Module 1 — Consumer Credit Advice

Reasons Why Clients Need Credit

Definition of Credit
Credit can be broadly defined as the basis of an arrangement where money or goods are
extended today by one party (the lender) to a second party (the borrower) for future repayment
by the borrower under agreed-upon terms.

Credit is also the term used to describe the ability of the borrower to take on debt. The lender
extends credit to the borrower to a certain limit. The amount of credit the borrower uses is the
amount of debt owed. In this sense, the terms credit and debt are often used interchangeably.

(Note, however, that the accounting terms, credit and debit are opposite parts of some financial
statements, and thus have opposite meaning.)

Repayment of debt in a credit arrangement is typically made in installments, with additional

interest premiums paid at an agreed-upon rate. The amount of interest paid represents profit to
the lender and cost to the borrower. There may be further borrowing costs in the form of fees or
insurance.

The amount of credit the lender will extend to the borrower, and the rate of interest the borrower
pays, depends on the borrower’s credit-worthiness. Credit-worthiness is the perceived ability
and willingness of the borrower to repay the debt on time and at the agreed‑upon rate of
interest. The lower the borrower’s credit-worthiness, the higher the risk will be for the lender
and the higher the rate of interest the borrower will be required to pay. If the borrower is
perceived to be too risky, the lender will not extend credit at all.

Sources of Credit
The three main sources of credit are public, private and consumer credit. Each type is
described in detail below.

Public Credit
Public credit is used by all levels of government to raise capital for operating and infrastructure
costs. Currently, governments are the largest users of credit. The buyers of the debt
instruments (the creditors) are essentially lending money to the government bodies (the
debtors). Government debt instruments are the most secure and most liquid of all types
of credit.

Debt instruments in Canada’s public sector are issued by all three levels of government.

Government of Canada
The federal government issues debt instruments in its own name and guarantees debt
instruments of government-controlled agencies and crown corporations.

Most federal debt is in the form of Treasury bills, Canada Savings Bonds and Canadian
government bonds. In the investment industry, Canadian government bonds are sometimes
referred to as Canadas.

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Provinces of Canada
The provinces issue debt instruments in their own names and guarantee the debt instruments
of government-controlled agencies and crown corporations.

Municipalities
Municipalities issue instruments in their own names. Serial debentures are the most common
municipal debt instrument issued.

Private Credit
Issuers of credit in the private sector include Canadian and foreign corporations. Corporations
issue debt instruments in the form of bonds and debentures to raise capital for various
purposes, such as investment or expansion.

A bond is a debt instrument that represents a contract between a corporation and an investor.
The bond is bought by the investor and held for a specific period, until it matures, at which time
the corporation buys it back. A bond may change hands before maturity, because it can be sold
by the original investor to other investors.

The corporation is obliged to pay the bond holder regular amounts of interest (called coupons)
in return for the use of the purchase amount. When the bond matures, the bond holder sells
it back to the corporation for the principal amount, plus any remaining interest. Bonds are
relatively low risk, because they are secured by the assets of the corporation that issues them.

A debenture is similar to a bond. However, unlike a bond, it is not secured. If the issuing
corporation defaults, the bond holder will be paid off before the debenture holder. Debentures
pay a higher interest rate than bonds to compensate for the higher risk.

Averis Financial Group Inc. sells 20,000 debentures worth $10,000 each to raise
$200 million for investment in Averis Assurance Company, a subsidiary firm. Averis pays
investors 6.5% per year, semi-annually. The debentures mature on November 24, 2035.
On that date, Averis will buy the debentures back from the investors, or from the current
holders at that time if the debentures have been sold.

Consumer Credit
Consumer credit is the type of credit commonly used by consumers to purchase merchandise.
Credit cards, personal lines of credit and bank loans are all types of consumer credit.

Consumer credit has traditionally been used to finance the purchase of goods and services
such as automobiles and travel costs. Today, however, credit is put to broader use by
consumers. Other purposes include investment and retirement savings plans.

Expanding consumer income and changing attitudes toward the assumption of debt has
resulted in increased use of consumer credit and increased growth in products and services.

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Reasons Why Clients Need Credit

Purposes of Credit
Consumers use credit for any of the following purposes:
Convenience
Payment deferral
Covering income shortfalls
Debt consolidation

The advantages and disadvantages of each purpose are described below.

Convenience
A credit card is convenient to use. For some people, it eliminates the need to carry cash.

Advantages Credit cards can be used without interest charges when outstanding
amounts are paid on time (unless they are used to take cash
advances).
The monthly statement provides a convenient summary of expenses.
Disadvantages The convenience of credit encourages some people to accumulate
excessive debt.
The interest rates charged on unpaid balances are often much higher
than on other borrowed funds (although some credit cards exist with
rates similar to consumer loan rates).
Convenience may also encourage impulse purchases, which may
further increase debt.

Payment Deferral
Credit provides a means to purchase goods or services while deferring payment until later.
This accommodates consumers who are unable or unwilling to pay the full amount at the time
of purchase but can afford to make monthly payments on outstanding debt.

Advantages The opportunity to have goods or services immediately can justify

the cost of credit.
Credit allows consumers to make reasonable purchases that exceed
their ability to pay in cash. For example, many people would not be
able to afford to buy a car without access to credit.
Some people find it difficult to save money for a significant purchase
of goods or services. Scheduled payments of credit impose a
discipline to pay for the purchase.

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Disadvantages Purchases cost more because of interest and other charges. These
direct costs vary with the length of time granted to repay the credit.
A repayment schedule reduces cash flow. For this reason, credit
used to buy goods or services now may limit the ability to buy goods
and services in the future.

Sylvia Dawson’s client Archie Mohr uses his credit card to purchase kitchen cabinets
that are on sale for 50% of the regular price this week only. This allows him to save a
substantial amount of money, provided that he pays the full credit balance due at the
end of the month. However, if Archie carries the balance forward, the high interest rate
he will be charged may quickly outweigh his savings on the purchase.

Covering Income shortfalls

Personal credit is commonly used in circumstances where income is fairly predictable but
irregular. Seasonal workers and sales representatives who are paid mainly on commission, for
example, rely on income that fluctuates from one month to the next. They may have trouble
meeting living or work-related expenses when their cash flow is low. They often do not qualify
for business credit facilities, because their income is not guaranteed. Such clients will often rely
on a personal line of credit when cash is short and repay it when expected income materializes.

Advantages Personal credit allows clients to meet expenses during periods of little
or no income.
Disadvantages Interest must be paid regardless of whether anticipated income is
actually received, as in the case of a sales representative who does
not meet targeted sales.

Income Shortfall Risk

A landscape designer may require credit to pay suppliers and cover expenses until
a job is complete and the client has paid up.

A real estate agent may need credit to pay regular daily expenses until a sale closes
and the commission is received.

An artisan who sells products at a Christmas fair may require credit to purchase
supplies in the fall with the intention of repaying it in January.

In all these examples, there is a risk that the expected income will not materialize.

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Debt consolidation
Loans are often taken to consolidate higher interest and several monthly payments into a lower
overall interest loan with a single payment.

Advantages Combined payments can lower interest costs, and may lower monthly
payments.

Disadvantages Individuals with poor personal finance management skills may

consolidate their debts, but may incur additional debt.

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Module 1 — Consumer Credit Advice

Types of Consumer Credit

Revolving Credit
Revolving credit is a type of credit granted up to a pre-approved limit, typically with a monthly
repayment schedule. Unlike an installment loan, there is no fixed number of payments.

Revolving-credit clients use as much or as little as they need in any given month. They may
repay the borrowed credit in full at any time without penalty, and they may reuse the credit when
they need it again. However, they must meet a minimum payment requirement. This may be the
entire amount borrowed or a small fraction of the amount, depending on the type of credit.

Typically, revolving credit accounts charge a high rate of interest. In some cases, the client must
pay an initial fee, for which they receive a benefit in return.

A credit card is the most common type of revolving credit, but it is not the only type. Other very
similar types include a charge card and a store card. The slight differences between each type
are described below.

Credit Cards

Issuers
Currently, Visa and MasterCard are the only major credit cards available to consumers.
They are issued by the following institutions:
Chartered banks
Trust companies
Credit unions
Caisses populaires
Department stores

Terms
Credit cards typically require a minimum monthly repayment equal to a percentage of the
outstanding balance.

A basic credit card typically has no annual fee. Some credit card plans, however, charge
fees for various types and levels of rewards or benefits. Higher fees (up to $120 per year)
accompany more generous benefits.

Some of the rewards and benefits offered by credit card plans include:
A percentage of cash back on purchases
Travel reward points to purchase airfare or hotel stays
Retail reward points to purchase catalog or brand-specific goods
Travel insurance
Insurance against loss or damage of purchased goods

Depending on the plan, cardholders may be rewarded more generously for specific purchases,
such as automobile or home-improvement purchases.

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Interest and Charges

The interest rate on bank-issued credit cards is typically about 20%, although most financial
institutions have a low interest option in their product suite for low-risk and high-value clients.
Visa or MasterCard credit cards issued by department stores may have rates that range up
to 30%.

Many institutions offer a lower short-term, introductory rate to attract new clients. The low rate
is offered as incentive to open a new credit card account or to transfer a credit balance from
another institution. The duration of the introductory period is typically six months to a year, after
which the card reverts to the market rate or higher. There are generally conditions attached to
these cards. A client’s credit must be in good standing to qualify for the lowest advertised rate.
If the client does not meet the minimum payments, the low rate may be withdrawn early.

Federal regulations in Canada require that a minimum amount of time between the billing date
and the balance due date be extended to the cardholder as a grace period. During this time,
interest is not charged. For example, a cardholder who purchases goods using a credit card
will not be charged interest if they pay the full balance before the due date. However, if the
cardholder carries an outstanding balance past that due date, interest charges begin to accrue
from the date the goods were purchased—not from the end of the grace period.

Note that the grace period does not extend to cash advances taken on credit cards.

Security Risks
Fraudulent use of credit cards has been rising steadily and is creating concern among card
issuers. The use of the internet for purchases has increased this risk and has prompted many
financial institutions to investigate new technologies such as using microchips instead of
magnetic strips to store information. This type of evolving technology is expensive and usually
incurs additional cost to the consumer. Criminals who use stolen credit cards tend to use them
within 48 hours of the theft of the cards, before measures used to detect and prevent fraud are
effective.

Advantages and Disadvantages of Credit Cards

Advantages No interest charged on purchases when outstanding amounts are paid
on time
Provides a source of emergency funds
Can be used as secondary identification
Can be used to establish a good credit history to obtain a mortgage
Provides an official credit bureau record that establishes identity and
personal facts such as birthdates, place of work, address, marital
status, identification

Disadvantages Allows excessive debt to accumulate if not paid in full each month
Charges a high rate of interest
May encourage impulsive purchases and overspending
Can lead to bankruptcy
Puts the client at risk of identity theft

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Charge cards

Issuers
Charge cards differ from credit cards in that the cardholder is not allowed to carry a balance.
The holder uses the card as a form of short-term credit to make purchases and is expected to
pay the outstanding amount in full by the statement due date. Issuers of charge cards include
American Express and Diners Club.

Charge cards are often advertised as having no pre-set spending limits. This does not mean
that there is no ceiling on the amount the cardholder can spend, but that the limit changes
according to annual income, payment history and credit rating. Because the issuer expects the
balance to be paid in full at every due date, the limit on a charge card is typically lower than that
on a credit card.

Because charge cards must be paid in full every month, they are a better option than credit
cards for clients who have had debt problems in the past.

Terms
If the cardholder does not pay within the specified grace period, the outstanding balance is
subject to a penalty at a high interest rate. The charge card will be cancelled if the balance
remains unpaid

Most charge cards offer reward features similar to those offered with credit cards. These
include reward points, discount programs, insurance plans and other perks.

Interest and Charges

Annual fees for charge cards are often high. Interest on outstanding credit can range up to
30% per year.

Store Cards

Issuers
These accounts are offered by retailers exclusively for the purchase of their own goods and
services. Some retailers (such as Sears and Canadian Tire) may offer both credit cards and
store cards, but the store card can only be used for that retailer’s merchandise. The following
stores are some of the retailers that issue store cards:
Sears
The Bay
The Brick
Canadian Tire

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Terms
The terms on these cards vary. However, the following are some of the general terms:
For 30-day accounts, payment is required in full within 30 days of the date of billing.
For revolving accounts, the minimum payment each billing cycle depends on the total
outstanding balance.
Installment accounts generally require large purchases to be paid through equal monthly
payments over a specific time frame commencing immediately, or after a payment deferral
period. These retailers are often major furniture or appliance stores.

Interest and Charges

Interest charges on store cards are very high—as much as 15% higher than credit cards. If a
payment deferral option is chosen, an upfront administrative fee is often charged.

Some retailers offer zero-interest teaser cards. Typically, the cardholder pays no interest on
goods purchased for a full year. However, if the credit amount is not paid by the one-year due
date, the issuer charges full interest on the outstanding balance from the purchase date. Many
consumers have good intentions to repay the balance by the due date. All too often, they fail
to meet the repayment terms and end up paying an exorbitant amount of interest on their
purchases.

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Types of Consumer Credit

Consumer Loans
A client seeking credit has several options, depending on needs and circumstances. A client
with disciplined spending habits will benefit from one approach, whereas a poor financial
planner may fare better with another. A client with short-term needs requires a different type of
credit from one with long-term or ongoing needs. It is your responsibility to determine what your
client needs and recommend the right credit product for that client.

The different consumer loan options are described in detail below.

Lines of Credit
A line of credit is by far the most common type of consumer loan offered by financial
institutions. Typically, a line of credit carries a lower interest rate over a longer period than other
types of consumer loans. Clients with a line of credit tend to stay with the institution longer than
clients with other types of consumer loans, because the line of credit is not closed once it is
paid off. It is a more profitable arrangement for the institution compared to credit that is paid off
quickly, with no incentive for the client to stay.

A line of credit is also desirable for the client, because it offers flexible payment options,
convenience and a lower interest rate. It gives clients easy access to an established credit
limit that they can use whenever they want. They can pay down credit in full or in part, without
penalty, as long as they pay the interest. In addition, the do not need to apply for credit approval
each time they need to use it.

