-keeper from whom the iterh is purchased or he may ~ign'a contract with financing company which makes payment to the retaIler on the consumer's behalf. The consumer, in turn, repays the money to the financing company. In any case the arrangements are made at the time of purchase of the article and refer specifically to the payment of that particular purchase. 1n retail credit the consumer borrows money trom one of the sources, purchases the desired item with that obtained cash. He mayor may not state the purpose of borrowing. Merchandise or Retail credit are further classified by these authors into two groups viz. (I) "open book" credit with credit card systems are also c.harge accounts. (2) Installment credit. In this system a specific contract IS drawn to specify the condition of payment. This is very commonly used by today's consumers. . (b) Cash Credit. In this system the consumer borrows cash money from any of the following sources: bank, licensed and small loan companies, pawn brokers, credit unions and other loan societies. The consumer must see the cost and time for retail or cash credit and then decide wisely. 6.6. TYPES OF CONSUMER CREDIT There are different types of consumer credit. l. Charge Account Credit. A charge account credit is an agreement between the buyer and the seller. [t provides the facility of buying now 6.12 Home Management and Family Finance and paying later. It is an understanding between the customer and generally the

retailer in their locality. For example most of us purchase groceries and provision item from a retail shopkeeper in our locality. You go on purchasing item through out the month and at the end of month you make payment. Newspapers, medicines, groceries, toiletries etc. are purchased by families. The creditability of the consumer is the criteria on the basis of which the shopkeeper extends credit. There is no down payment, no mortgage, and no legal documents are involved. Advantages of using Charge Account Credit Some of the advantages of using charge account credit are: (a) Temporary expansion of income. (b) Reduces.need for carrying cash. (c) Convenience shopping. (d) Helps build a Credit rating. (e) Makes it easier to return goods. Disadvantages (a) Shopping is restricted to only a particular store and cannot take advantage of sales and compare quality of products. The chances (b) Encourages over spending. 2. Credit Cards. In recent time credit cards have become a major source of credit. The cards or "Plastic Money" entitle the owners to credit in banks, petrol pumps, business houses, large retail shops and hotels and restaurants. Credit cards now-a-days use of credit cards has become popular to an extent that a purchaser found difficult in paying for a purchase by check than in charging it. Different credit cards like oil credit card, retail credit card, bank credit card make it possible to charge an infinite variety of items. Now all purpose credit cards are in fashion over a wide geographical area they appear in the check lesscashless society. Their greatest advantage is their convenience. Disa,S1vantages of credit cards are their cost i.e., 18 percent on an annual basis for credit not repaid. During 25 to 30 days no charge period. This leads to overspending. Another disadvantage is loss when stolen by another person or unauthorized use. .

The various types of credit cards (a) Bank Credit Cards. Credit cards issued by banks are honored . at many places. Master Card, VISA, SBI Card, City Bank card and many more are example. They can be used for booking tickets by rail or air, t '.' Credit 6.13 in hotels and restaurants and in several retail stores. The card holder does not have to pay immediately. He gets a credit of 45 days without any charges and later on a nominal amount is charged. The consumer does not pay anything upon applying for or receiving credit card. You do not have to join any club'or become member of an organization. Only finance charges have to be paid which could be avoided if you pay amount in full within specified time. (b) Travel and Entertainment Cards. Carte Balance, Diner's Club and American Express Cards are some of the widely used Travel and Entertainment cards. In this case the subscribers pay a fixed yearly membership fees. They pay extra for each additional card issued against an account. In India, however, Bank credit cards are used for travel and entertainment also. (c) Gasoline or Petrol Cards. The major oil companies issue credit cards for purchase of petrol at the authorized petrol pumps. It also includes purchase of oil, automobile maintenance services and emergency repairs. 3. Installment Credit. The schemes for installment credit were designed so that the consumers who want to buy expensive items can pay for them in easy installments. A contract has to be drawn up states, the amount of purchase, the amount ~f interest rate and '-'the tot;1 amount to be repaid. This type of credit is used to purchase expensive items such as car, house or other property. The buyer makes payments in regular installments and interest is included in each installment. Many finance agencies change interest reducing balance. Purchase made on charge account and credit cards are open end credit. Customer does not enter into

contract each time he makes purchase. The difference between open end and installment credit are: Installment Open end 1. A down payment is required. 2. The firm uses goods as a security against non-payment. 3. Interest is charged from first day of contract. 4. Contract is for closed end credit. 5. The due date and amount are speci3.ed in each contract. L No down payment required. 2. Many companies do not require security agreement. 3. The interest is not charged for a specified period. 4. Contract is open end. 5. Consumer decides how much to pay each period.