Basics Of Credit
- What is credit?
- Why do I need to establish credit?
- What is a credit report?
- What is a credit score and how is it determined?
- Why is it important to establish good credit?
Establishing Your Credit
- How do I start establishing credit?
- How do I get qualified for a credit card?
- How do I choose the right card?
- What if I get turned down for a credit card?
- My responsibilities as a cardholder
Maintaining Good Credit
- How do I maintain a good credit history?
- What steps can I take to improve my credit?
- How can I manage and reduce my debts?
- 5 Reasons to check your credit regularly
Credit Security / Fraud
- What if there are errors on my credit card bill?
- What if my credit card is lost or stolen?
- What can I do to prevent credit card fraud?
- Cybershopping – protecting yourself online
What is credit?
Credit is a privilege and a convenience. Credit lets you pay for electronics on an installment plan, take out a loan for a house, pay for clothing on a credit card, or pay for schooling with financial aid. Credit allows you to make a purchase without ready cash. You get credit by promising to pay in the future for something you receive in the present. But, there are strings attached; credit usually costs something (interest), and what is borrowed must be paid back.
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Why do I need credit?
Credit gives a number of benefits you don’t get when paying with cash or checks:
- Convenient, hassle-free shopping. When you use a credit card to make a purchase, you don’t have to carry a lot of cash, pay by check, or present additional identification. A credit card also simplifies and speeds up catalog ordering and currently is virtually the only way to make Internet purchases.
- Emergency protection. Credit cards are the ultimate financial security blanket. They can get you through nearly any emergency situation.
- Easier budgeting. With a credit card, you can make purchases and pay them off on a schedule that fits your budget. Credit cards also allow you to take advantage of sales and special offers.
- Security. If you lose cash, it can be used by anyone. If you lose a credit card and report the loss to the card’s issuer before it is used, the issuer cannot hold you responsible for any unauthorized charges. If a thief uses your card before you report it missing, the most you will owe is $50.
- Travel expenses. You’ll find that a credit card is almost essential for renting a car, purchasing an airplane ticket, or booking a hotel room. Whether you’re across town or on another continent, a credit card is the universal guarantee of your good financial standing. And if you need cash, you can get it at ATMs or banks around the world that accept your credit card.
What is a credit report?
When you apply for credit, the lender reviews your credit report before approving your application. Think of a credit report as a resume. It details how well you have paid your bills and used financial tools such as credit cards and checks.
Just like a report card or a resume, a credit report is used to document your performance; in this case, your financial performance.
The report details how well you pay your bills, bank loans and credit card purchases. It also can indicate if you have abused financial tools such as checking accounts and debit cards. Even debts of small amounts, if not paid on time, can hurt your credit standing.
The three major credit agencies which monitor this activity are Equifax, Experian, and TransUnion. These agencies, also called “bureaus,” collect and report information about your financial habits and put the information into a credit report.
Below is a list of information that can appear on a credit report:
- Your name, Social Security number, birth date and current and previous addresses.
- Information about your employers, both current and previous.
- Your payment history with major credit cards, department store charge accounts and loan payments.
- Your payment history with utility and telephone services.
- A list of your accounts (if any) that have been referred to a collection agency.
- Inquiries made about your credit history that have been made over the past several years, and whether or not you were granted credit.
- Public record information: such as bankruptcies, foreclosures, and tax problems.
Information on a credit report can remain for many years. (This is often referred to as your “credit history.”) Since this report is used by others to make important decisions affecting you, it is important to review your credit report for accuracy once a year.
What is a credit score and how is it determined?
A credit score number is often called a FICO score, for Fair, Isaac and Co., the California company that developed the system upon which it is based. The score is supposed to distill all the information in your credit report, using a formula to calculate a single number that indicates your credit worthiness.
It’s designed to give lenders a fast, accurate prediction of the risk involved in giving you a credit card or loan. Lenders have attested to the score’s value in streamlining the underwriting process and creating more opportunities for consumers to get mortgages as well.
