One of the bigger issues with credit occurs when people use credit cards to purchase items that they otherwise would not be able to afford. Credit cards are essentially an unsecured loan from a bank that allows people to purchase goods and services and pay later. Between credit card fees and interest rates that can reach above 20%, it can be very easy for people to dig themselves a financial hole that they can’t reasonably expect to escape. The best way to use a credit card is to pay the balance in full each billing cycle — this allows you to use the card interest free for about a month.
Credit cards do have some benefits — they are very useful when making online purchases, for example. Others also have reward programs that offer free airline tickets, cash back, and other perks. Additionally, paying in full monthly on a credit report is a great way to improve your credit score.
Before applying for a card, check the Annual Percentage Rate (APR) and make sure you know the long-term interest rate. Banks often offer a low introductory rate that is significantly lower than the eventual rate.
Always save your credit card receipts and reconcile them monthly with your statement. Look for discrepancies. As mentioned previously, plan to pay the balance in full each month and avoid late charges and never exceed your credit limit. Guard your credit card information and do not give it out over the phone.
If you have applied for credit (credit card, loans, insurance), then you have credit history that is compiled by a credit bureau. There are three main credit bureaus:
You have a right to know what information the credit bureaus have about you. You can request a free copy of your credit report annually — one from each of the three agencies. If you request the information more frequently there is a charge. It is possible that one credit bureau has different information from the other two, so it is important to check with all three of them.
You can receive your free credit reports through one of the following means:
Credit reports include a lot of information, including the basics, such as your name, Social Security number, birth date, and employer. The creditor may also have information about your employment history, home ownership, income, and previous address in some cases. Additionally, credit reports list payment histories with different creditors including how much credit has been extended and whether payments have been made on time. Credit bureaus also include public records such as bankruptcies, tax liens, and foreclosures, as well as a record of all creditors that have asked for your credit history within the past year. This might include businesses requesting your credit history for employment purposes.
Building credit at first can be difficult—some creditors require you to have past credit in order to get new credit. There are some things you can do to build credit:
Having a good credit score is critical — it not only affects your ability to get new credit but it also can dramatically affect the price you will pay for loans and insurance. Additionally poor credit can affect your ability to gain employment, so there are many reasons to strive to improve that credit score!
So what is this credit score? Your FICO score, developed by the Fair Isaac Corp. can run from a low of 300 to a high of 850. That score can vary depending on which credit bureau is reporting it. So the score you might get at MyFico (for a fee) may not be the score the lender (from whom you are requesting credit) may see. The three credit bureaus – Equifax, Experian and Transunion – sell their own proprietary scores.
The following reflects five factors that are included in your FICO score:
As you can see, 35% of your score is comprised of your payment history. Have you paid your bills on time? If not, how late were you on those payments and how often are you late? A late payment can remain on your report from one to seven years—depending on the type of payment.
Also it’s important to remember if you’re shopping around for a loan, the lender will more than likely “inquire” and check your credit. Multiple inquiries can also affect your credit score negatively.
Auto and home loans work a bit differently from unsecured credit. In order to purchase these big-ticket items, you generally have to make a "down payment" meaning that you have to pay a certain percentage of the cost of the home or auto. Most lenders prefer that you make at least a 20% down payment, but many lenders will accept far less. For these types of loans, the auto or home is generally pledged as collateral. This means that if you fail to make payments, the lender is permitted to repossess the car or foreclose on your home. If your car is repossessed, you may have to pay the full balance on the loan, plus storage and towing, in order to get it back. Most lenders are willing to work with borrowers on home loans, known as mortgages, as long as they believe your situation is temporary and that you are acting in good faith. If you end up in this situation, it is best to call your lender and attempt to work out a payment arrangement plan.
Another factor that lenders consider when looking at your application for credit is the debt-to-income ratio. As a rule, lenders prefer that less than 40% of your income be tied into payments on debt, including home and auto loans and credit cards. Truthfully, they would prefer the ratio be far less than 40%, but anything above that figure starts to make lenders nervous about your ability to repay the loan.
Predatory lending describes unfair, deceptive, or fraudulent practices during the lending process. Predatory lending refers to a number of different practices, including lending to borrowers who pledge collateral but have little realistic chance of being able to repay the loan. The lender plans to repossess or foreclose on the property and sell it for a profit. Other examples include unjustified risk-based pricing, failure to clearly disclose loan terms, disproportionately high fees, and any other deceptive practices.
While far less known, predatory borrowing is also a topic of concern. This occurs when the borrower misrepresents his/her information on the loan application. A recent study determined that many payment defaults had fraudulent misrepresentations on the original loan applications. In some cases, lenders do not ask for documentation of income which allows borrowers to misrepresent the figures. In other cases, borrowers falsified income documents.
If you’re having credit problems, one solution is to contact a credit counseling service. Creditors may be willing to accept reduced payments if you enter into a debt repayment plan where you deposit money each month with the counseling service. The service then pays your creditors. You may have to agree not to apply for—or use any—additional credit while you’re participating in the program.
It is also important to remember, however, that a debt repayment plan does not erase negative credit history.