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 rev-
enues 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 deter-
mine 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 reliabil-
ity. 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 bor-
rower’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 credi-
tor’s bill, is a written instrument from a bank or
merchant in one location requesting that any-
one, or some specifically named individual,
advance money or items on credit to the indi-
vidual holding, or named in, the letter. Repay-
ment of the debt is guaranteed by the bank or
merchant issuing the letter. Letters of credit are
popular in international commercial transac-
tions 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 indi-
vidual’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.