Scores range from the 300s to about 900, with the vast majority of folks falling in the 600s and 700s. The higher the score, the better.
When determining how high a score will be, five characteristics are considered above all. In order of score significance:
- Past delinquency: People who have failed to make payments in the past tend to do the same in the future.
- The way credit has been used: Someone who is maxed out or close to the limit on a credit card is considered a greater risk than someone who doesn’t look at the high credit line as a license to print money.
- The age of the credit file: Fair, Isaac’s model assumes people who have had credit for a long time are less risky.
- The number of times a person asks for credit: The system frowns upon those who have initiated several requests for credit cards, loans or other debt instruments over a short period.
- A customer’s mix of credit: Someone with only a secured credit card is generally riskier than someone who has a combination of installment and revolving loans. (On installment loans, a person borrows money once and makes fixed payments until the balance is gone, while revolving borrowers make regular payments, each of which frees up more money to access.)
Why is it important to establish a good credit history?
Establishing a good credit history is an important part of your personal and financial future. It can help open doors for you or keep them locked. A variety of people and businesses make decisions affecting your future based on your credit history. Banks and other lenders consider your credit report when reviewing applications for mortgages, revolving lines of credit or other loans. Landlords sometimes use credit reports to decide among rental applicants. And a potential employer may even assess an applicant’s credit report prior to extending a job offer. Your credit report may also be reviewed when you apply for auto insurance or homeowner’s insurance, or even a mobile phone. This is why it is so important to establish good credit.
How to establish your credit
To establish a good credit history, it’s important to consistently paying your bills on time. You should always pay at least the minimum amount due every month, by the due date.
Even if you’ve never taken out a loan or made a major credit card purchase, there are several ways to start establishing your credit history:
- Open a checking or savings account. While they won’t create credit, their existence will indicate that you have money and show how you manage it to lenders and creditors.
- Apply for a department store credit card or a major credit card (such as a MasterCard®, Visa®, or Discover®) and use it responsibly. Pay your bills on time!
- Apply for a small loan or line of credit from your local bank. To get a loan without a cosigner-signer, you must be at least 18 years old and have a steady source of income. To increase your chances of getting the loan, come up with a large down payment.
- If you don’t qualify for credit on the basis of your credit file, ask someone with an established credit history (like a parent) to cosign your application. Remember, the cosigner promises to pay your debts if you don’t.
Remember, in order to establish a good credit history, it is important to always pay your bills on time and never borrow or spend more than you can afford.
* See our ‘Cards for Poor Credit’ section for offers to help establish your credit.
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Qualifying for a credit card
If you are at least 18 years old and have a regular source of income, you’re on your way to qualifying for a credit card. But you still have to demonstrate that you’re a good customer. The proof is in your credit history, which lists the amount of credit you’ve received and how faithfully you’ve paid it back. If you’ve financed a car loan or any other purchase, you probably have a record at a credit bureau. This credit history shows how responsible you’ve been with paying your bills on time and helps the credit card issuer decide how much credit to extend to you.
If you don’t have any credit history established, there are special credit cards available to assist you, but be aware that you’ll pay higher interest rates and fees until you’ve proved yourself.
Before you submit a credit application, get a copy of your credit report to make sure it’s correct. Visit www.annualcreditreport.com for your free annual report, or visit our credit report section to order one now.
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Choosing a credit card
Today’s consumers are presented with a wide array of credit card choices—cards with low annual percentage rates, cards with no annual fees, rebate cards, gold cards, platinum cards, etc. So, how do you choose one?
Before selecting a card, be sure you know which credit terms and conditions apply to the account. Do you expect to pay your bills in full each month, or do you plan to pay off your purchases over time?
Consider the annual fee, finance charges, balance computation method, and whether or not there is a grace period for purchases.
* For more information on how to choose, see our article Choosing The Right Credit Card.