One disadvantage of a line of credit is that, unlike credit card debt, there is no interest-free
grace period. Interest starts to collect the day of purchase.

Lines of credit fall into three categories:

Unsecured line of credit
Secured line of credit
Home equity line of credit

Unsecured Line of Credit

An unsecured line of credit charges the highest interest rate. This is because it carries the
highest risk. An unsecured line of credit is generally backed by a promissory note.

Secured Line of Credit

A secured line of credit is backed by collateral in the form of client assets. Not every asset is
acceptable as collateral. Financial institutions generally require assets that maintain their value
and can be sold easily. Some investment assets, such as Guaranteed Investment Certificates
(GIC) and bonds, are worth 100% of their value as collateral. Other assets, such as equities,
may be valued at 50% to 75% of their full appraisal.

Consumer goods such as cars are rarely, if ever, accepted by financial institutions as security
for a line of credit; neither do they accept RRSP or RRIF assets as collateral.

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Terms of a Line Payments are not usually on a fixed repayment schedule. Either
of Credit a monthly interest payment or a monthly payment of a minimum
percentage of the outstanding balance is typically required.
As with a chequing account, the client typically receives monthly
statements and can withdraw funds with cheques or through direct,
automatic debit transactions.
Generally, there is no charge for accessing a line of credit

Interest and Charges Financial institutions normally charge a lower interest rate on a
on a Line of Credit line of credit account if the client pledges assets as collateral. The
rate the institution charges may be equal to prime or prime plus a
percentage, depending on the client’s credit rating and the value of
the asset or assets pledged. If the client defaults on the loan, the
institution can sell the collateral to recoup losses.

Home Equity Line of Credit Plan

With a home equity line of credit plan (HELOC), the client’s equity in a home is used as
collateral. A HELOC line of credit is the best type of credit for clients who manage their finances
well. Financial institutions always offer HELOC plans at the lowest rate, because real estate is
the best type of collateral. With a HELOC plan, disciplined clients can act as their own banker.
As the biggest debt is paid down, they can borrow at will from their line of credit for necessary
renovations or investments in other assets.

A client using home equity as collateral for a line of credit must still meet normal underwriting
requirements to qualify, including the institution’s debt capacity and other lending criteria.

In line with federal legislation, most financial institutions currently set the maximum limit
on a HELOC line of credit at 65% of the home’s appraised value (or 80% of the value less
any outstanding mortgage or mortgages, if that is the lesser amount). The whole HELOC
plan, including mortgage, is limited to 80%. The appraised value is usually determined by a
professional real estate appraiser.

As well, the institution may register 100% of the purchase price or property value. This allows
the client to increase the amount of the HELOC as the property rises in value without having to
re-register or pay further legal costs.

By federal legislation effective July 2012, if a HELOC plan is for a second mortgage, the
combined first and second mortgages cannot exceed 80% of the appraised value or purchase
price, while the HELOC line of credit portion must not exceed 65% of the total mortgaged
amount.

Terms of a HELOC The terms of a HELOC are similar to mortgage terms. Terms may
differ according to the specific institution. A HELOC can typically be
paid either in interest-only payments or in fixed portions of interest
and principal.

The HELOC client receives monthly statements, and can withdraw

funds with cheques or through direct, automatic debit transactions.

Generally, there is no charge for accessing a line of credit.

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Interest and Charges With a HELOC line of credit, clients can borrow a larger amount at
on a HELOC a lower rate of interest.

The main disadvantage of using a HELOC line of credit is that

application, legal and appraisal fees may be significant, and often
must be paid up front. An appraisal may not be necessary if the
institution has a database of property values. However, it is always
required for properties that are valued over a specific amount
(according to current market conditions).

The legal fees to set up a HELOC line of credit can be negotiated

as part of the mortgage deal when the property is purchased.
Typically, the fees are similar to the fees charged on the mortgage.
Legal costs are lower on a property that is already owned.

Installment loans
An installment loan is paid over a set amount of time on a set payment schedule. It is typically
used to fund a major purchase or to make a contribution to an RRSP.

Terms of an An installment loan (or term loan) is used to finance major

Installment Loan purchases, such as a car or home renovation. The amount borrowed
must be repaid over a certain period, or term, on a fixed schedule of
payments.

The loan term is often established to reflect the anticipated lifespan

of the asset being purchased. For example, a lender may only allow
a four-year term on a three-year-old vehicle to ensure that the loan
is repaid before the vehicle must be replaced. On the other hand, a
client may be able to finance the purchase of a new vehicle over a
six-or-seven-year term.

Installment loans often have an open prepayment clause, which

allows the borrower to pay off all or part of the credit without
penalty, before the end of the term. The interest rate charged on an
installment loan may be fixed or variable.

Interest and Charges Fixed-Rate Loan

on an Installment The interest rate is set for the term of the loan, and payments are
Loan usually a blend of principal and interest.

Variable-Rate Loan
The interest rate floats with the prime rate. Monthly payments are
blended in a fixed amount that includes a cushion, in case rates
rise. The last credit payment can be adjusted, or the term of the loan
extended, to take into account changes in interest rates over the
term. If the average rate is lower than on a fixed-rate loan, the client
benefits. However, the client bears the risk that interest rates will
increase.

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Other Types of Consumer Loans

Demand Loans
A demand loan is an interest-only type of credit, where the institution has the right to demand
full repayment at any time. This type of credit is becoming increasingly uncommon. It may
be granted at the discretion of the institution in relatively small amounts as a source of
emergency funds.

Terms of a Demand Some financial institutions allow the client to carry the loan
Loan indefinitely, making interest-only payments and occasional
payments toward the principal. Some may require periodic
payments of principal, or the repayment of both principal and
interest after a set period of time.

If the client defaults, the institution can call the loan, demanding
repayment of the entire amount.

Interest and Charges Generally, only payments of interest are required. The payment
on a Demand Loan amount changes as the balance of the principal declines or as
interest rates change.

Bank Account Overdraft

A bank account overdraft is available at most financial institutions that offer chequing accounts.

Terms of a Bank This type of credit protects clients when they have insufficient funds
Account Overdraft to cover cheques and other debits charged against their accounts.
In most cases, a set overdraft limit is attached to each customer’s
account. As long as the client does not exceed that limit, cheques
and debits will be covered.

It is generally required that an account in overdraft be liquidated

and brought into a credit balance at least one day over a 30-, 60-
or 90-day period, based on the lender’s requirements. This is to
ensure that the overdraft service is used as a short-term solution,
rather than as a perpetual source of funds.

Interest and Charges The interest rate charged is generally high (up to 28%), and there is
on a Bank Account usually a monthly fee. Limits range from $100 to $5,000.
Overdraft

Indirect Credit
Indirect credit is rarely used by consumers. There are several forms of indirect credit that are
mainly used by business clients.

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Terms of Indirect Letter of Credit

Credit A letter of credit is a document issued by a financial institution on
behalf of a client. It confirms that the institution will pay the seller
of goods the amount stated, when the goods are received by the
purchaser (usually the client). A letter of credit is often used when
goods are purchased in a foreign country. Occasionally, it is issued
to a consumer who needs to establish credit while working in a
foreign country
Letter of Guarantee
A letter of guarantee is an agreement by an individual or a business
to pay money directly to a third party, when stated conditions have
been met. For consumers, it is most often used as a guarantee
when they do not want to (or are unable to) provide a cash deposit
for utilities, such as hydro or gas.

Forward Exchange Contract

A forward exchange contract is a contract to buy or sell a currency
on a specified future date at a set rate of exchange. This type of
contract is usually needed by a client who has a financial obligation
in a foreign currency, which will arise or mature on a future date.

Interest and Charges Set up and renewal fees are charged for letters of credit and letters
on Indirect Credit of guarantee.

Forward exchange contracts generally are charged a fee equal to a

percentage of the value of the contract.

Life Insurance Loan

A person may obtain a loan through a life insurance company against any type of life insurance
policy that has a cash surrender value. Since it normally takes three to four years to build a
cash surrender value, no loans can be obtained until then.

When a loan is obtained using this method, the value of the life insurance policy is reduced by
the amount of the loan until it is fully repaid.

Closed versus Open-End Loans

Closed-end loans require a client to make regular payments, typically on a monthly basis. The
client either does not have the option to make additional payments or is restricted in the amount
and timing of additional payments. If a client wishes to pay off a closed-end loan prior to
maturity or make an additional lump sum payment, a penalty equal to several months’ interest
may be charged. Fixed-rate home mortgage loans are generally closed-end loans.

Open-end loans allow for additional payments or full payment of the outstanding balance at any
time without a penalty. Variable-rate loans are often open ended.

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Types of Consumer Credit

Consumer Loans
A client seeking credit has several options, depending on needs and circumstances. A client
with disciplined spending habits will benefit from one approach, whereas a poor financial
planner may fare better with another. A client with short-term needs requires a different type of
credit from one with long-term or ongoing needs. It is your responsibility to determine what your
client needs and recommend the right credit product for that client.

The different consumer loan options are described in detail below.

Lines of Credit
A line of credit is by far the most common type of consumer loan offered by financial
institutions. Typically, a line of credit carries a lower interest rate over a longer period than other
types of consumer loans. Clients with a line of credit tend to stay with the institution longer than
clients with other types of consumer loans, because the line of credit is not closed once it is
paid off. It is a more profitable arrangement for the institution compared to credit that is paid off
quickly, with no incentive for the client to stay.

A line of credit is also desirable for the client, because it offers flexible payment options,
convenience and a lower interest rate. It gives clients easy access to an established credit
limit that they can use whenever they want. They can pay down credit in full or in part, without
penalty, as long as they pay the interest. In addition, the do not need to apply for credit approval
each time they need to use it.

One disadvantage of a line of credit is that, unlike credit card debt, there is no interest-free
grace period. Interest starts to collect the day of purchase.

Lines of credit fall into three categories:

Unsecured line of credit
Secured line of credit
Home equity line of credit

Unsecured Line of Credit

An unsecured line of credit charges the highest interest rate. This is because it carries the
highest risk. An unsecured line of credit is generally backed by a promissory note.

Secured Line of Credit

A secured line of credit is backed by collateral in the form of client assets. Not every asset is
acceptable as collateral. Financial institutions generally require assets that maintain their value
and can be sold easily. Some investment assets, such as Guaranteed Investment Certificates
(GIC) and bonds, are worth 100% of their value as collateral. Other assets, such as equities,
may be valued at 50% to 75% of their full appraisal.

Consumer goods such as cars are rarely, if ever, accepted by financial institutions as security
for a line of credit; neither do they accept RRSP or RRIF assets as collateral.

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Terms of a Line Payments are not usually on a fixed repayment schedule. Either
of Credit a monthly interest payment or a monthly payment of a minimum
percentage of the outstanding balance is typically required.
As with a chequing account, the client typically receives monthly
statements and can withdraw funds with cheques or through direct,
automatic debit transactions.
Generally, there is no charge for accessing a line of credit

Interest and Charges Financial institutions normally charge a lower interest rate on a
on a Line of Credit line of credit account if the client pledges assets as collateral. The
rate the institution charges may be equal to prime or prime plus a
percentage, depending on the client’s credit rating and the value of
the asset or assets pledged. If the client defaults on the loan, the
institution can sell the collateral to recoup losses.

Home Equity Line of Credit Plan

With a home equity line of credit plan (HELOC), the client’s equity in a home is used as
collateral. A HELOC line of credit is the best type of credit for clients who manage their finances
well. Financial institutions always offer HELOC plans at the lowest rate, because real estate is
the best type of collateral. With a HELOC plan, disciplined clients can act as their own banker.
As the biggest debt is paid down, they can borrow at will from their line of credit for necessary
renovations or investments in other assets.

A client using home equity as collateral for a line of credit must still meet normal underwriting
requirements to qualify, including the institution’s debt capacity and other lending criteria.

In line with federal legislation, most financial institutions currently set the maximum limit
on a HELOC line of credit at 65% of the home’s appraised value (or 80% of the value less
any outstanding mortgage or mortgages, if that is the lesser amount). The whole HELOC
plan, including mortgage, is limited to 80%. The appraised value is usually determined by a
professional real estate appraiser.

As well, the institution may register 100% of the purchase price or property value. This allows
the client to increase the amount of the HELOC as the property rises in value without having to
re-register or pay further legal costs.

By federal legislation effective July 2012, if a HELOC plan is for a second mortgage, the
combined first and second mortgages cannot exceed 80% of the appraised value or purchase
price, while the HELOC line of credit portion must not exceed 65% of the total mortgaged
amount.

Terms of a HELOC The terms of a HELOC are similar to mortgage terms. Terms may
differ according to the specific institution. A HELOC can typically be
paid either in interest-only payments or in fixed portions of interest
and principal.

The HELOC client receives monthly statements, and can withdraw

funds with cheques or through direct, automatic debit transactions.

Generally, there is no charge for accessing a line of credit.

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Interest and Charges With a HELOC line of credit, clients can borrow a larger amount at
on a HELOC a lower rate of interest.

The main disadvantage of using a HELOC line of credit is that

application, legal and appraisal fees may be significant, and often
must be paid up front. An appraisal may not be necessary if the
institution has a database of property values. However, it is always
required for properties that are valued over a specific amount
(according to current market conditions).

The legal fees to set up a HELOC line of credit can be negotiated

as part of the mortgage deal when the property is purchased.
Typically, the fees are similar to the fees charged on the mortgage.
Legal costs are lower on a property that is already owned.

Installment loans
An installment loan is paid over a set amount of time on a set payment schedule. It is typically
used to fund a major purchase or to make a contribution to an RRSP.

Terms of an An installment loan (or term loan) is used to finance major

Installment Loan purchases, such as a car or home renovation. The amount borrowed
must be repaid over a certain period, or term, on a fixed schedule of
payments.

The loan term is often established to reflect the anticipated lifespan

of the asset being purchased. For example, a lender may only allow
a four-year term on a three-year-old vehicle to ensure that the loan
is repaid before the vehicle must be replaced. On the other hand, a
client may be able to finance the purchase of a new vehicle over a
six-or-seven-year term.

Installment loans often have an open prepayment clause, which

allows the borrower to pay off all or part of the credit without
penalty, before the end of the term. The interest rate charged on an
installment loan may be fixed or variable.

