Establishing credit

Managing credit

There are different ways to pay for goods and services, and at some point, you may need credit in your life. Very few people would ever buy a home, buy a car, start a business, or go to college without credit.
An important financial management skill is knowing how to handle credit and debt without blemishing your credit record.

What is credit?

Credit is a transaction in which the borrower receives goods, services or cash and agrees to repay the lender at a future date, normally with interest.
  • Credit enables people to obtain and use money that they do not currently have. DEBT is the amount you owe.
When someone is given credit in the form of a credit card or a bank loan, the lender will first assess your CREDITWORTHINESS . There is a trust that the person will pay back the money borrowed with interest in a timely manner.

What's in my credit report?

Annual Percentage Rate (APR)Some credit cards have APR’s as high as 20%. This means that a $200 pair of sneakers could actually cost you much more unless you pay the balance right away.
Annual FeeSome credit cards charge an annual fee just to use the card and some don’t. To save money, look for cards with annual fees.
Grace PeriodCredit card payments are due once per month, so there will be a period of time between when you use the card to make a purchase and when your payment on the credit card is due. During this time, no interest or finance charges will apply. The key is to pay off the entire balance of your card during the grace period, no later than the date that payment is due. If you don’t, a finance charge will be applied to the unpaid balance in your account. Twenty days is a typical grace period.
Credit LimitAll cards come with a limit establishing how much you can charge. If you reach your limit, your card is maxed out. Higher limits may sound good, but you need discipline to avoid running up big loan amounts.
Minimum PaymentMany cards require a minimum monthly payment of about 2% of your credit card balance. While making small payments like these may seem easy, remember that the remainder of your balance due is now compounding at the card’s APR. If you do decide to get a credit card pay your balance in full every month to avoid interest charges altogether.

Become familiar with the cost of credit cards

What does a lender expect in return for the use of borrowed money?
  • A bank that lends you money to buy a home expects the loan to be repaid on a payment schedule, paid on time, with interest and fees added in. That's why purchases bought on credit cost more due to interest charges and fees.
There is a downside to overusing credit, especially CREDIT CARDS .
  • Consumers might be tempted to overspend, committing too large a share of future earnings for debt repayment and risking a possible poor credit rating.
Credit card debt can be particularly dangerous because of its high interest rates and the low minimum payments allowed by credit card companies.
  • For example, if you owe $1000 on your credit card at 17% APR, it will take you 57 months to pay off your debt if you make the minimum allowable monthly payments (approximately $25 per month). In that time, you will have paid $451.55 in interest charges.
  • That’s why the best strategy for credit card debt is to make the biggest monthly payment you can handle and keep repeating that until the debt is gone.

Your credit report and credit score

Although each credit reporting agency formats and reports this information differently, all credit reports contain basically the same categories of information:
Identifying information
Your name, address, social security number, date of birth and employment information are used to identify you. These factors are not used in credit scoring. Updates to this information come from information you supply to lenders.
Trade lines
These are your credit accounts. Lenders report on each account you have established with them. They report the type of account (bankcard, auto loan, mortgage, etc.) the date you opened the account, your credit limit or loan amount, the account balance and your payment history.
Credit inquiries
When you apply for a loan, you authorize your lender to ask for a copy of your credit report. This is how inquiries appear on your credit report. The inquiries section contain a list of everyone who accessed your credit report within the last two years. The report you see lists both “voluntary” inquiries, spurred by your own requests for credit, and “involuntary” inquiries, such as when lenders order your report to make you a pre-approved credit offer in the mail.
Public record and collections
Credit reporting agencies also collect public record information from state and county courts, and information on overdue debt from collections agencies. Public record information includes bankruptcies, foreclosures, suits, wage garnishment, and liens.
Before a bank or other lending institution will make a loan or issue a credit card, they will want to know that the person borrowing money will repay it.
  • The lender will assess your creditworthiness will be based on your CREDIT REPORT and CREDIT SCORE .
Your credit report is a record of all your credit activities over several years. A poor credit report reflects on your creditworthiness.
  • There are three major U.S. agencies that operate credit-reporting businesses, Experian, Equifax, and TransUnion, that maintain and update the information about your use of credit on your credit reports.
  • These agencies sell your information to banks, mortgage companies, credit card companies, employers, department stores, small businesses, etc. Know your rights about how credit reporting agencies can use your information.
  • The consumer reporting agencies are required to provide every consumer with a free copy of his or her credit report, upon request, once every 12 months.
The information on your credit report is converted into your credit score.
  • Your credit score, commonly known as a FICO Score is a numeric value compiled from information in a credit report using a standardized formula that ranks the risk of a person defaulting on repayment per the person’s credit history.
People with good credit scores can obtain more favorable interest rates on credit cards and loans and subsequently pay less for the credit they use.
  • A poor credit score can mean a lack of credit opportunities or even the loss of a prospective job or rental opportunity.

Range of potential credit scores

    • Excellent/very good credit score: 700 to 850 70%
    • Good credit score: 680 to 699 (Average American score is 682)68%
    • Average/OK credit score: 620 to 67962%
    • Low credit score: 580 to 61958%
    • Poor credit score: 500 to 57950%

Tips for improving your credit score

  • Pay bills by the due date to demonstrate responsibility and reduce late payment fees.
  • Do not let charges approach card’s credit limit; i.e. Do not max out your credit cards.
  • Pay more than the minimum requirement, thereby reducing interest and fees.
  • Incur only charges that you can pay in full each month.
  • Do not use credit cards to pay monthly bills.
  • Have a long credit history to show you manage your credit over time.
  • Having a mix of credit types demonstrates you can manage different kinds of credit.
  • Don't stop using your card; make a few small purchases and pay them off each month.
  • Don't apply for many credit cards during short time period.
  • Avoid cash advances.
  • Monitor your credit to ensure accuracy or fraud like identity theft.

Establishing credit

Building credit can be tricky. If you don’t have a credit history, it’s hard to get a loan, a credit card or even an apartment. But how are you supposed to show a history of responsible repayment if no one will give you credit in the first place?
To have a FICO score, for example, you need at least one account that’s been open six months or longer, and you need at least one creditor reporting your activity to the credit bureaus in the last six months.

Tips for establishing a credit history

  • Secured credit cards — A secured credit card is a type of credit card that is backed by a secured payment used as collateral on the account. Secured credit cards are often issued to subprime borrowers or those with limited credit histories.
  • Credit-builder loan — A credit-builder loan holds the amount borrowed in a bank account while you make payments, building credit. You get the money when the loan is paid off. They do require that you have enough income to make payments. The amount you borrow is held in a bank account while you make payments.
  • Co-signed credit card or loan — When someone co-signs a loan or credit card for you, they are promising to repay the loan if the borrower misses payments or defaults.
  • Authorized user status on another person’s credit card — Becoming an authorized user on someone else’s credit card can be a simple and effective tactic if you’re still working to establish your credit. While it’s certainly not a substitute for building up your own credit history, it may be a good way to give your credit a nice boost as you’re getting started. Your credit can also be hurt if the primary account holder doesn’t stay on top of their payments. Make sure the card holder reports that you are an authorized user to the Credit Reporting Agencies.
  • Whichever you choose, make sure you use it in a way that will eventually earn you a good credit score.