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If your credit application is denied
If you’ve been denied credit for any reason, you should receive a written explanation from the financial institution describing the reasons for your denial. If you were denied because of information supplied by a credit bureau, federal law requires the creditor give you the name of the bureau that supplied the information. You have 60 days to contact the credit bureau if you would like a free copy of your credit report. If you find an error in your report, you are entitled to have it investigated by the credit bureau and corrected at no charge. However, if negative information on your credit file is accurate, only time and responsible credit habits can help restore your credit history.
It’s important to note that financial institutions must make credit equally available to all creditworthy applicants. Under the Equal Credit Opportunity Act, you have certain rights that protect you against unfair credit discrimination. Under this Act, you cannot be denied credit because of:
- Age (unless you are under 18)
- Marital status
- National origin
- Income derived from public assistance
- Intent to have children
- Birth control practices
You can only be turned down for credit based on:
- Your credit history
- A current or former spouse’s credit history
- Other financial information
If you suspect discrimination by a bank, savings and loan or credit union, ask for the name and address of the federal agency that enforces the Equal Credit Opportunity Act (depending on the institution, this will be either the Office of the Controller of the Currency, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision or the National Credit Union Administration). The Equal Credit Opportunity Act mandates that the creditor must give you this information. Not every institution can act on your individual case, but they can track your complaints, along with other similar ones, in order to find a pattern of discrimination.
If you suspect discrimination by a retail or department store, finance or mortgage company, utility, state credit union or government lending program, contact:
Consumer Response Center
Federal Trade Commission
Washington, DC 20580
The Federal Trade Commission (FTC) cannot intervene in individual disputes. However, the information you provide can show patterns of discrimination in which the FTC can act.
You can also direct complaints against all types of creditors to:
Department of Justice
Civil Rights Division
Washington, DC 20530
Because credit cards make it easy to purchase things now and pay later, it’s easy to lose track of how much you’ve spent. Make sure you pay all of your bills on time and only get the credit cards you need—don’t get a card just because the issuer is giving away a cool gift.
To establish and maintain good credit, it is important to pay at least the minimum amount due every month and to pay on time. Allow five to seven business days for payments made by mail. Use your credit card wisely as a beneficial financial tool. Do not fall into the trap of charging every single little thing you come across just because you can. This will leave you with a huge debt you can’t afford.
There are easy ways to keep your spending on track. Perhaps the easiest is to record your credit card purchases in a notebook. There are also a wide variety of software programs, such as Quicken®, available to help you manage your finances.
Lastly, take advantage of the services your financial institution offers. Through online banking, for instance, you can see your account activity on a daily basis and even arrange to make electronic payments over the Internet.
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How to maintain a good credit history
How you handle your credit cards and other loans affects your creditworthiness. Remember to use your credit responsibly and be sensitive to the terms of the payment agreements you made when you established your accounts. Whether you choose to pay the total outstanding balance on your bills each month or just the minimum payment due, your payment must reach the financial institution or business by the payment due date. Your payment due date is typically within two or three days of the same time every month. If that time of the month is not convenient because it doesn’t coincide with your paychecks, contact the creditor to see if your billing cycle can be changed. Or, adjust your budget accordingly.
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8 steps to improve your credit:
1. Pay your bills on time
Make it your personal goal to pay your credit and other obligations on time and for the required amount each month. Debt obligations will include: credit card charges, loan payment, rent or mortgage payments, utility bills, service or product bills, taxes, etc.
Take advantage of automatic payments and other online bill payment options offered by lenders and credit card issuers. This will ensure timely payments each and every month.
If you forget to make a payment, act promptly on any notices of non or late payment. Call the bill servicer to notify them that your payment will be sent immediately. If you act fast enough, this negative infraction may not be reported to credit agencies.
Make sure you do not ignore any creditor notices of non-payment. Contact the creditor to fix the problem as soon as possible. Even if you have already incurred penalties, you may be able to get the creditor to remove or correct these issues.
