Give Yourself Some Credit

by Laura Kapp

In today’s world, you can’t live without credit.  It’s a powerful tool – and it may just completely replace cash in the future.  But as with all power tools, credit can be extremely dangerous in the hands of these who do not appreciate its power.

Buy now, pay later

Credit permits you to obtain something now for little or no money out of your pocket, and pay for it over a specific period of time.  Today, almost everyone uses credit in one form or another.  Mortgages, credit cards, personal loans and car loans are all types of credit.  Types of credit include open-end credit and closed-end credit.  Open-end credit is credit which is extended on an ongoing basis, usually with a limit on how much you may borrow.  It is often referred to as “revolving credit” in that as you repay the balance due, credit up to a specified limit is then available to you again to use at anytime in the future.  The most common forms of open-ended credit are credit cards, such as VISA and Master Card.

Where does credit come from?

Credit is most frequently extended by department stores, finance companies, oil companies, credit unions, commercial banks and credit card companies.  Those who offer credit are called creditors.

How do I get credit?

For credit to be extended to you, a creditor looks at two things:  You and your collateral.  A creditor evaluates you as a credit risk by reviewing various factors such as income, length of employment, how long you’ve lived at one residence, previous credit history, amount of outstanding debts, stability of your checking and saving account, number of dependents, and so on.  Each creditor has different ways of evaluating applications for credit.  These factors reveal, to a certain degree, whether you will repay the amount borrowed over a certain period of time.  A creditor also considers the collateral you are purchasing with the credit.  Items such as furniture and appliances are easy for a creditor to repossess if you fail to make credit payments.  Therefore, since a creditor has less to lose in the long run, credit may be extended to even those with a questionable ability to pay when it comes to purchases like refrigerators and stereo systems.

On the other hand, a home where no collateral has been posted is more difficult or even impossible to repossess if you fail to make the credit payments.  A creditor is going to evaluate you and your credit history more carefully when you’re trying to buy a house.  Unfortunately, this is where most people learn their first real credit lesson – when credit is really important - because they are stunned and surprised when denied, based on their credit card use.

How to establish a good credit history

Establishing a good credit history is actually pretty simple.  Open a checking account or savings account (or both.)  Then apply for credit gradually through retail store credit cards, a major bank credit card or a gasoline credit card, if you believe your budget can handle the financial load.  Don’t apply for more credit than you can manage.  A credit card establishes you with credit as soon as your application is approved.  Now, Make regular payments for the products or services you purchase.  Every time you make a payment as agreed to a creditor, you are building a favorable credit history.  If you consistently repay your debts, your positive credit history will build. 

Failure to repay the credit extended as agreed is where most people get in trouble.  Even late payments affect your credit history.  It doesn’t matter that the credit card balance is only $5.00, or that the payment is only one day late, or that you pay the late fee.  Failure to pay on time will put a black mark on your credit history, a black mark that will last for a year or more.

Another trouble spot is the minimum payment, which is generally about 2%-3% of the outstanding balance.  While making the minimum payment is acceptable, it does very little – if anything – to reduce your outstanding debt.  It is easy with continued credit usage to go deeper and deeper in debt.  Let’s say you buy a $2500.00 computer using a credit card, and you make the minimum payment of $50.00 per month.  Assuming you don’t make any additional purchases using that credit card, how long do you think it will take to pay for that computer?  Would you believe EIGHT YEARS?  Its true.  By the time you’ve paid for the computer you’ll probably be using it as a doorstop.

You can make credit work to your advantage.  First of all, don’t assume that you have a great credit history because of the continuous offers for revolving credit you receive in the mail.  Make sure that you have credit when you need it for a mortgage or personal loan.  You don’t want to be denied due to poor history or overextension of credit cards.  What is more valuable – a house or a sweater?  It’s up to you.

To use credit effectively, first determine how much credit you can afford.  How?  By developing a household budget which is a detailed list of your income and expenses.  If you find that you cannot afford credit purchases, considering your current income and expenses, you should still concentrate on establishing good credit, but continue to making most of your purchases using cash.  Most credit purchases should generally be limited to those that can be paid off at the end of the month.  Larger purchases should be evaluated based on a usable life (remember the computer) and a payment schedule established to retire the debt.

When it makes sense to use credit

Using credit or credit cards can be a good financial move.  In this day and age, it’s nearly impossible to get by without it!  Use credit:

• When you’re building equity.  A mortgage is a good example of using debt to build equity.  Most people could not afford to buy a home by paying cash.  Yet a home is often the largest and most important investment many people will make, and the profits they realize after the house has appreciated will likely far exceed the amount of interest they paid to purchase it.