Interest and Charges Fixed-Rate Loan

on an Installment The interest rate is set for the term of the loan, and payments are
Loan usually a blend of principal and interest.

Variable-Rate Loan
The interest rate floats with the prime rate. Monthly payments are
blended in a fixed amount that includes a cushion, in case rates
rise. The last credit payment can be adjusted, or the term of the loan
extended, to take into account changes in interest rates over the
term. If the average rate is lower than on a fixed-rate loan, the client
benefits. However, the client bears the risk that interest rates will
increase.

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Other Types of Consumer Loans

Demand Loans
A demand loan is an interest-only type of credit, where the institution has the right to demand
full repayment at any time. This type of credit is becoming increasingly uncommon. It may
be granted at the discretion of the institution in relatively small amounts as a source of
emergency funds.

Terms of a Demand Some financial institutions allow the client to carry the loan
Loan indefinitely, making interest-only payments and occasional
payments toward the principal. Some may require periodic
payments of principal, or the repayment of both principal and
interest after a set period of time.

If the client defaults, the institution can call the loan, demanding
repayment of the entire amount.

Interest and Charges Generally, only payments of interest are required. The payment
on a Demand Loan amount changes as the balance of the principal declines or as
interest rates change.

Bank Account Overdraft

A bank account overdraft is available at most financial institutions that offer chequing accounts.

Terms of a Bank This type of credit protects clients when they have insufficient funds
Account Overdraft to cover cheques and other debits charged against their accounts.
In most cases, a set overdraft limit is attached to each customer’s
account. As long as the client does not exceed that limit, cheques
and debits will be covered.

It is generally required that an account in overdraft be liquidated

and brought into a credit balance at least one day over a 30-, 60-
or 90-day period, based on the lender’s requirements. This is to
ensure that the overdraft service is used as a short-term solution,
rather than as a perpetual source of funds.

Interest and Charges The interest rate charged is generally high (up to 28%), and there is
on a Bank Account usually a monthly fee. Limits range from $100 to $5,000.
Overdraft

Indirect Credit
Indirect credit is rarely used by consumers. There are several forms of indirect credit that are
mainly used by business clients.

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Terms of Indirect Letter of Credit

Credit A letter of credit is a document issued by a financial institution on
behalf of a client. It confirms that the institution will pay the seller
of goods the amount stated, when the goods are received by the
purchaser (usually the client). A letter of credit is often used when
goods are purchased in a foreign country. Occasionally, it is issued
to a consumer who needs to establish credit while working in a
foreign country
Letter of Guarantee
A letter of guarantee is an agreement by an individual or a business
to pay money directly to a third party, when stated conditions have
been met. For consumers, it is most often used as a guarantee
when they do not want to (or are unable to) provide a cash deposit
for utilities, such as hydro or gas.

Forward Exchange Contract

A forward exchange contract is a contract to buy or sell a currency
on a specified future date at a set rate of exchange. This type of
contract is usually needed by a client who has a financial obligation
in a foreign currency, which will arise or mature on a future date.

Interest and Charges Set up and renewal fees are charged for letters of credit and letters
on Indirect Credit of guarantee.

Forward exchange contracts generally are charged a fee equal to a

percentage of the value of the contract.

Life Insurance Loan

A person may obtain a loan through a life insurance company against any type of life insurance
policy that has a cash surrender value. Since it normally takes three to four years to build a
cash surrender value, no loans can be obtained until then.

When a loan is obtained using this method, the value of the life insurance policy is reduced by
the amount of the loan until it is fully repaid.

Closed versus Open-End Loans

Closed-end loans require a client to make regular payments, typically on a monthly basis. The
client either does not have the option to make additional payments or is restricted in the amount
and timing of additional payments. If a client wishes to pay off a closed-end loan prior to
maturity or make an additional lump sum payment, a penalty equal to several months’ interest
may be charged. Fixed-rate home mortgage loans are generally closed-end loans.

Open-end loans allow for additional payments or full payment of the outstanding balance at any
time without a penalty. Variable-rate loans are often open ended.

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Complete the Credit Application

How to Conduct a Client Interview

The Application Process

Traditionally, clients apply for credit in person. However, most financial institutions now also
offer clients the option to apply by telephone or online. The majority of credit applications at
most financial institutions are still done in person, but the volume of telephone and internet
applications has been increasing.

Whether a client applies for credit in-branch, by telephone or online, the same application
form is used. A telephone or online application will be referred to you by your institution, and
supporting documentation is usually faxed or mailed back and forth between you and the client.

The application for credit is filled out during a credit interview between you and your client. The
interview may happen in person or over the telephone, and some information may be collected
by email. The final signing of the documents, however, always occurs during a face-to–face
meeting.

There is some indication that delinquency and fraud rates are higher for credit
applications conducted over the telephone and the Internet. Financial institutions work
continuously to improve the quality of information they gather through these channels.

The Interview
The interview should be confidential, and your client should feel at ease discussing personal
information. An appropriate area in which to conduct the interview can help the client feel more
comfortable, and thus more likely to provide the required information.

During the interview, you must gather detailed information on the client to help with the follow-
up credit investigation. The information provided on the application may also be required for the
collection process if the credit goes into default.

You are responsible for collecting all pertinent information about the client’s situation. During
the interview, the client may consciously or unconsciously withhold information. Wording your
questions skillfully will help reveal the necessary information.

Your objective during the credit interview is to obtain accurate, complete and up-to-date
information to reveal the following details about your client:
Character
Stability
Credit history
Ability to repay
Security for credit (if required)

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A good interviewer is tactful and acts in a relaxed manner. Remain positive and withhold any
negative comments. Take cues from your client and respond in a similar manner. If your client is
friendly, talkative and joking, you can respond with friendly humor. If your client is reserved and
businesslike, your manner should be respectful and professional.

Types of Questions
To uncover valuable information about your client, it is important to ask the right kinds of
questions to suit the circumstances. The following guidelines will help achieve this:
Use closed-ended questions only to get simple facts, such as the client’s address and
phone number.
Use open-ended questions to allow the client to provide more complete, meaningful
answers.
Use probing questions to reveal details and nuanced information or when you require
clarification.
Never use leading questions. These tend to force the client to provide only what you want to
hear, not necessarily what the client wants to say.

Remember that the interview is a form of discussion. It should not appear to be an interrogation.

Julie Travent is interviewing her client Cecilia Lopez, a dental hygienist who is applying
for credit to purchase a car. Cecilia tells Julie that she’s planning to move to a new
neighborhood and will need a car to get to work. Cecilia then tells Julie excitedly that
she recently got engaged.

Julie congratulates Cecilia and then considers the following questions:

Closed-ended question:
“When are you planning to marry?”

Open-ended question:
“Is there a reason you decided to move farther away from your job?”

Probing question:
“Did you mention your engagement because you think it’s relevant to your
application, or simply to tell me the news?”

Leading question:
“I suppose you’ll be moving in with your new husband?”

Julie decides that the open ended question is the best response to Cecilia’s news.
If she needs to discover more details, she can move on to probing questions.

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Tips for the Interviewer

Greet the client in a friendly manner.

Use a respectful, conversational manner.
Do not interrogate the client.
Remain neutral—do not offer opinions or judgments.
Check inconsistencies in the information the client provides.
Do not ask leading questions.
Do not ask questions about private matters beyond the scope of the application.
Maintain eye contact.
Listen carefully to be sure you understand the client’s responses.

Remember that you are the representative of your institution. Whether the application
is approved or not, it’s up to you to create a professional atmosphere, and goodwill
between the client and the financial institution.

Human Rights Legislation

As an advisor conducting a credit interview, you must comply with the requirements of human
rights legislation such as the Canadian Human Rights Act. This act requires that lending
decisions must be based only on a client’s home stability, job stability, credit report and income.
It prohibits discrimination based on any of the following:
Race
National or ethnic origin
Religion
Age
Skin color
Gender
Marital status
Physical or mental disability
Sexual orientation
Convictions for which a pardon has been granted

Julie Travent wonders whether her client Cecilia will take a leave of absence from her
job to have children after she marries. However, Julie knows better than to ask Cecilia
such a personal question. She also knows that, under the Canadian Human Rights
Act, she cannot allow a change in marital status to influence her decisions regarding
Cecilia’s application for credit.

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Completing the Interview

You must make sure that the credit application form is fully completed before you submit it for
assessment of creditworthiness.

Keep the following points in mind as you wrap up the interview:

Inform the client that you have enough information to assess the application.
Ask if the client has anything to add.
Do not make a commitment to the client about the final decision.
Inform the client that a credit investigation and evaluation will be performed.
Let the client know when to expect a decision on the application.
Let the client know who will be calling about the decision on the application.
Thank the client for coming to the interview.

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Complete the Credit Application

Components of a Credit Application
It is vital that all components of the credit application are complete, accurate and up-to-
date. You must be sure that the client is not misleading you or misrepresenting their financial
situation. All information provided must be backed up by supporting documentation, such as
personal identification, proof of address and proof of employment.

The credit application typically consists of five sections:

1. Purpose of Credit
2. Personal Information
3. Employment Information
4. Financial Statement
5. Signature and Authorization

Each section is described in detail below.

Purpose of credit
This section includes the reason the client is borrowing the funds and the amount they want to
borrow.

After the credit assessment and second meeting with the client, this section will also include the
amount of the credit, the rate and the term, if applicable.

Personal Information
This section includes the client’s name, age, birth date, housing information, marital status,
dependents, contact information and other personal information.

The housing information will include:

Two pieces of identification, including one photo ID
The current address
The length of residence at that address
The name of the landlord or the mortgage holder
The monthly rent or mortgage payment amount
The balance of the mortgage, if applicable

Most institutions require a prior address if the client has been at the current address for less
than a specific time (usually three years).

The amount and purpose of the loan is also stated in this section.

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Employment Information
This section includes the client’s employment information. This includes the employer’s name
and address, as well as the client’s occupation, length of service, employment income and
other income, if any.

Most institutions require employment information about a previous job if the client has been at
the current job for less than a specific time (usually, three years).

Financial Statement
This section lists the client’s assets, liabilities and total net worth.
When you are helping your clients fill out their net worth statement, make sure they fully
understand what you are asking for. Don’t assume, for example, that they know the difference
between an asset and a liability.

Amy Riley, who rents an apartment, has decided to get a consolidation loan to pay off
$15,600 that she owes on her credit cards and car loan. She has a car worth $5,000
with a large portion of the loan paid off. She has $900 in a bank account and no
investments.

As part of the credit application, Amy’s advisor has asked for a list of current assets
and liabilities to calculate her net worth. Her net worth statement is shown.

Note: Additional information regarding the names of the creditors and the details of
repayment are also usually included in the Net Worth Statement.

Net Worth Statement for Amy Riley

Assets Liabilities
Details of Assets Amount Details of Liabilities Amount
Cash $900 Visa $8,000
Automobiles $5,000 MC $6,500
Investments — Automobile loan $1,100
Total Assets $5,900 Total Liabilities $15,600
Net Worth -$9,500

Signature and Authorization

This section includes the client’s signature, which certifies that the information given is
correct. It also authorizes the financial institution to obtain information from credit granting
and employment organizations. You must have your client’s written authorization to obtain
the client’s credit report. Most institutions have incorporated a permission clause into the
application form.

Make sure you explain to clients that their signature allows the institution to review their credit
bureau report. You should also reassure your clients that you will use the report only to evaluate
the application. The information will not be shared with anyone who is not involved in the
application process.

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Tips to Help Complete the Credit Application

Verify the identity of the applicant.
Look for discrepancies in the information given.
Ask for explanations where necessary.
Double-check the information whenever possible.
Ask probing questions to make sure your client has accounted for everything.
Don’t make any assumptions.

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Module 1 — Consumer Credit Advice

Conduct the Credit Investigation

PRELIMINARY INVESTIGATION
Credit investigation is the most important part of the credit decision-making process. Your
performance of the investigation is called due diligence. The investigation should begin
immediately after the interview. This is because you are obliged to respond to clients about their
applications within a promised time period.

The main purpose of the investigation is to determine the client’s creditworthiness, or credit risk.
Creditworthiness is based on the premise that a client with a strong job history, steady income
and a good record of past payments is considered a good credit risk.

Indications that a client is not a safe credit risk include the following:
Moves from job to job
Is always short of cash
Frequently borrows or refinances
Has a history of slow payments or bad debt write-offs
Has multiple credit accounts which are at or near maximum limits

Know Your Client

Know your client (KYC) refers to the important process of verifying the identity of the client
you are dealing with. Valid and proper identification is required to protect against fraud and to
register the financial institution’s security interest in any collateral.

Keep in mind that fraudulent people often impersonate good clients with clean credit records to
negotiate loans and lines of credit. These people may then disappear, leaving legitimate clients
responsible for repaying credit they had no intention of borrowing. You should also be very
diligent with credit applicants who have never dealt with your bank before.

Steps in the Preliminary Investigation

During the investigation, you should review the credit application to consider the client’s
employment and financial situation. The steps outlined below will help you determine the client’s
ability and willingness to repay the credit.

1. Determine intent to repay.

First, make sure that the client has full intention to repay the credit. To do this, you must
assess the merits of the credit application. A client with a history of infrequent borrowing and
rapid repayment likely has good intentions.

2. Determine the purpose of the credit.

Is the purpose of the application legitimate? To answer this question, you must be unbiased.
What may seem a perfectly suitable purpose to one person may not appear the same to
another. Nevertheless, declining a credit application early in the process may be justified. If
you suspect fraudulent or illegal intentions, discuss these concerns with your supervisor.

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3. Determine job stability.

Three years with the same employer is generally considered a good indication of job
stability. A positive net worth indicates stable income as well as good saving habits.
Note that financial institutions in Canada normally do not offer credit to non-landed
immigrants, or people working in the country on a visa or permit.

4. Determine the level of debt.

The client’s level of debt is referred to as the total debt service ratio (TDSR). The TDSR
is calculated by adding together mortgage or rent payments, property taxes, heat, credit
payments and other regular payments such as credit cards. The sum is then divided by the
gross income amount.

Some financial institutions include an additional 3% to 5% of the limits of the client’s

revolving credit above the credit balance. This offsets the risk that the client will increase the
credit card portion of the TDSR.
The TDSR is necessary to ensure that the newly granted credit will help the client finance a
particular need without causing undue financial hardship. If the client’s TDSR is within the
guidelines of the institution (typically 40%), you should proceed to completing a thorough
credit assessment.

