Credit Education
Credit Basics
Gone are the days when having a good credit rating was considered a luxury. Today it has become a necessity.
In many ways you are your credit rating. Your credit rating is used not only by lenders but insurance, phone and utility companies, and even potential employers and landlords. Your rating helps them judge your creditworthiness and your reliability to repay them. Even if you aren't looking for a loan, your credit history can affect you!
Bad vs. Good Credit
Bad credit can occur when you do not make payments for financial obligations in a timely manner, default on your loan for some reason or you have allowed your debt to increase to such unmanageable levels that it has overcome your life.
With bad credit, the opportunities that those with good credit have access to are often not available. Creditors and lenders will likely deny your request for any type of loan or credit, you may have troubles renting a house or an apartment, and you might even be turned down for a job application.
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A Good Credit Rating Can...
Staying on top of your credit may reduce the amount you'll pay for everything from insurance to installment loans, and can provide you with more freedom to shop around for loans and lenders. This can lead to:
- Qualifying for lower payments and better rates
- Less documentation and hassle
- Credit line increases
- More options available
If you have less-than-perfect credit, it's important to take steps to gradually improve your credit score. Once you have good credit, it's important to maintain that credit as well. When you know how to manage your credit activity properly, you are ensuring yourself a great financial future.
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A Bad Credit Rating Can...
Being credit-challenged can create many financial obstacles, such as:
- Higher rates on loans and insurance
- Being declined for new accounts
- No credit line increases
- Being rejected for jobs, apartments or insurance
Good credit can be established a number of ways. In financial terms though, credit scores are affected positively when a person has been successful at making timely and complete payments for all of their debts. These debts may include credit card debts, rent payments, utility bills, loan repayments and other types of financial obligations that require you to make an ongoing payment.
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Free Credit Reports
The three nationwide consumer reporting companies have set up one central website, toll-free telephone number, and mailing address through which you can order your free annual report. To order:
Annual Credit Report Request Service
P.O. Box 105281
Atlanta, GA 30348-5281
You may order your reports from each of the three nationwide consumer reporting companies at the same time, or you can order individually. The law allows you to order one free copy from each of the nationwide consumer reporting companies annually.
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How to Read Your Credit Report
You've ordered a free copy of your credit report. You have it in front of you. Now what? Do you know how do read it? Do you know what a "charge-off" is? What about an "inquiry?" What do all those numbers mean? Think of this as the Beginner's Guide to Reading (and Understanding) Your Credit Report.
There are three major credit bureaus: Equifax, Experian and TransUnion. Each is required by law to allow you a free copy of your credit report once a year. Each agency has different ways of reporting information about you, so it might be a good idea to look at all three.
Your credit report will basically consist of the following sections:
1. Information.
An area describing your basic contact information such as your current and previous addresses, date of birth, phone number, and social security number. You will want to examine these for errors, and notify the bureaus with the corrections.
2. History.
Your credit history will consist of the accounts (or "trade lines") you have and will list the creditor and your individual account number for each. It will also contain details such as when the account was opened, the type of credit you received (either installment or revolving), the amount of the loan issued and its credit limit, how much is still owed on it, payment amounts, your history of payments and what status your loan is in.
Your status is defined differently by each bureau. Some will simply say: open, closed, paid, behind or charged off, while others will use codes in a series of 1-9. Typically, 1 represents a good payment history and 9 is very poor.
3. Public Records.
Depending on your history, this area may or may not contain any information. Some things you might see, if you have faced credit challenges, are charge-offs, bankruptcies, repossessions, settlements, judgments, tax liens, etc.
4. Inquiries.
This is the section where every person who has asked to see your record within the last two years will be listed, including yourself.
The inquiries range from soft to hard, depending upon the seriousness. Soft inquiries come from those who want to pre-qualify you for direct mail and other promotions. Hard inquiries result from applying for a loan or another type of credit.
Now that you are aware of what your credit report consists of, remember to check it for errors. If you discover an error, file a dispute by completing the form provided with your report.
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The Difference Between Your Credit Score and Your Credit Report
Your credit report is a list of your personal and financial information, your history, any public records created (like bankruptcy or judgments) and the number of people who have requested to see it.
Your credit score, however, is a three-digit number used by lenders when evaluating your creditworthiness. This three-digit number is also known as a FICO score. Insurers, employers and landlords may use this score to evaluate applicants. The scores range from 300 to 850. Lenders use different ways to evaluate your score. That means that different lenders will rate you in different ways – and that can lead to various price points on your loan or line of credit.
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Five Tips On Managing Your Finances
- Pay your bills on time. Set yourself up on an automatic payment schedule where payments are deducted from your checking account every month, or pay bills as soon as the statements come in the mail.
- Pay off existing loans and credit obligations. It's good idea to carry a balance that is less than half of your total credit limit. If you know that within the year you may want to apply for a large loan, such as for a car or mortgage, begin paying off other debts now.