• When the interest is tax deductible, borrowing makes sense.  Mortgages and home equity loans remain two of the last types of tax – deductible consumer loans.

• To take advantage of sales.  But ask yourself the following questions before purchasing a sale item with a credit card:

• Do I really need it?

• Will the amount of interest I pay on the amount I borrow plus the sale price of the item, still be significantly less than if I paid full price for the item with cash? (People use credit cards to take advantage of bargains, but then find they have run up large balances they can’t pay off right away.  But by the time they do pay them off, they have paid so much interest that they might as well have paid full price in the first place.)

•   When you are financing a business or venture.  Few people who start a business have the financial means to begin without borrowing.    In may cases, they find the convenience of using credit cards preferable to begging their bankers for loans.

• To take advantage of “The Float.” If you are disciplined enough to pay off your credit card bills in full each month, you can use your credit cards as an interest-free loan.  If you time your purchases right (make the purchases right after the closing date or cutoff date on your statement,) you will have as many as 50 days to pay back the amount borrowed.

• To shop by mail.  Sending cash or a check to an out-of-town company you’ve never dealt with before can be dangerous.  If you pay by credit card, you are protected under the Fair Credit Billing Act if it turns out to be different than what you ordered.

• To pay for car repairs and other services.  The Truth in Lending Act also provides protection against shoddy goods and services paid with a credit card.

Your credit history

As you read this article about credit, are you becoming anxious about your own credit history?  You can find out how creditors view you and your credit history by reviewing your credit report.  The credit report’s purpose is to help a creditor decide whether to grant you credit.  It typically includes four types of information:

• Identifying Information:  Your name, nicknames, current and previous addresses, Social Security number, year of birth, current and previous employers, and if applicable, your spouses name.

• Credit Information:  The credit accounts you have with banks, retailers, credit card issuers and other lenders.  For each account, your credit report will list the type of loan revolving credit, student loan, mortgage, etc.,) the date you opened the account, your credit limit or loan amount, your account balance, and your payment pattern during the past two years.  The report also states whether anyone else besides you (your spouse or cosigner, for example) is responsible for paying the account.

• Public Record Information:  State and county court related to bankruptcies, tax liens or monetary judgments.  In some states, credit reports list overdue child support payments.

• Inquiries:  The names of all credit grantors and potential employers who obtained a copy of your credit report for any reason.  The inquiries section of your report contains a list of anyone who accessed your report for up to two years.  Federal law requires the two-year retention for employer inquiries but only six months for credit grantor inquiries.)  These time periods protect you as a consumer or job applicant.

What’s not in a credit report?

Almost as important as what is in your credit report is what isn’t: no information about your race, religious preference, medical history, personal lifestyle, personal background, political preference or criminal record.

Information, please

One thing to keep in mind: the credit report just provides information.  It’s up to the creditor to use this information to determine if you are a good or bad credit risk.  And each creditor will analyze the information differently when deciding whether to extend credit to you. What does your credit report say about you?  It doesn’t have to be a mystery!  To obtain a copy of your credit report, contact the credit-reporting agencies listed below.

Help! I’ve found and error!

To correct any errors on your credit report, you must write to the credit card company and explain the error.  If the creditor concurs that an error has occurred, the credit card company must report and correct the error to the credit-reporting agency.

Okay, I have a bad credit history.  Now what?

It may take some time, but it can be fixed.  You can contact a professional financial counselor or one of the agencies listed below, if you need help developing a budget/debt reduction plan.  The good news is that if you work to reduce your debt by regularly making payments ON TIME for at least a year, then your credit history will be much better looking to future creditors.  Although establishing good credit may take a couple of years, once you start making on-time payments, your credit history begins to improve immediately!

Non-profit credit and budget counseling agencies:

The National Foundation for Consumer Credit has a great web site with good information and a listing of non-profit member organizations in your area or on line:

National Foundation for Consumer Credit  www.nfcc.org

1-800-388-2227

8611 2nd Avenue, Suite 100

Silver Spring, MD, 20910

Neighborhood Housing Services:  Neighborhood Housing Services are a good resource for home buying programs in your local area.  Check your phone directory for local Neighborhood Housing Services or a Neighbor Corporation district office. 

NeighborWorks: www.nw.org 

Neighborhood Reinvestment Corporation, local NeighborWorks organizations and Neighborhood Housing Services of America make up the Neighborworks system which has successfully built healthy communities for 26 years.

National Community Reinvestment Coalition: www.ncrc.org 

NCRC was formed in 1990 by national, regional, and local organizations to develop and harness the collective energies of community reinvestment organizations from across the country so as to increase the flow of private capital into traditionally underserved communities.