Howard Hanson’s client Julia Schmidt earns $65,000 annually. Her monthly
commitments are as follows:

Mortgage $750.93
Property tax $150.93
Heat $55.00
Car payments $351.00
Credit cards $345.00
Credit limit (5%) $500 (5% of $10,000)
Total $2,152.86

Howard calculates Julia’s TDSR at 39.7%, as follows:

($2,152.86 x 12)/$65,000 = $25,834.32/65,000 = 0.39745

This falls below the 40% TDSR limit set by Howard’s institution.

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Conduct the Credit Investigation

The Five Cs of Credit
A client’s success in obtaining credit at a reasonable interest rate depends on how well the
individual’s financial situation is presented to the advisor. The client is assessed on credit
history information provided in the credit application. The advisor uses these details to
determine if it is in the institution’s best interests to advance credit to the client.

There are several tests that advisors use to assess a client’s creditworthiness before credit is
extended. These tests may also be useful for the client’s own financial planning. If the tests or
ratios indicate a high risk, the client should view this as a warning sign and reassess all credit
habits.

Traditionally, advisors have used a method known as The Five Cs of Credit to assess a client’s
credit worthiness. The term five Cs refers to the following characteristics:
1. Character
2. Capacity
3. Capital
4. Credit
5. Collateral

In recent years, this method of gauging credit-worthiness has been supplanted by the methods
of credit bureaus. Nevertheless, it’s a good idea to know how to apply these principles.

Each of the Five Cs of Credit is explained in detail below.

Character
Character is reflected in the client’s sense of responsibility and willingness to meet obligations.
Character assessment is based on both intuition and an examination of the facts. Clients with
poor character are likely to make a poor impression. Their credit history will reveal their past
payment habits, which are usually an indication of future habits.

When evaluating character, pay particular attention to collections (unpaid debts), late payments,
delinquency and repeated credit inquiries. If the report shows a trend toward irresponsibility, be
cautious in approving credit.

Olivia Turple’s credit history shows a collection on unpaid gym membership fees.
Olivia claims that she is in a dispute with the gym. “They closed the only location that’s
convenient for me and refused to cancel my contract. The nearest location is in the
next town!” she complained.

Olivia may have a valid argument in her dispute with the gym. However, her credit
history also shows that she cancelled her phone contract without paying the required
penalty, has consistently made late payments on her credit cards and was delinquent
on numerous other bills. Olivia’s advisor views Olivia’s trend toward irresponsibility as a
strong mark against her character.

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Remember that even well-intentioned clients sometimes suffer illness, injury or job loss. Any
of these could make repayment difficult, increasing the likelihood of delinquency and the
financial institution’s risk. You should look for signs that the client has handled such a setback
responsibly. For example, did the client contact the mortgage holder to arrange interest-
only payments for the period in question? Have minimum monthly payments on credit cards
been kept up? A client who has allowed a financial situation to deteriorate, without taking any
measures to maintain a good credit, is unlikely to be a good risk.

Capacity
To determine the client’s capacity to repay credit promptly, assess the following:

Affordability
Assess current financial information to determine whether the client can afford the credit over
a specified period without incurring financial hardship. Many clients feel they have the ability
to manage the cost of credit. However, an examination of their financial commitments, such as
food, clothing and utilities, proves otherwise.

Total Debt Service Ratio

The total debt service ratio (TDSR) helps determine the client’s ability to repay credit. This is
calculated by adding together mortgage or rent payments, property taxes, credit payments
and other regular payments, such as credit cards. The sum is then divided by the client’s gross
income.

Income Source
Applicants with salaried positions and long-term service present the lowest risk of loss of
income. A history of short-term contract employment indicates lower capacity.

Income Stability
Stability of employment shows that the client is a responsible worker who may have progressed
through various positions and income levels. It is also important to consider the client’s
employer. Has the firm been operating for a short time or for a number of years? Employees
have less chance of losing a job from well-established employers.

Capital
Material net worth indicates stability, because it takes time to accumulate it. A client’s high net
worth also indicates good saving and budgeting habits. A client with enough liquidity and cash
flow to handle an emergency, such as a job loss or unexpected expenses, is considered to have
good net worth.

Use caution under the following circumstances:

The client borrows frequently.
The client has a high TDSR.
The client’s net worth is lower (or marginally higher) than the credit amount applied for.

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Credit
Credit refers to the client’s use of credit. You should take into account the client’s purpose for
the credit being applied for, as well as current use and availability of existing credit. You should
also review the client’s credit bureau report to assess the overall quality of the client’s credit. To
properly interpret a credit report, you must learn the rating codes of the credit bureau that your
financial institution uses.

Collateral
A major consideration of credit approval is the collateral obtained for the credit. Collateral
provides security that reduces risk for the institution. The higher the amount of credit, the
greater the risk will be. It is normal practice for the institution to require security for larger loans.
By pledging assets, the client strengthens a commitment to repay the credit.

Credit is occasionally given to clients without security, but this type of credit is usually for
smaller amounts than that secured by real estate or other assets. Credit that is unsecured by
collateral is based on the client’s credit history, personal covenant, net worth, amount borrowed
and stability. Each financial institution has its own policies that establish credit limits and
guidelines for this type of credit.

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Conduct the Credit Assessment

Proof of Borrower’s Income
It is important that you verify all income, and that relevant documentation is well organized. This
includes documentation of verbal communications that may be needed for verification of other
documents or details.

The key types of documentation that help confirm the borrower’s income information are
described below.

Primary Income

Employer Letter
The client should provide a letter of employment on company letterhead that is signed by
someone in a position of authority. This letter confirms income and verifies that the client is
still working.

Verbal Confirmation
In addition to written confirmation of income, most financial institutions require verbal
confirmation. Contact the client’s employer directly by phone, and document the call. Include
the time and date of the call and the name of the person you spoke to. If the borrower defaults
on the credit, this information will be required to prove that due diligence was conducted.

Proof of Income Amount

Notices of Assessment (NOA’s), employer’s statements of remuneration (T4 slips), income tax
returns (T1 General) and financial statements are acceptable as proof of income, as long as
the information is reasonably current. A recent payroll statement or pay stubs should also be
provided by salaried and contract employees.

Independent sources, such as a credit report, should also show that the client is still employed
as claimed. However, the credit report serves as an indicator rather than proof. If the client has
not recently applied for credit, you may find that his or her current place of employment is not
recorded in the report.

In the interest of preventing fraud, a Notice of Assessment is preferred over a T-4 slips,
as it is more difficult to counterfeit.

Financial Statements
Financial statements submitted by the client or by the client’s guarantors should be signed and
dated.

Be cautious when analyzing the income of clients in occupations where income may be
inconsistent. This includes clients who occasionally earn large commissions, such as realtors
or sales representatives. This may also include short-term contract consultants and part-
time or self-employed workers. These clients may have no trouble being accepted for credit.

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However, you must determine that they have had sustained and sufficient earnings during the
past three years.

A T4A is the income tax form employers use to report commission earnings. Your client must
provide a copy for your review. If the client is self-employed, a T1General form will show
expenses as well as income. This gives a more accurate indication of the client’s business
income.

Secondary Income
If a client has significant overtime or bonus income, you should verify the amount for the
previous three years.

Depending on how consistent this income has been, you can determine what portion is likely
to be sustained over the estimated life of the loan. A client may have received a considerable
amount of income from a second job or from overtime work. You should determine whether this
overtime is typical for this occupation or was simply a temporary event.

In some situations, a supplementary employment income substantially increases earnings.

Workers in this situation may include elementary school teachers, firefighters and labourers.
The income received from a supplementary occupation should be carefully considered. There
should be an established record of the arrangement, and it must be evident that the work
does not interfere with the principal job. For example, school teachers tend to be available for
summer employment. Firefighters may work multiple-day shifts, which may leave two or three
days each week available for other employment. This income, if verified, would be considered
stable and satisfactory.

Self-employed Income
Self-employed clients present more complex situations for analysis than salaried employees.
Common sense is essential when evaluating the income of such a client.

In addition to requiring an individual credit report, you will need a T1General form showing
expenses from the client’s business. You should carefully audit financial statements if they
exist. It is most important to review more than one year’s financial statements to determine the
stability of self-employed income. Three years is generally a satisfactory amount.

Financial Statements
Review financial statements to determine the efficiency and profitability of the
self-employed client’s business. This will help determine whether the client can afford
to repay the debt.

Financial statements include the following three statements:

Balance sheet
Income and expense statement
Statement of retained earnings

In most cases, the financial statements provided by your client will not have been audited.
Therefore, the information disclosed in the statements cannot be accepted at face value.

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Section 3: Credit Investigation and Assessment 3•7

Module 1 — Consumer Credit Advice

If a self-employed client claims to have earned a specific amount of money, ask for the
paperwork to back up that claim.

Audrey Brown’s client Clint Sutherland is a landscaper with a net income of $30,000.
However, his income and expense statement shows that his income before expenses
was $100,000. Audrey asks Clint to provide evidence that the statement is accurate. At
their next meeting, Clint provides papers showing that he purchased a truck and other
equipment in the previous year, which accounted for most of his expenses.

Balance Sheet
The balance sheet provides an overall picture of the self-employed client’s business at a given
time. The accumulated net income (profit) should be shown under retained earnings.

Income Statement
The income statement should include the client’s income as declared on the credit application.
The net income (revenue after expenses) should indicate a positive cash flow before taxes.
Quite often, taxes create a break-even or loss position, which requires further explanation.
Negative income does not qualify for credit. Canada’s tax laws allow a business to show a
negative position for no more than three years. Banks are regulated by the government and
therefore should provide credit only on declared income. You can sometimes make allowances
for the cost of doing business. However, as much as possible, you should provide credit based
only on net income.

Retained Earnings
Retained earnings should increase from year to year, unless the borrower has taken all the
earnings out in the form of salary or dividends. Small business financial statements are
not always reliable. Additional information, such as good credit ratings, must be in place to
supplement inadequate financial statements. It may also be necessary to obtain advice or
assistance from a qualified professional to complete the assessment.

Your financial institution may also require specific types of ratio analyses, which may provide
valuable insight into the client’s profitability and efficiency.

© CSI Global Education Inc. (2013)

3•8 Section 3: Credit Investigation and Assessment

Module 1 — Consumer Credit Advice

Conduct the Credit Assessment

Analysing a Credit Report

Credit Bureau Report

Credit bureau agencies compile and distribute credit and personal information to creditors.
They are often the main source of information used to determine an applicant’s credit history.
Many institutions regularly update their clients’ credit information with a credit bureau.

The client’s credit bureau report should depict a long-term history of debt repayment reflecting
historical and recent payment patterns. Slow payments or lawsuits by collection agencies or
individual creditors are points of concern. It is essential that you determine the cause of any
repayment difficulties.

The three credit bureaus most commonly used by financial institutions in Canada are Equifax,
Trans Union and Experian.

Components of a Credit Bureau Report

The typical credit bureau report contains the following components:
Personal information
Credit bureau score
Inquiries
Public information
Trade lines

Each component is described in detail below.

Personal Information
The personal information section normally includes the following details about the client:
Name, including maiden name and any aliases or alternatives
Current and previous addresses
Social Insurance Number
Birth date
Current and past employers

Credit Bureau Score

The credit bureau score is a single number on a client’s credit bureau file that depicts the
individual’s overall strength as a borrower. It indicates the level of risk to an institution in
granting credit to the client. The closer a client’s score is to 1, the lower the risk of loss will be to
the institution.

A credit score associated with a lengthy credit history has more integrity than a credit
score based on a short credit history, as it is much less prone to wide swings. It is less
volatile than that of a young borrower, for example, who has just a few trade lines.

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Section 3: Credit Investigation and Assessment 3•9

Module 1 — Consumer Credit Advice

The credit bureau score is sometimes known as the FICO score, because Fair Isaac &
Company (FICO) created the mathematical formulas used to calculate credit scores.

Depending on the credit bureau your institution uses, the credit score may also be called the
Beacon score (Equifax) or the Empirica score (Trans Union).

The following factors play a part in the calculation of a credit score:

Past payment history:

‒ Bankruptcies
‒ Late payments
‒ Past due accounts
‒ Wage attachments

Credit amounts owing:

‒ Amounts owed
‒ Percentage of the outstanding balances compared to the credit limits

New credit history:

‒ Length of time the client has had the credit
‒ Last activity on the credit account

Types of credit:
‒ Credit cards
‒ Retail accounts
‒ Mortgage
‒ Line of credit

Which factors can have an adverse affect on a credit score?

A high number of enquiries posted on a credit file in the past 12 months:

This usually means the client is actively applying for new credit. The impact will be
greater on a credit score for someone that has a limited credit history or someone that
has a history of late payments.

A short history of revolving and non-revolving accounts:

Clients with longer credit histories have been shown to have better repayment histories
than those with shorter credit histories.

A large amount owing on accounts:

There is a higher repayment risk for clients owing larger amounts.

High loan balances n relation to the original loan amounts:

Paying down loans reflects well on a credit score, as it shows that a client is able to
manage and repay debt.

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3 • 10 Section 3: Credit Investigation and Assessment

Module 1 — Consumer Credit Advice

Inquiries
The inquiries section shows which businesses have requested a credit report on the client. The
level of overall activity includes the number of recent inquiries. A client who has a high number
of recent inquiries may be a credit seeker, and is therefore a higher risk than someone with few
inquiries.

Public Information
The public information section includes the following details:

Derogatory comments
Bankruptcies
Judgments
Garnishments
Lawsuits by collection agencies

Trade Lines
The trade lines section answers the following questions related to the credit history
of the applicant:

Who extended credit?

On what date was the account opened?
On what date was the last advance given?
What is the revolving credit limit?
What is the balance?
What was the highest level of credit outstanding?
What is the current amount past due?
What terms were used to rate accounts? (for example, Paying promptly or Not paying at all)

You should advise clients with a poor credit report to contact the credit bureau to begin
the process of rebuilding their credit. If they ask you for details, explain that the credit
bureau will provide a copy of the report for a small fee. Some clients may find the
information in the report to be inaccurate and may ask you to dispute it. Advise these
clients to contact the credit bureau directly to resolve the issue.

