Credit is more than just a plastic card you use to buy things. It represents your financial trustworthiness. Your credit history can follow you for many years. So if you want to make a purchase using credit, it's important to understand how credit works.
Credit is simply the promise to pay for something over time instead of paying the full price in cash up front when making a purchase. Credit can come in the form of a credit card or a loan. Both credit cards and loans come with terms for repayment that specify when payment is to be made, what interest rate or Annual Percentage Rate will be associated with your payments, and what you monthly payment will be or how it will be calculated. When you borrow money from a lender, you usually will be charged interest.
Credit is issued on either a revolving basis or in installments. A revolving credit account comes with a credit limit – the maximum amount you can owe at any time. You must make the required minimum payment by the payment due date each month. Your available credit at any point in time becomes the difference between your credit limit and the total you owe. So if you have a $5,000 credit limit and you owe a balance of $800, your available credit (your amount available to use) is $4,200. An example of a revolving credit account is a credit card.
Credit in installments means that you borrow a set amount of money at one time and you make payments on a specific date and for a specific amount each month toward paying off the amount you borrowed plus any interest, fees and other charges. Once payments are complete, the installment loan account is closed. An example of an installment loan is a car loan.
Credit history is important because it is how lenders determine whether they will give you a loan or credit card and what sort of interest rate you will be charged.
With a good credit history lenders should see:
A poor credit history will reveal:
The impact of good or bad credit is not simply in being approved or denied for a loan or credit card.
Most people who have taken out a loan or credit card will have a credit report establishing the person's credit repayment history from at least one of these three credit reporting agencies:
These agencies collect information sent to them by creditors about your credit history. This information can include things like:
Your report details your personal history in these areas and assigns you a credit score that lenders and credit card companies use to evaluate your credit worthiness. In general terms, a credit score falls into these ranges:
As you build your credit history, your credit score increases or decreases based on your activity in applying for credit, using your credit and remitting payments.
It is a good idea, especially when applying for credit, to know what information currently appears on your credit report. You can obtain a copy of your credit report by contacting one or more credit reporting agencies. Each of these companies – Equifax, Experian, and TransUnion – is required to provide you with one free copy of your credit report once every 12 months.
However, do not contact them individually. They have set up a central website, toll free number, and mailing address at which you can order your free credit report:
Web: www.annualcreditreport.com
Mail: Annual Credit Report Request Service
PO Box 105281
Atlanta, GA 30348-5281
Getting started with credit may seem difficult but you can begin to build a credit history in several simple ways, such as:
Once you have established a strong credit profile, you can maintain your good standing by following these guidelines:
Credit is a useful financial tool when carefully managed. However, you should use caution to avoid specific credit traps and financial fraud that can be associated with making credit purchases.
Scenario 1 – Some creditors mass-market to individuals with the promise of account approval. However, the terms of repayment often include a low minimum payment with a high interest rate. If only the minimum monthly payment is made, the account balance can grow quickly because the minimum payment may not cover any of the actual balance from the purchases you've made. Additionally, the minimum payment may not cover all of the interest that is being charged for the monthly payment. The result is an account balance that grows quickly even though you may not be making additional purchases.
Example:
Scenario 2 – You might also be offered a deferred interest account. You will be charged no interest on purchases as long as you pay off your balance within the promotional period. However, if you do not, you will often be charged interest retroactively on all of your purchases at a high rate.
Example:
In all cases, use caution and read the terms and disclosures carefully before opening a credit account.
Using credit cards can make purchases easier but also comes with the risk of financial fraud such as identity theft. To avoid someone else using your name to obtain credit or simply using your card in an unauthorized way to make purchases, keep these precautions in mind:
FEDERAL TRADE COMMISSION
Phone: 877-382-4357
The FTC works for the consumer to prevent fraudulent, deceptive, and unfair business practices in the marketplace. You can file a complaint with the FTC or find free information on things like credit card practices and identity theft protection.
FREE ANNUAL CREDIT REPORT
Mail: Annual Credit Report Request Service
PO Box 105281
Atlanta, GA 30348-5281
You can obtain a copy of your credit report and score by contacting the credit reporting agencies. Each of these companies – Equifax, Experian, and TransUnion – is required to provide you with one free copy of your credit report once every 12 months.
CONSUMER FINANCIAL PROTECTION BUREAU
Phone: 855-411-2372
The Consumer Financial Protection Bureau works to give consumers the information they need to understand the terms of their agreements with financial companies. You can find more information on paying for college, owning a home, getting mortgage relief, or filing a complaint if you believe you have been the victim of discrimination in a lending situation.
Affordable Housing Program