2. Build strong payment patterns
Adverse conditions such as late or non-payments are two of the most common items reported to credit agencies. You can start building strong payment patterns by making on-time payments each and every month.
Your credit report will also list all open credit cards and loans, listing the amount borrowed and the amount owned on the account. Your objective is to build a pattern where you payoff large credit card balances in full each month. This pattern conveys a sense of responsibility for your debt obligations.
Another way you can build strong payment patterns is by charging everyday living expenses on your credit card, deducting the charge from your checking / savings account, and then paying off the monthly credit card charge in full each month.
Please be sure follow these rules before you use this method:
- You must set aside funds for every credit card purchase you make
- You must pay your credit card balance in full each month
- You must have an existing credit line or home equity line (with lower interest rate) to finance large ticket items – never finance purchases with your credit cards.
3. Maintain only a few credit cards
As your credit rating improves, you will soon receive pre-approved offers from credit card companies and lenders with attractive rates and programs. You should limit your credit to 3-4 cards maximum. Maintaining a large collection of cards can hurt your credit rating.
4. Close all retail and gas cards
Since you maintain 3-4 credit cards (VISA, MasterCard, Discover, American Express, or other), it isn’t necessary to hold onto gasoline cards, retail store cards, and other specialized credit cards. Again, holding multiple cards can drag down your credit score.
5. Don’t have too many outstanding loans
Excessive loan balances (especially loans that exceed your Debt-to-Income ratios) can effect your credit rating. Maintaining a good credit rating requires that you reduce your debt holdings by consolidating balances, closing unused credit card accounts, and paying off outstanding loan.
6. Avoid getting too close to your credit limit
Using your credit up to your maximum credit line balance can impact your credit rating. Maximized credit lines (including home equity lines, credit cards and unsecured credit lines) indicate that you are a consumer who borrows willingly. Many lenders consider this a great risk and may not approve you for additional credit. A good rule to follow is to keep your balances at or below 60 percent of the available credit line.
7. Review your credit report annually
About 1-in-4 credit reports have errors. Either a payment on a loan amount has not been recorded correctly or another billing company has posted incorrect non-payment information to your account.
Your credit report also maintains records on your employment, salary, bank accounts, etc., and all of the information that you supplied when filling out previous credit applications. You should review your report annually for errors and make the necessary corrections as instructed by the credit agency.
* Everyone is entitled to one free credit report per year at: www.annualcreditreport.com
8. Limit inquiries on your credit report
Every time you apply for credit, seek some kind on contractual service, or in some cases employment, a credit inquiry will be made on your report. Multiple inquiries over a short period of time may have a negative impact on your credit score. Models show that multiple inquiries over a period of time indicate an applicant who is anticipating credit problems. So limit credit inquiries when only necessary.
What about having multiple lenders compete for your loan? Many Internet services and brokers (including lenders on our site) allow you to submit one form and have up to four lenders review your credit information. Credit agencies understand that these services may require an inquiry by “multiple lenders” at the same time.
These kind of inquiries, coming from multiple lenders within 20-30 days of each other, indicate that you are shopping for the best deal. Credit agencies will count these inquiries as being only one inquiry. This allows you to shop and negotiate best deal without being penalized on your credit report.
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Managing and reducing your debt
If you find yourself spending more money than you make, don’t rely on your credit card to pay for things that aren’t necessities. If you do, you are only making a bad situation worse.
Take the time to establish a monthly budget. Differentiate between the things you “need” and the things you “want.” Start with your fixed expenses or “needs”—like rent, food, utility bills, phone bills, car loans, and insurance payments. Then figure in variable “wants” like clothing, eating out, and entertainment. Subtract your expenses from your income and you have your starting point. If the sum is below zero, it’s time to reduce your expenses by cutting out any unnecessary spending on “wants.”