Credit Rating Codes

To accurately interpret a report, you must learn the rating codes of the credit bureau used by
your financial institution. Some of these are explained below.

Credit Type
I = Installment loan (account with a fixed payment)

R = Revolving account (open-ended account)

O = Open account (30-day, 60-day or 90-day account)

© CSI Global Education Inc. (2013)

Section 3: Credit Investigation and Assessment 3 • 11

Module 1 — Consumer Credit Advice

Credit Score
Each creditor assigns a rating on a scale from 1 to 9, where 1 is the best credit rating and 9 is
the worst. (A score of zero means the account has been approved but is too new to rate.)

Each number from 1 to 9 has a specific meaning, as described below (assuming the account
is revolving):

R-1 Account is on time

R-2 Payments are 30 days late
R-3 Payments are 60 days late
R-4 Payments are 90 days late
R-5 Payments are 120 days late
R-6 Typically not used
R-7 Account is in a consumer proposal, consolidation order or debt management plan
(offered through a non-profit credit counselor)
R-8 A secured creditor has taken steps to realize on the security (such as repossessing
a car); rarely appears on a credit bureau report, because after a creditor takes
possession of an asset, it immediately commences legal or collection action, which
is rated R-9
R-9 Loan write-offs (a debt placed for collection or considered uncollectible)
or bankruptcy

Slow payments (rated R-3 or higher) are points of concern. Lawsuits by collection agencies,
loan write-offs (rating R-9) or collections by individual creditors should all raise red flags. It is
likely that such a client presents too great a risk.

In analyzing the credit report, it is important to determine if there are discrepancies between the
information given in the report and information given by the borrower in the application. Follow-
up is necessary for any inconsistencies, inaccuracies or omissions.

A client’s lack of honesty at this early stage may be an indication of future difficulties. Quite
often, additional loans show up on the credit report that were not included on the application.
Remember, however, that clients may understate the amount of credit owing out of ignorance
rather than as a deliberate attempt to deceive. You should request a legitimate explanation for
any questionable information.

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3 • 12 Section 3: Credit Investigation and Assessment

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Conduct the Credit Assessment

Signs of Credit Risk
The purpose of the client interview is not only to gather information. You should also look for
possible signals that the client is a poor credit risk whose application should be rejected.

Signs of Risk
Below are some warning signs that may lead you to reject a client’s request for credit.

Undisciplined Spending Habits

The client’s reason for wanting credit can be a warning signal. For example, if debt
consolidation is the reason for the request, it could mean that the client spends impulsively
rather than based on need. The client may have been extended credit from many different
sources and is now unable to meet all the payment responsibilities. The risk with this situation
is that the client will use the credit to consolidate current debt and resume overspending habits,
which will lead to further debt.

Unstable Employment
Job stability is an indication of the client’s ability to repay credit in the future. This factor is
as important as income for assessing risk. The risk of default is higher for a client who is
unemployed or seasonally employed or whose income source is government assistance or
spousal support. If the client has changed jobs frequently in the past few years, you will need to
determine the reason and assess the level of risk this poses.

Types of unstable employment include the following:

Seasonal Income If income is derived from seasonal employment, it means that

repayment during times of unemployment may be problematic.

Self-Employed For clients who are self-employed or working on commission, an

Income average of the last three years’ income is often used as an indicator
of income.
Income from Other Some applicants may have more than one income source. All sources
Sources of income must be verified if they are used to calculate the client’s
TDSR.

Use discretion when determining the reliability of a client’s income and ability to repay credit.

Jane Murdock, an existing client, wants an unsecured line of credit to start a home-
based business. She currently has a stable, part-time job as a day care coordinator
and has been receiving $700 a month in spousal support payments for the past three
years. Jane’s advisor reviews Jane’s account history and finds that her ex-husband
has never missed a support payment. In this case, the fact that Jane receives spousal
support is considered to be a smaller risk factor than it might be in similar situations.

© CSI Global Education Inc. (2013)

Section 3: Credit Investigation and Assessment 3 • 13

Module 1 — Consumer Credit Advice

Client Misrepresentation
Clients sometimes misrepresent facts with incorrect or incomplete information. For example,
they may inflate their income or neglect to disclose all debts. The misrepresentation may be
unintentional. However, it is often a deliberate attempt to have a weak application approved.

When misrepresentation with a deliberate intent to mislead comes to light, the credit application
should be refused. Specific details of any misrepresentation uncovered during the credit
investigation should be documented using the methods of your institution.

Bad Credit History

Sometimes, a closer investigation of a credit request reveals that the client has poor debt
repayment habits. Derogatory ratings on the client’s credit history may be due to collections,
late payments, written off accounts, judgments or settlements. Multiple applications for credit
(credit seeking) will also reduce a client’s credit score.

It is important to inform the client that the application was declined because the credit agency
provided negative information. However, you do not need to provide specific details. If the client
wants to see the report or specific details, the client should contact the credit bureau directly,
and request a copy of the report. If the client believes that the report may contain false or
outdated information, the credit bureau will work with the client to rectify all possible errors.

Negative Net Worth

Clients with very few assets and considerable debt may not be disciplined in their use of credit.
Be cautious when considering extending credit to these clients. However, rather than declining
the application outright, try to work with them to rectify the situation.

For example, a consolidation loan may help a client with credit owing on multiple credit cards,
but only if the client is willing to change spending habits. You should firmly emphasize a need
for discipline.

© CSI Global Education Inc. (2013)

3 • 14 Section 3: Credit Investigation and Assessment

Module 1 — Consumer Credit Advice

Conduct the Credit Assessment

Risk Management Considerations
Risk management is an essential component of the credit investigation. Consumer credit risk is
becoming increasingly complex and unpredictable. Rapidly changing technology has increased
the frequency of consumer credit fraud. In addition, an unstable economy has changed the
credit climate.

The financial institution’s risk management department typically distributes credit policies to
help manage credit risk throughout the institution. Your primary role related to risk management
is to apply due diligence. Due diligence requires strong reliance on the following aspects:
Knowledge
Experience
Effective communication with the risk management department

Tips to Help Manage Risk

Conform closely to credit guidelines at all times.

React quickly and appropriately to changing client situations.
Keep your guard up and trust your instincts.
Do not advance inappropriate credit out of pity for a client.
Verify that all necessary client documentation is in good order.
Be alert for discrepancies and irregularities.
Investigate all irregularities thoroughly.
Document all inquiries and aspects of the investigation.
Resist a client’s insistence on urgent approvals.
Treat your institution’s money as you would your own.

Consumer Credit Fraud

Fraud is an increasing risk in the consumer credit business that can take many forms. In some
cases, clients applying for credit deliberately misrepresent the facts or fail to disclose important
information. On a more serious level, they use counterfeit or stolen documents to obtain
credit under a false identity. The person committing fraud may act alone or may be part of a
sophisticated crime ring.

When you are under pressure to approve new credit while maintaining existing credit accounts,
you may be tempted to take shortcuts. However, you greatly increase the risk of fraud when
you fail to follow risk policies and guidelines. You must always be alert to signs of fraud and act
promptly and correctly when you detect them.

Due Diligence
To use due diligence means to follow up on every instance of dubious information or
documentation. Watch for warning signs of fraud and act promptly to verify the facts. If
something doesn’t feel right, trust your instincts. Don’t hesitate to reject an application if you
suspect fraud.

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Section 3: Credit Investigation and Assessment 3 • 15

Module 1 — Consumer Credit Advice

Above all, document all your actions, including dates and times. Some fraud is very
sophisticated. It is nearly impossible to detect and prevent every fraud attempt. When fraud
happens despite your best efforts, you must be able to prove that you were thoroughly vigilant
and alert. Meticulous documentation will help you prove that you followed your institution’s risk
management procedures to the letter.

Due Diligence

What does due diligence entail? Use the following examples as a guideline.

A client’s name and address on Ask for another picture ID.

her driver’s license doesn’t match
Match the client’s name to her SIN number.
the name on her credit card or the
address on the application. Search for the name or address using the
Canada 411 service.

A client claiming to have a net Ask the client to log on to his bank account;
monthly income of $10,000 offers then review and print the account history
a printout of his bank statement as for the last.90 days.
proof.
Ask for pay stubs, T4 slips or a notice
of assessment.

If any income of the claimed income is

from spousal support, ask for a separation
agreement.

A client claims that he worked for Search for the company name and phone
three years with one company, but number on the Internet.
there is no record of the job on his
Verify, if possible, that the client or
credit report.
employer is listed in the company directory.

Call the employer and speak to the client’s

manager in person.

A client makes an urgent request for If the request doesn’t feel right, you should
credit that she must have as soon as reject the application.
possible. You try to establish clear
reasons for the rush but are met
with confusing details and changing
circumstances.

Advising in an Unstable Economic Climate

Credit granting can become very risky when the economic climate is unstable. Most financial
institutions will have specific guidelines for advising during economic slowdowns. When interest
rates are rising and unemployment is increasing, policies regarding underwriting are tightened.

Traditionally, interest rates rise during an economic downturn. However, this is not always
predictable. In recent recessionary times, interest rates have remained low. Nevertheless, when
the economy is unstable, you must be particularly alert to increased risk.

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The following are some ideas to consider during an economic slowdown:

Institutions may be less inclined to extend unsecured credit.
You may need to factor in a higher payment amount to calculate the total debt service ratio
(TDSR). This is to ensure that the client can make payments even if interest rates increase.
Advisors often provide clients with more information and more flexible credit options.

Ideally, your advice will not change dramatically with economic circumstances. Conditions may
change for individual clients. Generally, however, a client with a good credit record in a strong
economy will still be the best candidate for credit during a downturn.

Mariam Kandir would like to borrow funds to complete a bathroom renovation in her
home. She is confident that she can manage the credit payments over a 3-year term.
Her advisor, Dmitri Belak, reviews her financial information and agrees that Mariam
could likely meet her obligations. However, Mariam also has a variable-rate mortgage,
and Dmitri is expecting interest rates to rise. If that happens, Mariam’s mortgage
payments will increase. He offers to extend credit for a 5-year term instead, to
decrease Mariam’s monthly payments to a more manageable amount.

Refinancing
Requests for debt consolidations and refinancing require advisors to take extra precautions to
ensure that all facts are verified prior to approval. In periods of high unemployment, you should
confirm that the client is still working for the same employer at the same salary. Review credit
reports carefully to be sure the client is keeping up to date with all financial obligations

Arrears
Arrears become more common in a difficult economic climate. When this happens, you should
act early and quickly to collect payments.

In changing economic times, you must be increasingly alert for risk. However, look out
for opportunities as well. An economic slowdown can be a favorable investment climate
for stable, high-income clients.

© CSI Global Education Inc. (2013)

Section 3: Credit Investigation and Assessment 3 • 17

Module 1 — Consumer Credit Advice

Calculate the Costs of Borrowing

Calculate the Cost of Borrowing
The cost of borrowing is the total amount the borrower pays in fees and interest charges until
the borrowed funds are entirely repaid. This cost depends on the rate of interest charged and
on the terms of payment. All things being equal, the longer it takes to pay off the credit, the
more interest will be paid and the higher the borrowing cost will be. Higher principal payments
reduce the length of time it takes to repay the credit. Therefore, the amount of interest and the
overall borrowing cost are also reduced.

When you are explaining the cost of borrowing to clients, you must disclose all fees and
administrative costs, and you must include these costs in your calculation of the interest rate.
Under banking regulations, you must state the effective annual percentage rate (APR) if it
differs from the annual interest rate, and you must give an explanation of how it is determined.
Disclosing the effective APR makes it easier for clients to evaluate the true cost of credit and to
compare the the cost among various institutions.

The effective annual percentage rate (APR) is the rate of interest the client pays when
fees, administrative costs and compounding are included in the calculation.

Calculating the cost of interest

Credit payments are typically paid monthly, while interest on credit is calculated daily. The
monthly amount varies, depending on the number of days in that month and the amount of
remaining principal.

The formula below is used to calculate the monthly amount of interest on credit:

( Amount of Principal´ Annual Rate of Interest )

´ Days in the Month
365

Calculating the Cost of a Demand Loan

To demonstrate, let’s first assume that the credit is an interest-only demand loan, or a line of
credit on which interest-only payments can be made. Let’s also assume that there are no fees
or administrative costs.

© CSI Global Education Inc. (2013)

Section 4: Cost of Borrowing 4•1

Module 1 — Consumer Credit Advice

Frank Geist borrows $5,000 at a fixed interest rate of 15%. The credit is extended on
March 1. Frank makes his first interest-only payment of $63.70 on April 1, based on
the following calculation:

(5, 000 ´ 0.15) (750)

´ 31 = ´ 31 = 2.055 ´ 31 = 63.698
365 365
(4, long
As the) ´
500 ´as0.15 (675)
principal
31 = remains intact,
´ 30 = 1.849Frank’s
´ 30 = payments
55.470 will be approximately the same
every 365 365 will be $63.70 or less, depending on whether that month
month. (The payments
has 31, 30, 29 or 28 days).

(5, 000suppose
Now, ´ 0.15) that on (June
750) 1, Frank pays $500 on the principal. On July 1, he will
´ 31 = ´ 31 = 2.055 ´ 31 = 63.698
owe an interest
365 payment of $55.47, based on the following calculation:
365
(4, 500 ´ 0.15) (675)
´ 31 = ´ 30 = 1.849 ´ 30 = 55.470
365 365

With every payment made toward the principal, the interest cost will be reduced.
The less time it takes Frank to pay off the principal, the less it will cost him to borrow
the $5,000.

Calculating the Cost of a Fixed-Rate Installment Loan

Most credit does not fit the description of an interest-only demand loan. A consumer loan is far
more likely to be an installment loan that is paid off on a schedule.

Installment loans are designed so that the balance is paid through a series of equal, periodic,
blended payments of interest and principal. With blended payments, interest owing is paid first.
The balance is applied to the outstanding principal. As the balance of the credit declines, a
greater portion of the payment is applied to the principal and less to interest.

© CSI Global Education Inc. (2013)

4•2 Section 4: Cost of Borrowing

Module 1 — Consumer Credit Advice

Joan Algernon borrows $30,000 at a fixed interest rate of 9% for a 5-year term, with
blended monthly payments of $622.75. The credit is extended on August 1, and
payments are due on the first of each month thereafter.