- Keep your paid-off accounts open. Keeping older accounts open can help demonstrate a stable credit history. If you have to close an account, its best to close the most recently opened account.
- Go to credit counseling only if you need to. Credit counseling can be helpful for those with serious debt problems but this should be a next-to-the-last resort, ahead only of bankruptcy.
- Avoid bankruptcy at all costs. The cost of filing for bankruptcy is high. This event may stay on your record up to ten years, three years longer than it takes for all else to be wiped off.
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Why is it Important to Avoid Late Payments?
It can take only one late payment to trigger higher rates and fees. Whether it is on credit cards, utility bills or auto insurance, if a company sees just one late payment on a credit report, they can use that to justify raising interest rates or decreasing credit limits.
To minimize your chances of a making a late payment, make a list of all your bills, their due dates, balances and credit limits, and pay the bills as soon as they arrive or before the due date. If you see in advance that you may not be able to pay on time, call the creditor and ask them to move the due date back.
Be sure to watch each of your accounts carefully, and check your credit report at least once a year. Also, keep copies of all statements and payments made, so if you notice any errors you can contact the creditors immediately with proof of their error.
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Additional information available from the Federal Trade Commission
Privacy: Tips for Protecting Your Personal Information
Getting Credit: What You Need to Know About Your Credit
Choosing and Using Credit Cards
Avoiding Credit and Charge Card Fraud
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Credit Terminology
These are a list of credit terms that the financial industry uses that you should be aware of:
Annual Percentage Rate (APR): The cost of consumer credit expressed as a yearly rate. Under the Federal Truth in Lending Act, it must be calculated in a standard way.
Balance Transfer: The process of moving one outstanding balance from one credit card issuer to another.
Bankruptcy: The borrower is unable to pay their debts as they become due. Chapter 7 and 13 are two basic ways of filing for personal bankruptcy.
Chapter 7 Bankruptcy: A federal procedure under which a debtor may eliminate most debts.
Chapter 13 Bankruptcy: A federal procedure which allows a debtor with a steady stream of income to pay off his or her debts over a 36 to 60 month period.
Charged off: The balance on a credit obligation that a creditor no longer expects to be repaid and writes off as a bad debt. Even if a debt is charged off, it can still be sold to third party collectors who can still legally collect on it.
Consumer Credit Counseling Service (CCCS): A service that offers financial counseling, such as how to work out a realistic budget, create a debt repayment plan and work with creditors. The goal is to ensure that debts are paid back over a length of time.
Debt to Income Ratio: A person's debt divided by their income. Used as a measure of leverage to show the ability to repay obligations.
Default: The failure of a consumer to make payments as agreed in a loan or credit agreement.
FICO score: The widely used credit scoring model that is used to determine a person's credit risk. Created by Fair Isaac Corporation.
Finance Charge: Is the cost of consumer credit as a dollar amount. It does not include any charge of a type payable in a comparable cash transaction.
Installment loan: A credit agreement in which the debt is divided into amounts to be paid successively at specified intervals set by the terms of the loan agreement.
Interest rate: A rate which is charged or paid for the use of money.
Liability: The responsibility of the borrower for charges to an account, including purchases, fees and finance charges. Your liability is described in the cardholder agreement you receive from the issuer.
Line of credit: An agreement by a creditor to extend credit up to a certain amount during a certain period of time.
Minimum Payment: Represents the minimum amount of money you are obligated to pay each month against your credit balance. It is determined by the size of the balance and the formula the lender chooses to use in determining the minimum amount due.
Pay-down program: Steps for paying down a credit balance.
Prime Rate: The interest rate a bank charges to its best or "prime" customers. Each bank will quote a prime rate, but there is also a prime rate average listed in the Wall Street Journal that is an average of the largest commercial banks. The rate given to consumers on their credit cards or loans is often based on the prime rate plus a certain percentage that represents the lender's assessment of the risk in lending plus its profit margin.
Revolving charge account: Credit extended by a business to a customer that is automatically available up to a predetermined limit as long as the customer makes regular payments.
Revolving line of credit: This is an agreement to lend up to a specific amount to a borrower, and to allow that amount to be borrowed again once it has been repaid by the borrower.
Secured Credit Card: A type of credit card that is linked to a bank account, allowing a credit card issuer to deduct payment if the cardholder doesn't pay. To obtain a secured card, the cardholder must generally maintain in the bank account an amount of money equal to the credit limit on the card.
Secured Debt: A type of debt that is secured by collateral such as a house (a mortgage or a home equity loan) or a car.
Sub-Prime: Borrowers with less than perfect credit. This may include but is not limited to late or missed payments, past bankruptcies, or judgments. Sub-prime borrowers may still be eligible for a loan, but will generally be subject to higher interest rates.
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