In most cases, cutting your expenses is the first step towards paying off your debts and becoming more financially independent. To help you move in the right direction, here are a few tips on how to do this as painlessly as possible:
- Be careful with your credit card. It’s not free money! Pay on time and pay at least the minimum due each month (but more is better if you can). Be aware of finance charges.
- Avoid “impulse purchases”. Think about it: do you really need that magazine, extra-large pizza with all of the toppings or designer shirt? Or can you do without? You’ll be surprised at how much you’ll easily save by adopting a more disciplined spending routine.
- Learn to cook. The difference in cost between a week of eating at restaurants and a week of groceries will send you running to the supermarket.
- Buy in bulk. You’ll always need toothpaste, toilet paper and cereal, right? You might as well save some money by buying in bulk.
- Clip coupons, watch for sales and shop at outlets. Find out where the best prices are and look out for opportunities to increase your savings. Many grocery stores now double the coupons you find in the Sunday newspaper. It may only be 30 cents here or a couple of bucks there, but over a year, it all adds up. If you can’t cut your addiction to designer labels, try the outlet stores. Imagine the fun of finding a pair of $36 designer khaki shorts for $9.09.
- Look for ways to lower education costs. If you’re a college student, check out off-hour courses. Some colleges set lower rates for evening, weekend and summer courses. Other schools have innovative tuition plans. Some schools give tuition discounts to students who persuade other students to enroll. Dorm supervisors may get free room and board. Some schools reward students who maintain a straight four-year graduation schedule. A little research may result in substantial savings.
- Keep track of all ATM withdrawals. If you use an ATM that is not operated by your bank, the bank that owns the machine may charge a transaction fee ranging on average from 50 cents to $3.00. If you only make one withdrawal a month, this may not be much of a problem. However, several small withdrawals will add up. Just think: two weekly withdrawals of $20 with a $2 fee adds up to $208 a year in fees alone!
5 reasons to check your credit:
Ideally, your credit report is an accurate, up-to-date reflection of your credit history. However, since we don’t live in an ideal world, there are many reasons that your credit report could contain inaccuracies that might prevent you from receiving the credit you deserve. The good news is you can take action to keep your report accurate.
Here are FIVE REASONS why you should review your credit report regularly:
- Inaccuracies and mixed credit files: Many inaccuracies on a credit report can be the result of simple human error, and are therefore are not difficult to dispute. Whether the inaccuracies relate to payments not credited, late payments, or data mixed in from the credit file of someone else with a name similar to yours, you will want to contact the credit bureau to dispute inaccurate information promptly.
- Tracking and payments: One of the most important elements of credit is a demonstrated history of on time payments. Once you send the check though, anything can happen–a delay in the payment being received can kick you over to a 30-day delinquency. This has a negative affect on your credit, and creditors don’t take it lightly. If you call your creditor and explain the situation, they might adjust the info, but you need your credit report to know whether you have a delinquency or not.
- Identity theft: This issue alone is reason to order your credit report immediately. Identity theft is an insidious crime, involving a thief who assumes your name to open new accounts, divert your card statements to another address, and run up all sorts of bad debt without you ever knowing about it until collectors come calling. The best way to catch a thief who is using your name is by getting a copy of your credit report, which will show you if there are accounts listed you know you haven’t opened. For example, if a thief has intercepted a pre-approved credit card offer in your name and sent it in with a change of address, your credit report will include the account.
- Inquiries: If you’re shopping around for a loan or more credit, you should know when creditors check your credit, it places an inquiry on your credit report. Inquiries can add up, which is often interpreted as negative by creditors. For this reason, too many inquiries can actually make getting credit more difficult. Moreover, if you didn’t authorize someone to look at your credit report and they did, they may have broken the law. Who’s been looking at your credit?