Assuming there are no other fees or costs, the interest on the first payment is $229.31,
calculated as follows:

(30, 000 ´ 0.09) (2, 700)

´ 31 = ´ 31 = 7.397 ´ 31 = 229.31
365 365

The blended payment of $622.75 consists of $229.31 in interest payment

and $393.44 in principal payment. The amount of principal remaining is now
$29,606.56 (30,000 – 393.44). Interest on the next payment is calculated on that
amount.

Joan’s payment schedule for the first five months of the 5-year term is shown below:

Date Payment Interest Principal Balance

August 1 N/A N/A N/A $30,000.00
September 1 $622.75 $229.31 $393.44 $29,606.56
October 1 $622.75 $219.01 $403.74 $29,202.82
November 1 $622.75 $223.22 $399.53 $28,803.29
December 1 $622.75 $213.06 $409.69 $28,393.60
Total paid: $884.60 $1,606.40

Over the 5-year term of the loan, Joan will make 60 payments and pay $7,365 in total
interest costs (60 x $622.75 – $30,000 = $7,365).

© CSI Global Education Inc. (2013)

Section 4: Cost of Borrowing 4•3

Module 1 — Consumer Credit Advice

Calculate the Costs of Borrowing

Calculate the Monthly Payment
You will likely never have to manually calculate the monthly payment amount on a client’s credit.
Your institution will have its own system that automatically calculates the monthly amount after
factoring in all applicable fees and insurance costs. However, it is helpful for you to understand
how the monthly payment is calculated so you can explain it to your clients. Otherwise, the
effect of payments on the principal can appear erratic, especially when the payment is a blend
of principal and interest.

Calculating the monthly payment amount on a demand loan (or on a line of credit on which
interest-only payments can be made) is a simple matter of calculating the cost of interest. As
payments are made toward the principal, the monthly interest payment is recalculated on the
reduced principal amount.

With an installment loan, however, there is no simple formula to calculate the monthly payment
amount. Because the interest portion of blended payments diminishes and the principal portion
increases over the life of the credit, the monthly payment amount is based on a geometric
series of all payments made. For example, a 5-year installment loan repaid monthly would
require 60 separate calculations to arrive at the payment amount. Fortunately, this impractical
method is not necessary. The monthly payment can be calculated quickly and easily using a
financial calculator.

Antoine Landry borrows $15,000 at 10% (0.8333% monthly) to buy a new car.
The term of the loan is 5 years (60 months).

The monthly loan payment is $319, calculated as follows:

Key Touch Display

15,000 PV $15,000
60 N 60 Months
0.8333 I 0.8333%
-0 FV -0
-319 (Rounded)

The monthly amount of $319 is a fixed-rate, level payment. One portion of the payment
reduces the principal balance and the other portion covers interest costs.

The first month’s interest amount comes to $125 (calculated as $15,000 × 0.008333);
the second month’s interest amount is $123 (calculated as $14,806 × 0.008333); and
so forth.

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4•4 Section 4: Cost of Borrowing

Module 1 — Consumer Credit Advice

The table below details each month’s principal payment, and the respective interest
due during the first 3 months and the last 3 months of the payment period.

Payment Schedule
Monthly Outstanding
Loan Monthly Monthly Principal Loan
Months Balance Payments Interest Paid Balance
1 $15,000 $319 $125 $194 $14,806
2 $14,806 $319 $123 $196 $14,610
3 $14,610 $319 $122 $197 $14,413
58 $840 $319 $8 $311 $629
59 $629 $319 $5 $314 $315
60 $315 $319 $3 $316 $0
Total $0 $19,140 $4,140 $15,000 $0

Total interest paid on the loan is $4,140 (calculated as 19,140 – $15,000 = 4,140).

© CSI Global Education Inc. (2013)

Section 4: Cost of Borrowing 4•5

Module 1 — Consumer Credit Advice

Calculate the Costs of Borrowing

Reduce the Cost of Borrowing
Under the Bank Act, you must disclose the full cost of interest under the terms of a loan, and
you must inform clients of their option to prepay.

With clients who object to the cost of borrowing, or simply in the interest of building good
client relationships, it’s a good idea to explain in detail how prepayment options work. You can
use several scenarios to demonstrate how to save money by paying off credit as quickly as
possible.

The following are various ways to pay credit down faster:

Shorten the term of the credit
Repay the credit on an accelerated bi-weekly schedule
Make annual lump sum payments on the principal
Round up monthly payments
Make small payments whenever possible

By shortening the term of the credit (for example, by taking a 4-year loan rather than a 5-year
loan) clients make larger payments over a shorter period, and the overall cost of credit is lower.

An accelerated bi-weekly schedule breaks the 12 monthly payments into 24 bi-weekly

payments, and adds two extra payments of the same size. In this way, clients make the
equivalent of 13 monthly payments each year rather than 12.

When clients make lump sum payments, round up to pay a higher monthly amount or make
frequent small payments, the extra payment amount goes directly toward the principal. This
lowers interest costs by shortening the length of time it takes to repay the principal.

© CSI Global Education Inc. (2013)

4•6 Section 4: Cost of Borrowing

Module 1 — Consumer Credit Advice

Joan Algernon borrows $30,000 at a fixed interest rate of 9% for a 5-year term, with
blended monthly payments of $622.75. Joan’s advisor, Bruno Sarto, recommends that
Joan round up her monthly payments to pay down the credit faster. Joan decides to
round up her monthly payments of $622.75 to $700, with the extra 77.25 going directly
toward the principal.

Joan’s payments for the first five months under a regular payment schedule is shown
below:

Date Payment Interest Principal Balance

August 1 N/A N/A N/A $30,000.00
September 1 $622.75 $229.31 $393.44 $29,606.56
October 1 $622.75 $218.44 $404.31 $29,202.25
November 1 $622.75 $222.04 $400.71 $28,801.54
December 1 $622.75 $211.34 $411.41 $28,390.13
Total paid: $881.13 $1,609.87

Her new payment schedule for the first five months, with payments rounded up to
$700.00, is shown below:

Date Payment Interest Principal Balance

August 1 N/A N/A N/A $30,000.00
September 1 $700.00 $229.31 $470.69 $29,529.31
October 1 $700.00 $218.44 $481.56 $29,047.75
November 1 $700.00 $222.04 $477.96 $28,569.79
December 1 $700.00 $211.34 $488.66 $28,081.13
Total paid: $881.13 $1,918.87

At this rate of payment, Joan will make 52 payments over four years and four months.
The total cost of interest on this schedule will be $6,400 (52 x $700 – $30,000).

Under a regular payment schedule (60 payments of $622.75), Joan would pay $7,365
in interest. By rounding up her payments to $700, Joan will save $965.

© CSI Global Education Inc. (2013)

Section 4: Cost of Borrowing 4•7

Module 1 — Consumer Credit Advice

Recommend Credit Products

Collateral and Documentation
Various types of collateral are taken as security on credit to meet the various needs of clients.
As part of the approval process, you must determine the form of collateral your client will use
and clearly explain the details.
It is vital that clients understand the terms under which they must forfeit an asset that is put up
for collateral. A good advisor does not rush this conversation, but takes the necessary time to
ensure that the client is fully informed.
You should convey that collateral reduces risk, which in turn can reduce rate of interest. By
encouraging a client to secure a loan, you have reduced the risk for the lender and can save
the client interest costs.

Roberto Prima has determined that his client Irfan Bandali qualifies for a $10,000
consumer loan to renovate his kitchen. Roberto explains to Irfan that the loan will
be secured by a mutual fund that Irfan considers to be a long term investment. Irfan
is relieved that his credit application has been approved, and he smiles and nods in
agreement.

Roberto knows that his client is not completely fluent in English. He wants to be certain
that Irfan understands the terms of the agreement. Roberto explains, “If you miss
payments on the loan, you will lose your mutual fund investment.” Irfan considers
carefully and replies, “Yes, I understand. If I don’t pay back what I owe, the bank will
cash in my mutual fund and repay themselves.”

Roberto grins. “That’s right!” he says. “If you’re okay with that, then let’s proceed.”

Acceptable Collateral and Documentation

The various types of acceptable collateral and documentation are described below.

Promissory Note
A promissory note, which is a signed promise to pay, is a form of documentation that is required
for all consumer credit. When security is pledged, it is collateral to the promissory note.
The simplest type of credit is given on the client’s signature alone, without any other security.
The promissory note may be kept on a demand or installment basis. Unless the applicant has
substantial income and assets, such as real estate or investments, this type of credit is usually
for a small amount.

Chattel Charge
When moveable property (such as cars, equipment or boats) is taken as security, a chattel
charge (or chattel mortgage) is registered in addition to a promissory note. (The term for such a
charge on property other than real estate may differ from one province to the next.)
You must assess the value of this type of security to accept it as collateral. Adequate insurance
must be placed on all chattels, with loss payable to the institution. If a claim is filed due to a
loss incurred, the insurance proceeds are directed to the institution and applied against the
client’s debt.

© CSI Global Education Inc. (2013)

Section 5: Finalizing the Offer 5•1

Module 1 — Consumer Credit Advice

Negotiable Instruments
Negotiable instruments such as Guaranteed Investment Certificates (GIC), Canada Savings
Bonds and savings accounts, as long as they are not registered, are relatively liquid assets that
normally do not fluctuate in value. Credit backed with this type of security usually qualifies for
the best rates. This type of security renders the credit nearly risk free.

Documentation obtained for negotiable instruments, in addition to a promissory note, may

include a hypothecation pledging the asset as security for the loan, as well as specific
assignment forms.

Real Property
When real property is pledged as security, a collateral mortgage is the document obtained in
addition to a promissory note. The collateral mortgage places a lien (or charge) against the
property, and is registered at the Land Titles/Registry office.

Assignments
Credit may be secured by assigning an interest in something of value that is legally assignable.
Examples include a life insurance policy with cash surrender value, an inheritance or the
proceeds from the sale of a home. Specific assignment forms are used in addition to a
promissory note.

Assets that are not acceptable as Collateral

Government-registered assets such as Registered Retirement Savings Plans (RRSP) and
Registered Retirement Income Funds (RRIF) cannot be pledged as collateral on credit
applications. Assets registered with the government are protected by the government, and
financial institutions are not permitted to accept them as security. This is because, unlike other
assets such as cars or boats, a financial institution cannot legally repossess an RRSP or force
the owner to cash it.

A good advisor does not rush the client through the documentation process. It is vital
that the client understand all the terms and conditions of the credit agreement.

© CSI Global Education Inc. (2013)

5•2 Section 5: Finalizing the Offer

Module 1 — Consumer Credit Advice

Recommend Credit Products

Presenting the Offer
Once the client’s application for credit is approved, it’s time to present the offer. The
presentation should take the form of a friendly conversation between you and your client. The
purpose of the conversation is to present the options, make recommendations and provide
information regarding all aspects of the credit agreement. You also need to help set up and
organize the client’s accounts to ensure a smooth process.

The six steps to effectively present the offer are outlined below.

Steps to Present the Offer

1. Convey the message.
Congratulate the client on receiving approval on the credit application.

2. Make a recommendation.
Determine the best solution based on the client’s circumstances. What is good for one
client is not necessarily good for another.
Clearly explain why your recommendation is the best solution.

Mary Ogden’s client Harold Kristen is approved for $15,000 of credit. Harold would
like to borrow $8,000 to do some home repairs. Mary knows that Harold is a careful
spender.

Mary says, “Have you considered a line of credit? I think this is the best solution for
you, because you can borrow what you need and pay it back on your own terms. Then,
say an appliance breaks or another need arises, you will have quick access to funds.
You won’t have to go through the approval process a second time.”

Another client, Brent James, always carries a full balance on his credit cards. Mary
knows he’s a heavy spender and therefore not a good candidate for a line of credit. She
recommends a consumer loan instead, because it would make it easier for Brent to
stay on a disciplined schedule of repayment.

3. Explain the features and benefits.

Explain in detail how the credit product works.
Give the client real-life examples of how to use it. Explain, for example, how a low-
interest line of credit can be used to pay down the balance on a high-interest credit card.
Explain prepayment options in detail, including lump-sum payments and accelerated
payment schedules.

4. Explain the cost of borrowing.

Calculate the cost of different options, including different credit amounts and different
repayment schedules.
Give the client specific dollar figures. Explain exactly how much the monthly payment will
be with each option.

© CSI Global Education Inc. (2013)

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Module 1 — Consumer Credit Advice

Never make assumptions about the client’s level of knowledge. Explain everything in
detail to make sure the client understands all aspects of the cost of borrowing.
Where the effective annual percentage rate differs from the annual interest rate, you
must disclose the fact and explain the reason for the difference.

5. Look for opportunities to add value.

Look for cross-selling opportunities, such as opening an RRSP account along with a
consolidation loan to encourage savings.
Look for up-selling opportunities, such as offering a credit card with rewards points
rather than a no-fee card.
Suggest that clients move all their accounts to your institution for convenience—but do
not make it a condition!

6. Implement the solution.

Help your client organize his or her accounts so that they operate more efficiently.

Mary Ogden sets up a direct deposit savings account for Brent James so that his
bi‑weekly pay cheque is deposited automatically. She then links Brent’s bi-weekly loan
payments to the same account, so that the payments come out on the same day that
the pay cheque is deposited. This helps to provide the discipline that Brent needs to
meet his repayment schedule.

© CSI Global Education Inc. (2013)

5•4 Section 5: Finalizing the Offer

Module 1 — Consumer Credit Advice

Recommend Credit Products

Deferred or Declined Offers
In some cases, a client’s application for credit may be deferred, pending further review. In other
cases, the application may be declined outright. In either case, it is important that you know
how to communicate the message to your clients in a positive way.

When the Credit Application Is Deferred

When an application is deferred, you must provide the reasons and explain to the client what is
required for acceptance. Usually, this means that the institution is willing to work with the client,
but there is a significant problem with the application that must first be resolved. The problem
generally falls under one of two categories—there is not enough information, or there is an
obstacle to overcome.

The first problem is generally more easily rectified than the second.

