Credit Basics
Credit is more than just a plastic card you use to buy things—it is your financial trustworthiness. Good credit means that your history of payments, employment and salary make you a good candidate for a loan, and creditors—those who lend money or services—will be more willing to work with you. Having good credit usually translates into lower payments and more ease in borrowing money. Bad credit, however, can be a big problem. It usually results from making payments late or borrowing too much money, and it means that you might have trouble getting a car loan, a credit card, a place to live and, sometimes, a job.
Americans living in debt has become very common over the past quarter century. In particular, credit card debt is reaching all time highs. In a period of large amounts of disposable income, it is vital that the consumer be informed and aware of their credit rights and know exactly how a credit card works.
To start simply, a credit card is not a symbol of endless financial possibility. Just like borrowing money from a friend, it is expected that it will be repaid in a timely fashion. All too often, people are not aware of how a credit card works, and before they know it, they find themselves in over their heads. The ability to buy what they want when they want blinds them to the fact that they will soon be expected to hand over the money for their recent acquisitions. Credit card companies try to appeal to the consumer's impulsive side by allowing them to make a minimum payment each month. This payment is usually a fraction of the total bill, and they then charge interest to the portion of the bill that was not paid off.
For example: if you buy a computer for $1,200, and make only the minimum monthly payment of $50, you then still owe $1,150. Then there is the interest. If your credit card interest rate is 15%, the next month you will still owe the $1,150 with an additional $172 in interest attached. This then exceeds the original cost of the computer. With a credit system like this, it is very easy to see why many people get pulled in and then need years to get themselves out.
There are three national credit-reporting agencies, Equifax, Experian and TransUnion. Your credit report from these agencies is free thanks to the Federal Trade Commission that ruled every American is entitled to a free credit report from each agency every 12 months. See www.annualcreditreport.com.
The FICO score, named after Fair Issac Corp., the firm that developed the scoring model back in the 1950’s, compares the information in your credit report to what’s on the credit reports of thousands of other customers.
FICO scores range from about 300 to 900. The higher the score, the better a credit risk you will be considered. The credit score is based on five factors: past payment history, outstanding debt, length of credit history, how much new credit has been sought recently and the types of credit.
Credit reports should be checked for any misinformation or outdated information. As a general rule, a negative report stays on the record for seven years, a bankruptcy for 10 years.
Potential lenders (including credit card companies) use your credit score to help predict whether you are a good risk to repay a loan and make payments on time.
Many people just starting out have no credit history and may find it tough to get a loan or credit card, but establishing a good credit history is not as difficult as it seems.
- You might apply for a credit card issued by a local store, because local businesses are more willing to extend credit to someone with no credit history. Once you establish a pattern of making your payments on time, major credit card issuers might be more willing to extend credit to you.
- You might apply for a secured credit card. Basically, this card requires you to put up the money first and then lets you borrow 50 to 100% of your account balance.
- You might ask other people who have an established credit history to co-sign on an account. By co-signing, the person is agreeing to pay back the loan if you don’t.