- Credit fraud / unauthorized charges: Credit fraud involves the theft of your credit card or account number to make unauthorized charges to your account. Though consumers are protected financially from this abuse, other creditors may take note of all this activity and decide to raise your interest rates or refuse to grant you a loan. Ordering your credit report will help you catch new activity on accounts that you haven’t been using, or may have closed. When it comes to managing your credit worthiness, your credit report is your best resource. Your credit report gives you the opportunity to manage your credit wisely, while planning your credit strategy for achieving future goals.
* To receive a free copy of your credit report, go to our Credit Reports Section
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Errors on your credit card bill
Under the Fair Credit Billing Act, you are protected whether you use your card online, over the phone, through the mail, in person or at a store. If you find any questionable charges or billing errors on your monthly credit or charge card statement, you may dispute the item and provided you follow the guidelines for resolving a dispute you may withhold payment for that amount while the issue is being researched. The issue might be a charge for the wrong amount, for something you didn’t accept, or for a product or service that wasn’t provided. To dispute a charge on your credit card:
Write to the creditor and include your name, address, credit card number, and a description of the billing error. Look for instructions on the back of your billing statement.
Send your letter as soon as possible. You must notify the card issuer in writing within 60 days after the first bill containing the error was mailed to you. In your letter, include your name and account number, the amount of the error, and the reason you believe there is an error. The card issuer will then investigate the problem and either correct it or explain why the original bill was correct. The issuer’s response must occur within two billing cycles but no later than 90 days after the issuer receives your billing error notice. Although you do not have to pay the amount in question during the investigation, you are still responsible for payment on the remaining balance.
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Stolen credit card
If your credit card is used without your authorization, the most you can be held liable for is $50 per card. Many credit card issuers offer a “Zero Liability” policy, which removes your obligation to pay for any charges. But different issuers have different policies. Either way, if you report the loss of a card before it is used, the credit card issuer cannot hold you responsible for any unauthorized charges.
It is important to safeguard your cards and account numbers, and to review your statements promptly. If you suspect unauthorized activity on your account, or if your card is lost or stolen, contact the financial institution that issued the card as soon as possible.
Tips to prevent credit card fraud
Follow these simple tips to help prevent identity theft and credit card fraud:
- To protect yourself against loss or theft of credit, sign your credit card immediately so no one else can use it. File the papers that came with your card in a safe place.
- Always protect your credit cards as if they were cash. Just like cash, credit card numbers can be stolen.
- If your credit card has a PIN (personal identification number), do not keep your PIN with your credit card. File the PIN separately.
- Keep your account number to yourself. Give your credit card number or expiration date over the telephone only if you know you are dealing with a reputable company.
- Never put your account number on the outside of an envelope or on a postcard.
- Draw a line through blank spaces on charge slips above the total so the amount cannot be changed.
- Keep copies of sales slips and compare charges when your monthly statements arrive. If you see any questionable charges or errors, you must report these, in writing, to the card issuer, within 60 days.
- Make a record of your credit card numbers, their expiration dates, and the telephone number for each credit card company in case of an emergency such as reporting lost cards.
- Carry only those credit cards you regularly need, especially when traveling.
- Never give out additional personal information when you use your card for purchases. Merchants cannot ask for a driver’s license number or phone number as a condition for accepting your card. All that’s required is your signature.
- Never use a credit card as personal identification. Your credit privileges and history are too precious to risk.
Cybershopping — protect yourself online
Whether you’re interested in computer software or compact discs, online shopping can give new meaning to convenience and choice. Should you decide to pay by credit card, your online transaction will be protected by the Fair Credit Billing Act just as other transactions. But before you visit your favorite online store, take care to make your cybershopping experience safe. Security is a must and begins with your connection and your browser. Unsecured information sent over the Internet can be intercepted. That’s why a secure browser—one that encrypts or scrambles purchase information—is important.
If you’re unsure if your browser is secure, check with your Internet service provider. When you’re ready to make an online purchase, pay close attention to the information you need to enter. Be cautious if you’re asked to supply personal information such as your Social Security number or your mother’s maiden name. If you have any doubts, cancel your order immediately.