In the first case, the client must provide additional information to the underwriter to gain
approval. For example, your institution may require written documentation, such as proof of
assets or employment, to support claims. This may consist of a car’s registration information or
a letter from the client’s employer confirming the client’s permanent and full-time employment.

In the second case, the client must overcome a bigger obstacle than an information gap before
the application is approved. The credit bureau may require an action that cannot be performed
quickly or easily. For example, the client may have little or no credit history, or their credit record
may show an outstanding debt that must be repaid.

Whatever the reason for the deferral, your role is to determine if you can help the client resolve
the problem. If there is a barrier that prevents approval, you may be able to provide them with
options to overcome that barrier.

Charles Ng’s client Ling Han recently separated from her husband, who had been
paying all the household bills under his own name. Ling’s application for a credit card
has been deferred because she has no credit history.

Charles advises Ling to apply to the bank for a credit card with a $500 limit, secured by
a $500 GIC.

The bank decides to approve Ling’s card. Under Charles’ advice, she uses it regularly
and makes her payments on time.

After a year of faithful payments, the institution releases Ling’s GIC. Depending on the
institution’s policies and on other factors affecting Ling’s credit, her limit may continue
at $500 but no longer secured by her GIC, or it may even increase.

As time goes on and Ling’s creditworthiness continues to increase, the limit on her
credit card will also increase. She may also eventually qualify for other types of credit.

© CSI Global Education Inc. (2013)

Section 5: Finalizing the Offer 5•5

Module 1 — Consumer Credit Advice

When the Credit Application Is Declined

In some cases, the client’s credit application is declined altogether because the client
represents too high a risk for the institution. The reason may be too low an income, too little net
worth or a poor credit report.

When the application is declined, you should convey the message in a positive light. You don’t
need to be too blunt or too specific.

Instead of saying: Say:

“You don’t make enough money,” “You don’t qualify right now, but that doesn’t
mean you won’t qualify in the future.”
“Your credit score was too low,” “It’s a good idea to contact the credit bureau
to ask for a copy of your credit report and
discuss ways to rebuild your credit.”

You should also present options and offer recommendations to help the client regain good
credit and build net worth. Your ability to coach clients through the necessary actions to
improve their credit score will mean the difference between their eventual success or failure.

Disagreements
Clients sometimes dispute the accuracy or fairness of their credit bureau report. Clients who
suspect that there is an error in the report should contact the credit bureau directly. They
should also contact any institution that may have provided the bureau with false or outdated
information. Credit bureaus are usually very prompt in helping consumers to correct false
reports.

Your financial institution, on the other hand, is not in a position to make adjustments. Most
institutions will not issue copies or provide specific details of reports to their clients.

In rare cases, a rejected application may be appealed based on circumstances. A client may
have had a temporary, unavoidable setback that had a negative impact on the credit report. You
should examine the reason for the setback and the client’s handling of the circumstances. If you
are satisfied that the client has made every attempt to maintain a good credit record, you may
recommend an appeal.

For example, a client who was off work due to illness should have made arrangements with the
bank to reduce mortgage payment to interest-only for the duration of illness.

Document the reason for delinquency, then send the application back to the underwriter for
review in light of the client’s situation.

© CSI Global Education Inc. (2013)

5•6 Section 5: Finalizing the Offer

Module 1 — Consumer Credit Advice

How to Effectively Communicate a Credit Decline Message

Tell the client why the application was declined.

Recommend that the client contact the credit bureau to gain a better understanding
of why they were denied.
Provide the client with options:
‒ “Can you find a guarantor?”
‒ “Can you make adjustments to re-establish your credit?”
Help the client devise a plan of action to regain good credit and establish net worth:
‒ Analyze cash flow.
‒ Create a budget plan.
‒ Close down all credit cards but one.
‒ Reduce the spending limit on the remaining card to $1,000.
‒ Keep the credit card balance as low as possible.
‒ Never go over your credit limit.
‒ Pay at least the required minimum amount on the due date of your bills.
‒ Pay down debt more aggressively, if possible.
‒ Link credit payments to payroll deposits to impose discipline.
‒ Establish a savings plan to build net worth.
‒ Do not make multiple credit applications.
Tell the client to avoid companies that offer to fix a bad credit score for a fee.
A good credit report cannot be bought!

Charles Ng recommends to clients whose applications have been declined that they
regularly deposit a small portion of their pay cheques into a registered savings plan,
such as an RRSP or a TFSA. He tells them that even a small amount, such as $25 per
month, will help build assets. More importantly, it shows that his clients have a record
of savings when they reapply for credit.

© CSI Global Education Inc. (2013)

Section 5: Finalizing the Offer 5•7

Module 1 — Consumer Credit Advice

Recommend Credit Products

Guarantors and Co-Borrowers

Guarantors
Credit is usually extended on the strength of the personal qualifications of the applicant and the
available security. However, in some circumstances, a personal guarantee must be provided to
support the credit. In these cases, the client will require a guarantor.

A guarantor is used when the client is generally an acceptable risk but requires additional
support because of a lack of collateral. The guarantor’s role is not to strengthen an application
for a client who has a poor credit record, excessive debts or questionable character.

The guarantor receives no benefit from the credit, but will be liable for the full amount if the
client defaults. A guarantor can only be called upon to repay the credit if the borrower defaults.

Depending on the institution’s policy and the credit amount, the guarantor may be required to
receive independent legal advice before credit will be extended.

It is important to verify the creditworthiness and good character of a guarantor who signs the
guarantee for the full amount of the credit outstanding up to a maximum of the original amount.
Sometimes, a guarantor will object to repaying the credit when called on to do so. Before
advancing the credit, you should carefully explain the implications of guaranteeing credit. This
ensures that the guarantor fully understands the obligation. It also provides him or her with the
opportunity to withdraw support.

Joseph Stein is guaranteeing credit to purchase a car for his son Roger. The funds will
be advanced to Roger, and Joseph will receive no benefit. However, he will be 100%
liable and responsible for repaying the borrowed funds if Roger defaults on payment.

Joseph’s advisor Theresa Kane explains this obligation very clearly to Joseph. She will
not submit the application for approval until she is certain that Joseph understands his
obligation. She tells him that he still has time to change his mind, but Joseph lets her
know that he agrees with the terms of the transaction.

Co-borrowers
Co-borrowers are equal partners in a credit arrangement. With a borrower-and-guarantor
arrangement, only the borrower receives the benefit of credit, although the guarantor is
ultimately responsible for repayment. When co-borrowers enter a credit arrangement, they both
receive the benefit of credit, and they are jointly responsible for repayment. If either co-borrower
defaults, the other can be pursued for the full amount.

To determine whether a client is a co-borrower or a guarantor, you must establish whether

the client is receiving a benefit from the credit. There must be a benefit to each co-borrower;
otherwise, the one receiving no benefit is a guarantor.

© CSI Global Education Inc. (2013)

5•8 Section 5: Finalizing the Offer

Module 1 — Consumer Credit Advice

Jon and Lana Dzurka wish to take out a consolidation loan of $55,000 as co-
borrowers. They plan to use the funds to pay off Lana’s credit card debt. Theresa Kane,
their advisor, explains that Jon cannot be a co-borrower unless he receives a benefit
from the credit. She also explains that if Jon acts as a guarantor on a credit amount
over $50,000, the institution will require that he get independent legal advice.

Theresa suggests that Jon should use part of the consolidation loan to pay off some of
his own debt. That way, he will receive a benefit from the transaction. Jon chooses to
pay $3,000 of credit card debt, so that he can be co-borrower rather than guarantor.

© CSI Global Education Inc. (2013)

Section 5: Finalizing the Offer 5•9

Module 1 — Consumer Credit Advice

Recommend Credit Products

Independent Legal Advice
When a client applying for credit has little security, a second party will sometimes provide a
guarantee that the credit will be repaid. The second party (the guarantor) receives no benefit
from the transaction but is fully responsible for repayment.

In this situation, you must make sure that the guarantor fully understands the consequences
if the client defaults on the credit. Otherwise, the guarantor might later deny any obligation to
repay the credit on the grounds that the obligation was not made clear. If such a dispute arises
between a guarantor and the institution, the institution will likely lose the claim.

To protect against this risk, independent legal advice is recommended, and sometimes
required, for a second party who guarantees credit. A lawyer at arm’s length from the
transaction can explain the implications to the guarantor without compromising the other parties
involved. This provides legal protection for the institution in case the guarantor later challenges
the obligation for repayment. It also ensures that the guarantor understands the terms of the
transaction and is not unduly influenced by any other party.

Each financial institution sets its own guidelines and requirements regarding independent legal
advice. When a large amount of credit is guaranteed by a party who will receive no benefit,
independent legal advice is almost always required.

Anna Herrera’s clients Juan and Lucy Borges wish to provide their home as collateral
security for their son Miguel. Miguel is seeking credit to start a business. Anna explains
that, if Miguel’s business fails, his parents may be forced to sell their home to pay off
the debt. Before she will submit the application, Anna tells Juan and Lucy that they
must get independent legal advice from a lawyer who can objectively explain the
implications of the transaction.

Anna requests that the lawyer provide a statement of independent legal advice
confirming that all risks and conditions having impact on the Borges have been
discussed. The statement provides the lawyer’s guarantee that the Borges understand
those risks. The statement is kept in Anna’s file and becomes part of the security
documentation for the credit.

© CSI Global Education Inc. (2013)

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Module 1 — Consumer Credit Advice

Legislation and Compliance

Consumer Credit Regulations
Advisors working at Canadian institutions must be authorized by law to provide credit. They
must also conform to the various regulations that govern the financial services industry.
Financial institutions in Canada are regulated at the federal level and also under provincial
Consumer Protection Acts.

Institutions that provide consumer credit must be familiar with applicable portions of the various
acts that regulate consumer credit. Generally, all requirements are addressed in your financial
institution’s policies and procedures. Requirements for each product are typically addressed in
a document called a lending folio that is specific to the product.

In most institutions, compliance training in some areas of consumer credit regulation is

mandatory. In other areas, your financial institution’s legal department may be able to provide
the necessary information regarding legislation and regulations that apply to your institution.

The Bank Act

Cost of Borrowing Regulations under the Bank Act were created to address consumer concerns
that they weren’t getting enough information from their financial institutions about the cost
of borrowing money. The federal government determined that federally regulated financial
institutions must disclose the full cost of borrowing in language that is easy to understand and
not misleading.

Interest Costs
The act states that the effective annual percentage rate (APR) must be stated if it differs from
the annual interest rate, along with an explanation of how it is determined. Unlike an annual
interest rate, which is the rate before other fees and charges are taken into account, the
effective APR also includes all non-interest charges levied by the institution. Disclosing the
effective APR makes it easier for consumers to evaluate the true cost of credit and to compare
the cost among various institutions.

If Lily Sung borrowed $10,000 at an annual interest rate of 7% for a 3-year term, her
monthly payment would be $308.77. She would pay a total of $11,115.75. The interest
portion is $1,115.75 (calculated as 7% of $10,000 over three years).

However, if Lily pays $500 in administrative fees, that amount is added to the borrowed
amount, and the payment and interest are then based on $10,500. She will pay $324.
21 per month, for a total of $11,671.54. The interest portion is $1,171.54 (calculated as
10.33% of $10,000 over three years).

Therefore, the annual percentage rate, is 10.33%, which is 3.33% higher than the
annual interest rate of 7%.

© CSI Global Education Inc. (2013)

Section 6: Legal Issues 6•1

Module 1 — Consumer Credit Advice

Prepayment Options and Costs

The Bank Act stipulates that you must do the following regarding prepayment options and costs:
Explain to clients the total cost of interest under the given terms of credit
Inform clients of their option to reduce this amount by making prepayments
Disclose penalties, if any, that are triggered by prepayment

The Bank Act gives clients the right to prepay fixed loans, other than mortgages, without
penalty.

Other Costs
Other costs that must be disclosed in the cost of borrowing include the following:
Non-interest charges, such as:
‒ Administrative fees
‒ Insurance costs,
‒ Fees for appraisals
‒ Legal fees
Fees for document preparation and document registration
Changes to borrowing costs, due to both customer-initiated changes and changes in lending
rates
Ongoing costs over the life of the credit
The effect of penalty fees, such non-sufficient funds (NSF) fees on loan payments

Other Federal Acts

Other federal acts that apply to the financial services industry in Canada are described below.

Criminal Code of Canada (Section 347)

The Criminal Code of Canada (Section 347) provides a definition for what constitutes a criminal
rate of interest on credit (an effective annual rate that exceeds 60% a year). It further defines
“interest” as the aggregate of all fees, fines, penalties, commissions or other expenses.

Competition Act
The Competition Act protects consumers from restrictive or coercive selling practices. One
coercive practice that is particularly relevant to consumer credit is tied selling. This occurs when
an institution or its representative agrees to provide a product or service to a client only on the
condition that they purchase another product or service from the same institution. For example,
you cannot tell clients that you will process their credit application only if they agree to transfer
their mortgage or other product from another institution.

© CSI Global Education Inc. (2013)

6•2 Section 6: Legal Issues

Module 1 — Consumer Credit Advice

Canadian Human Rights Act

The Canadian Human Rights Act prohibits discriminatory practices by suppliers of goods and
services. In the context of financial services, this means that you must base your clients’ credit
assessment solely on factors such as their income, net worth, credit history and job stability.
You cannot refuse to provide credit to clients because of their race, religion, age, gender or
marital status.

An exemption to this act that is pertinent to insurance allows distinctions to be made based on
age and disability under certain conditions.

Bankruptcy and Insolvency Act

The Bankruptcy and Insolvency Act establishes regulations to ensure bankruptcies are carried
out in a fair manner and that assets are distributed appropriately. Most importantly for the client,
it requires that first-time bankruptcies must be discharged after two years, at which point credit
can be re-established and the client is considered free of debts. First-time bankruptcies may be
discharged as early as nine months after the date of bankruptcy. The Act requires that first-time
bankruptcies be discharged after two years unless the bankruptcy is opposed.

Personal Information and Electronic Documents Act

The Personal Information and Electronic Documents Act (PIPEDA) was established to provide
regulatory guidelines regarding collection, distribution and retention of personal information of
consumers.

