Credit

CREDIT

A term used in accounting to describe either an entry on the righthand side of an account or the process of making such an entry. A credit records the increases in liabilities, owners' equity, and revenues as well as the decreases in assets and expenses.

A sum in taxation that is subtracted from the computed tax, as opposed to a deduction that is ordinarily subtracted from gross income to determine adjusted gross income or taxable income. A claim for a particular sum of money.

The ability of an individual or a company to borrow money or procure goods on time, as a result of a positive opinion by the particular lender concerning such borrower's solvency and reliability. The right granted by a creditor to a debtor to delay satisfaction of a debt, or to incur a debt and defer the payment thereof.

consumer credit consists of short-term loans made to people so that they can purchase consumer goods and services for personal or household purposes.

The term credit has various applications to transactions that involve borrowing. Credit can be used in reference to the ability to postpone payment, as in the case of an individual who has credit with a local store that allows purchase of items on a weekly basis and settlement of account due once a month. An individual might also be extended a credit line, the maximum amount of money that a lender will put at a borrower's disposal. In such case, an individual enters into an agreement for the taking out of a series of loans. Since there is a fixed limitation on the amount to be borrowed, payments must be made to reduce the debt incurred when the maximum is reached.

A letter of credit, sometimes called a creditor's bill, is a written instrument from a bank or merchant in one location requesting that anyone, or some specifically named individual, advance money or items on credit to the individual holding, or named in, the letter. Repayment of the debt is guaranteed by the bank or merchant issuing the letter. Letters of credit are popular in international commercial transactions because they enable parties to transact business without the need to exchange large amounts of cash. This type of instrument was also popular prior to the common usage of credit cards and travelers' checks.

Personal credit is granted based upon an individual's character, reputation, and business standing regarding his or her financial reliability.

Development of the Law of Credit

Traditionally, the law has sought to protect borrowers since they are easily exploitable by lenders. Often the two parties do not have equal bargaining opportunities to negotiate all the terms of the agreement, and, therefore, the stronger is able to take advantage of the more vulnerable. The established legal viewpoint is that a lender can properly charge a fee for use of the funds he or she lends, but the rate of interest should be neither unfair nor unconscionable.

usury traditionally meant charging interest or a fee in exchange for a loan, but it has come to mean charging an illegal rate of interest. Certain credit transactions, such as the loan of money pursuant to a mortgage, are exempt from the provisions of usury statutes.

Amortization Amortization—a system that allows a borrower to discharge a debt in regular, equal installments—was developed in the nineteenth century by savings and loan associations. To amortize a loan, the lender must calculate the total interest due over the term of repayment, add that figure to the total sum borrowed, and divide the total by the number of payments to determine the size of regular, periodically scheduled payments to be made by a debtor.

Morris Plans The establishment of Morris plan companies, still found in some states, was a significant development in the consumer credit business. These industrial banks accept deposits from the general public and issue investment certificates in the amount of each deposit. The certificates entitle the holder to obtain interest on a deposit at regularly scheduled intervals. The bank utilizes the funds primarily to make small loans to wage earners who are steadily employed. It is necessary for borrowers to secure two other salaried individuals to endorse the agreement. The loan is repaid in installments during the course of a one-year period.

State Consumer Laws Originally the fact that consumer loans were difficult to obtain created loan sharking—the practice of lending money at usurious interest rates—coupled with the threat or use of extortionate methods of enforcing repayment. The Russell Sage Foundation analyzed the loan shark problem in 1916 and suggested that credit should be made available to consumers. It proposed a Uniform Small Loan Law for enactment by the states that defined small loans as those under $300. A maximum interest rate of three and one-half percent monthly on small loans was suggested. The interest rate was stated as a per-month charge in order to encourage legislators to adopt the act and to prevent consumers from going to loan sharks who make a practice of concealing their true rates of interest.

The Uniform Small Loan Law was subsequently revised but was important since it made way for legal lending to consumers. It was created as an exception to state usury laws and furnished the pattern for the subsequent creation of consumer credit legislation.

Legal Rate of Interest

Interest can be computed in a number of ways, and creditors generally attempt to use the most profitable way that is within legal limits. In figuring the legal rate of interest, it is essential to determine which expenses are a part of the finance or interest charges. Not customarily considered components of finance charges are fees for filing or recording a document, for payment of an individual who does an appraisal, and for the expense of preparing documents; closing costs; and prepayment penalties.