Topic 3.2 · Borrowing, Credit, and Debt
Borrowing, Credit, and Debt
Why people borrow, where loans come from, how lenders judge creditworthiness, and strategies for managing debt and building credit.
Learning objectives
- 3.2.ADescribe reasons consumers borrow money and the funding sources available to them.
- 3.2.BExplain how a lender evaluates the creditworthiness of a potential borrower.
- 3.2.CRecommend a strategy to manage a consumer’s existing debt and/or use of credit.
Objective statements © College Board, quoted from the Course and Exam Description.
Why people borrow
- To buy things that cost more than current income and savings, such as a car, a house or tuition
- To handle an emergency
- To keep savings intact while still making a purchase
- For convenience, such as using a credit card
Borrowing creates a liability. Loans must be repaid with interest, and the rate and terms depend on the lender, the type of loan, the amount and the borrower's credit history.
| Secured loan | Unsecured loan | |
|---|---|---|
| Backed by collateral? | Yes (car, house) | No |
| Typical rate | Lower | Higher |
| Examples | Auto loan, mortgage | Credit card, personal loan |
Who lends
Banks and credit unions lend out the deposits they receive from savers. Credit card companies, retail stores, mortgage lenders and alternative financial services such as payday loans, check cashing and instant tax refunds lend to consumers too. Alternative services usually charge much higher rates.
Key terms
- Debt (liability)
- Money owed that must be repaid, usually with interest.
- Secured loan
- A loan backed by collateral, such as a car or house. It usually has a lower interest rate.
- Unsecured loan
- A loan with no collateral, such as most credit cards. It usually has a higher rate.
- Collateral
- An asset the lender can claim if the borrower defaults.
- Default
- Failing to repay a loan as agreed.
- Creditworthiness
- A lender's judgment of how likely a borrower is to repay, based on income, savings, existing debt and credit history.
- Credit report
- A record of a person's use of credit compiled by credit bureaus, including a credit score.
- Credit score
- A number summarizing past credit behavior that lenders, landlords, employers and insurers may review.
- Down payment
- Paying part of a big purchase up front, which reduces the amount borrowed and can earn better loan terms.
- Bankruptcy
- A legal process that eliminates some debts and sets up repayment of others.
- Alternative financial services
- Payday loans, check cashing, instant tax refunds and similar lenders, typically charging high rates.
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