© CSI Global Education Inc. (2013)

Section 6: Legal Issues 6•3

Module 1 — Consumer Credit Advice

Legislation and Compliance

Privacy

Personal Information Protection and Electronic documents Act

The Personal Information Protection and Electronic Documents Act (PIPEDA) establishes
rules for the protection of personal information. PIPEDA provides guidelines for collection, use
and disclosure of personal information by federally regulated financial institutions and other
industries. Virtually all financial institutions require their employees to take courses in PIPEDA
compliance.

The general information provided by PIPEDA includes the following guidelines:

Gain your clients’ written consent to collect, use, retain or disclose their information.
Keep necessary client information accurate, complete and up to date.
Retain information only as long as you need it, for the purpose for which you collected it.
If you need to use a client’s information for a purpose other than that which was authorized
by the client, you must apply to the client again for permission.
Use safeguards to protect client information from unauthorized use.
Never share client information with any other person unnecessarily.
Respect Do No Solicit designations on client files.

Specific PIPEDA guidelines relating to the use and disclosure of personal information are
described below.

The Use of Personal Information

Personal information is collected for the following purposes:
To establish and maintain a relationship with clients
To offer and provide products and services as permitted by law
To comply with the law
To protect the client’s interest
To protect the financial institution’s interest

If you wish to use personal information for a purpose other than the original reason it was
collected, you must obtain your client’s consent.

Third Party Disclosure

Your client’s personal information may be disclosed to a third party only under the following
circumstances:

Your client has consented to the disclosure.

Your institution is legally obliged to disclose the information through a subpoena or search
warrant.
Your institution has a public duty to disclose the information to prevent fraud or crime.
Your institution is required to do so in response to litigation, to protect its own interests.

© CSI Global Education Inc. (2013)

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Client Access to Information

Clients have the right to obtain confirmation that the financial institution has personal
information about them. They also have a right to access this information, with the following
exceptions:
Opinions
Judgments
Calculated information such as credit scores

If a client specifically requests it, the financial institution must provide information in an
alternative format, such as Braille or audiotape, if it is available or reasonable to obtain.

Clients may challenge the accuracy and completeness of their personal information. Incorrect
or incomplete information must be amended. However, if the client questions or refutes the
information provided by the credit bureau, refer them directly to the bureau to resolve any
dispute. Your institution pays the credit bureau for access to the client’s credit bureau report.
It does not own the information and cannot make any changes to the report.

Client Complaints
Each financial institution has procedures for handling client complaints. Each major financial
institution has established an internal ombudsman to investigate complaints, report findings and
mediate settlements. The complaint process should be used first to resolve any problems.

In addition, the federal government has established the Canadian Financial Services
Ombudsman (CFSO). The CFSO deals with complaints that have not been resolved to the
satisfaction of customers under an organization’s internal dispute resolution process.

Clients who are dissatisfied with the manner in which a complaint has been handled by the
financial institution may then contact the Office of the Superintendent of Financial Institutions
(OSFI) for assistance.

As an ombudsman service, the CFSO can only make recommendations. It cannot make orders
that are binding on the parties. A client who is dissatisfied with the CFSO process, however,
may seek redress through the courts.

Additional information relevant to this topic can be found at [Link]

© CSI Global Education Inc. (2013)

Section 6: Legal Issues 6•5

Module 1 — Consumer Credit Advice

Minimizing Risk of Default

Delinquency
Delinquency will inevitably occur in every credit portfolio. It may result from any of the following:
Accident or illness
Temporary or permanent loss of job
Poor management of personal finances
A negative attitude toward the institution that granted credit

It is important that you learn to recognize the early warning signs of delinquency and take
immediate action to address it.

Early Warning Signs of Delinquency

Warning signs that indicate a potential delinquency include the following:
The client requires constant reminders that payment is due.
Payments are always later than the due date.
The client does not make payments as promised.
The client requests extensions or asks to make partial payments.

Reasons for Delinquency

The most common reasons for default on debt are inability to repay and unwillingness to repay.
Clients who have incurred excessive debt are most at risk of being unable or unwilling to repay,
and are therefore most likely to fall into delinquency.

In our society, we increasingly use credit, rather than cash, to buy goods and services. Our
economy encourages and rewards impulse purchases. This has not only contributed to
increasing demands for economic growth, but has also led some people to take on more debt
than they can afford. Many consumers fail to consider the overall debt load they are assuming
and their ability to make future payments. Many of those who recklessly assume excessive debt
will default.

Others become indebted beyond their means through circumstances such as illness, strikes or
unemployment. Often, savings are not enough to withstand such an emergency, and clients are
forced to buy on credit that they are unable to repay.

In some cases, clients who do have the ability to repay are simply unwilling to do so.

Remedies for Excessive Debt

Clients who are unable to work out a plan to repay excessive debt are at risk of having their
assets repossessed by creditors. If the situation deteriorates, these clients may become
insolvent and eventually bankrupt.

However, before reaching that stage, there are two remedies to alleviate excessive debt and
repair credit: negotiation with creditors and debt consolidation. Each of these remedies is
described below.

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Negotiation with Creditors

In most cases, the creditor wants the borrower to be in a position to repay credit. Most
institutions are willing to renegotiate the terms of credit to make it easier for the client to repay.
Ideally, clients at risk of default will inform the institution of the situation before it becomes
unmanageable, so that a solution can be negotiated.

Debt Consolidation
A consolidation loan can be used to pay numerous creditors when the client cannot maintain
repayment of multiple loans. If the reason for excessive debt was temporary, such as
unemployment, debt consolidation might be the right remedy. However, borrowing money to pay
other creditors is risky.

A consolidation loan often costs the client more over the long term. The credit may be for
a longer period or the interest rate may be higher than the overall terms or rates of the
consolidated debt. In addition, the consolidation loan can be the beginning of a vicious circle
that can be difficult to escape. New, smaller payments may entice some clients to incur even
more debt.

A solid credit assessment is necessary to determine if a consolidation loan is the right solution
for the client and for the institution. Additional security may be required to obtain such a loan.

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Minimizing Risk of Default

Debt Collection
When risk of default on a client’s credit reaches an unacceptable level, the client’s account is
typically referred to debt collection. This may be an internal department of your institution or an
independent agency.

Debt collection is not a desirable outcome for the institution. Revenue generated by the interest
collected will not compensate the financial institution for any of the following:

Personal time devoted to the collection function

Lost opportunities to develop new business because of time and effort diverted to the
collection process
Write-off of principal

Ideally, your interviewing and investigation skills will be sound enough that none of your clients’
accounts will ever go to debt collection. However, such situations do sometimes develop. And
while it is unlikely that your institution will require you, personally, to collect on debt in such a
situation, you should understand the process.

Methods of Collection
Most institutions have similar objectives and methods of debt collection, and all are bound by
the same legal restrictions. These are described below.

Objectives
The two objectives of collection are listed below, in order of importance:
1. To avoid loss for the financial institution
2. To preserve a good relationship with the client

Methods
The two primary methods for contacting the clients for overdue payments are as follows:
Correspondence
Telephone
Correspondence

This method is normally used for clients who have missed a payment. It is sent within seven
days of the overdue payment. The letter is used as a reminder and informs the client of
the payment details. In most cases, the client simply lost track of upcoming payments, and
the letter will trigger payment. However, this method may not produce results if the client is
experiencing problems.

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Telephone
The telephone call is one of the quickest and most effective ways to collect a late payment.

The call must never entail threats or derogatory statements. It consists of the following tasks:
Determine why the payment has not been made
Review the client’s situation
Recommend solutions suitable for both the client and the institution
Receive acknowledgement that the client understands and will follow through with the
solutions

Legal Restrictions
Each province and territory in Canada has its own legislation regarding debt collection.
However, laws are more or less similar across the country. They are designed to allow lenders
to collect money that is owed to them in a way that respects the rights of borrowers.

Typically, legislation allows debt collectors to use reasonable means to collect, but it requires
that they refrain from any of the following activities:
Threaten, use profanity or verbally abuse clients
Cause distress or humiliation to clients or their family members
Talk to a client’s employer without permission (except to confirm employment)
Harass clients with frequent calls
Mislead clients with documents made to look like official court documents
Make any kind of charge that is unrelated to collection of the debt

Four Steps to Effective Collection

1. Recognize the situation
Watch for early warning signs indicating that the client is experiencing difficulty. Is an
investigation is warranted?

2. Investigate the situation

Determine the nature of the problem. Is the situation is severe or temporary?
Short-term lapses may require that the client be reminded of the terms of the credit.
More serious problems, such as a loss of employment, may require a full review,
investigation and assessment.

3. Reach a satisfactory arrangement

If the situation is relatively straightforward, there may be no need to develop an action
plan with the client.

However, when the delinquency is expected to continue over the long term, you
must develop a plan, and the client must agree to it. The value of collateral becomes
apparent in this situation. It not only affords protection; it also induces the client to
agree to the arrangements.

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Additional security in this situation is a priority requirement. Prompt acquisition of the

security reduces credit risk and places the financial institution in a better position to
withstand any additional adverse developments.

4. Follow up after implementation

Following the negotiations with the client and the accepted arrangements, the action
plan should be implemented. Even the best-laid arrangements are inclined to go
astray if they not are consistently monitored.

The collector will follow up on any deviation from the expected arrangements. This
requires a clear understanding from the client about what will occur and when it will
occur, and a consistent and prompt follow-up program.

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Minimizing Risk of Default

Bankruptcy and Credit Counselling

Bankruptcy
Individuals who are unable to meet their obligations to creditors, and have debts due and
accruing that exceed the value of their assets, are considered insolvent. If they are insolvent
and voluntarily declare themselves bankrupt, or if creditors are successful in forcing them into
bankruptcy, they are declared legally bankrupt.

Bankruptcy is the legal process that halts all proceedings by creditors to collect certain debts.
Individuals who declare bankruptcy are no longer obliged to pay their unsecured debts, as long
as those debts qualify for discharge. However, they may lose ownership of major assets (such
as a car or a house) that were put up as security.

Debts that are not discharged by bankruptcy include the following:

Secured debt, such as a mortgage or car loan that is secured by the asset
Student loan debt that is less than 10 years old
Outstanding child or spousal support payments
Most court-ordered payments such as fines, restitution payments and damages for physical
or sexual assault
Some government overpayments

Bankruptcy will remain on the individual’s credit record for a period of six to seven years. When
the bankruptcy is removed from the record, the credit rating is reset to zero.

A person who declares bankruptcy for the first time is eligible for a discharge nine
months after declaring bankruptcy, provided certain conditions are met.

Most agreements for credit secured by an asset, such as a mortgage or a car loan, contain a
clause that allows the institution to repossess the asset in case of bankruptcy. In the case of
a mortgage on a property, it may also be possible for a municipality or utility company to put a
lien the property for unpaid bills or taxes, thus changing unsecured debt to secured debt.

However, the institution will not automatically seize the bankrupt person’s secured assets.
For example, a client who discharges unsecured debt through bankruptcy may be in a better
position to make their mortgage payments, in which case it would be more profitable for the
institution to hold onto the mortgage.

If the institution seizes and sells the property, any excess equity beyond what is owed to the
institution or other secured creditors is included in the bankrupt person’s estate and applied
toward unsecured debt.

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Clients considering bankruptcy, especially those who hold mortgages, should consult
a licensed bankruptcy trustee who can explain provincial bankruptcy exemptions and
their impact on home equity.

Advantages and Disadvantages of Bankruptcy

Advantages
The advantages of bankruptcy are as follows:
The client is protected from collection, legal action and garnishment of wages
Discharging unsecured debt may free up money to meet other obligations, such as
mortgage payments.

Disadvantages
The disadvantages of bankruptcy are as follows:
Future earnings or assets may be turned over to the supervision of a bankruptcy trustee for
disbursement to creditors.
Credit cannot be obtained until the bankrupt individual is discharged from bankruptcy.
Even after a discharge from bankruptcy, it may be difficult or impossible for the bankrupt
person to obtain credit or to be bonded for employment.

Alternatives to Bankruptcy
Two alternatives to bankruptcy are consumer proposals and credit counseling. Each alternative
is described in detail below.

Consumer Proposal
One alternative to bankruptcy is for the insolvent person to negotiate debt settlement with
creditors by proposing to repay a portion of the total unsecured debt. Under the Bankruptcy and
Insolvency Act of Canada, borrowers may make a consumer proposal to pay creditors over a
specified period (a maximum of five years) to reduce or eliminate indebtedness. A consumer
proposal is a workable solution for clients who can pay some, but not all, of their debts. They
will still be required to make monthly payments. However, the montly payment and the total
amount paid will most likely be lower than the current amounts.

A consumer proposal must include all of the individual’s unsecured debt, including personal
loans, but it cannot be used to reduce debts secured on a principal residence or other asset
(unless the person surrenders the asset). Debts such as child support and court fines cannot be
included in the proposal.

A borrower with liabilities of less than $75,000 (excluding debts) may make a consumer
proposal through a licensed bankruptcy trustee. The proposal must be submitted to creditors for
approval. If they accept the proposal, the plan is implemented. If they reject it, or if the individual
is unable to make payments, then bankruptcy may be the only course of action. Creditors are
frequently inclined to accept a consumer proposal over bankruptcy. They are likely to realize a
higher portion of the debt through a consumer proposal than through bankruptcy.

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A consumer proposal has a less severe impact on an individual’s credit rating than bankruptcy.
It brings the credit rating down to R-7 (instead of R-9) and will remain on the credit record for a
period of three years after the completed proposal.

Credit Counseling
In some cases, clients who have difficulty managing credit can avoid bankruptcy through
credit counseling. This is provided by credit counseling agencies, where debt management
consultants work directly with customers to help them put their finances in order. Good
candidates for credit counseling are people who have the ability to pay their debt, but whose
efforts may be daunted by high interest.

Credit counselors provide personal finance advice and budgeting tips to help their customers
improve their financial habits. They work with their customers to create a budget that includes
a manageable monthly amount to pay bills. In many cases, the credit counselor contacts the
customer’s creditors to negotiate a debt management plan that may reduce or freeze interest.
The customer typically makes a monthly payment to the agency, which then disperses it to
creditors. Credit counseling is usually provided free to customers, with expenses and fees
typically paid by the creditors in the form of a small percentage of the money collected.

Credit counselling will show a credit rating of R-7 and will remain on the individual’s credit
record for a period of three years.

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