What is Credit?

Having credit allows you to make purchases and pay at a later date. Credit is provided to you based on the trust that you will repay within a specified time. It is an agreement that allows you to use goods and services today and permits you to pay on some agreed schedule in the future.

Using Credit

Types of Credit

Credit transactions are of four types. A credit card purchase is the most frequently used credit. When a consumer makes a purchase, they may use a credit card to pay for it. A credit card is an example of "unsecured, open-end" type of credit. In this agreement, the borrower has a line of credit available for a specific limit backed only by his or her creditworthiness. A borrower must make at least a minimum payment each month based on the outstanding balance. The wise consumer will pay the entire balance each month.

Another often used form of credit is a mortgage loan. When consumers decide to buy a house, they go to a bank or finance company to take out a mortgage. Mortgage loans are known as "secured, closed-end" credit. The loan is based on collateral and a specific number of payments are scheduled for a specified period of time. A car loan is also this type of credit.

A third form of credit would enable consumers to obtain a loan without collateral to make improvements on their home. This "unsecured, closed-end" credit is available when the creditor is willing to make the loan based on the borrower's creditworthiness. It is often referred to as a "signature loan." Payments are for a specific amount for a specified period of time.

Finally if consumers decide to get a loan using their home as collateral, this type of credit is known as an "open-end equity" or "secured, open-end" loan. These loans are made against a borrower's property and the amount of the loan is based on the equity in the home.

Why is Credit Important?

Credit can be useful in times of emergencies

Credit is sometimes more convenient than cash

Credit allows you to make large purchases such as a car or a house

Applying for Credit

When you apply for credit, the lender will review three main factors to decide whether you are a good credit risk and if you will be able to pay back the loan. The factors are often called the Three C's.

Capacity
Capacity is your present and future ability to meet your payments.

Capital
Capital is your savings and other assets, which can be used as collateral for loans.

Character
Character means how you have paid your bills or debts in the past.

Banks use credit reports to obtain character information. You can request a copy of your credit report by contacting any of these credit reporting agencies. In the state of Maryland, you can obtain one free copy of your credit report annually. In other states, cost will vary.

Here are some questions you might be asked when applying for credit:

How long have you been in your job?

How much money do you make each month?

What are your monthly expenses?

How much money do you have in checking and savings accounts?

Do you own a house?

Do you have investments or other assets (e.g., car)?

Have you had credit in the past?

How many credit accounts do you have?

Have you ever been denied credit?

Have you ever filed for bankruptcy?

Have you had any outstanding judgments, property repossessed or foreclosed upon?

Have you ever made late payments?

Ask yourself these questions before obtaining credit:

Do I need this?

Do I need it now?

Can I wait until I have cash to pay for it?

Can I get credit?

How much more will I pay if I buy on credit?

Can I afford the monthly payments?

What is the total cost of credit?

Are there any fees?

What is the annual percentage rate?

You have no cash reserve.

Your revolving charge accounts are never paid up.

You continually send creditors less than is actually due.

You put off medical or dental visits because you can't afford them right now?

You are unsure about how much money you actually owe.

You are working a second job or overtime to make ends meets.

You lost your job and immediately you are in financial trouble.

You are threatened with legal action.

You are paying bills with money earmarked for something else such as retirement, savings, or medical expenses.

Tips for Managing Your Credit

Once you get credit:

If possible, pay off your entire credit card bill each month. If you can’t, try to pay more than the minimum balance due. This will reduce finance charges and total interest paid.

Pay on time to avoid late fees and to protect your credit. If you cannot pay on time, call your creditor immediately to explain the situation. They may waive late fees or be willing to make different payment arrangements.

Always check your monthly statement to verify transactions. Call your creditor right away if you suspect errors in your statement.

Ignore offers creditors may send you to “reduce” or “skip” payments. You will still be charged finance charges during this period.

Think about the cost difference if you purchase your item with cash versus if you purchase your item with credit

Remember, if you purchase a $500 stereo with a credit card with a 20% APR, it will cost $1,084 and take 9 years to pay off if you only pay the $10 minimum monthly payments.

There are several steps you can take to establish and maintain a good credit history.

Always pay your bills on time.

Never borrow more than you can comfortably pay back.

Borrow only the amount you need.

Know how much you owe at all times.

Contact lenders immediately if you expect to have a payment problem.

Develop good savings habits to handle financial emergencies without borrowing.

Report lost or stolen credit cards immediately.

Never give your credit card number over the phone unless you initiated the call.

Open a checking account and a savings account.

Do not apply for too many credit cards. Even if you don't use them, the credit limits are taken into consideration when you apply for credit.

What is a Credit Report?

A credit report is a picture of your credit, debt and payment history. When you apply for credit such as a credit card or a loan, this is reported to one of the major credit bureaus and a file is established in your name. Your credit file will document: credit inquiries made on your file by credit providers, employers, insurance companies and government agencies (usually within the past two years), public record information such as bankruptcies, judgments and tax liens. Your credit history includes the names of your creditors, your payment history, and consumer statements made by you.

How Do I Establish a Credit History?

There are several ways to establish a credit history. Primarily, you have to be extended credit and develop a credit record. If you have not been given credit recently, you can obtain it in a number of ways. For example, you might get a credit card at a local store. If you belong to a credit union, you may be able to apply for a small loan. In addition, you may apply for a loan at a bank or a finance company.

When you receive credit and pay your monthly bills on time, you establish a good credit record. If you are denied credit, find out why and ask how you can correct the situation.

How Do I View My Credit History?

If you write a credit reporting agency and include the proper identification, the bureau is legally required to show you everything in your file and its origin. You may want to request your report every one or two years or before a major credit purchase. There is usually a reasonable fee for this service.

When a credit grantor denies you credit because of information in the credit file, you may contact that reporting credit bureau to obtain a copy of your file.

You can find your nearest credit bureau by looking in the yellow pages under "Credit Bureaus" or "Credit Reporting Agencies." Most credit bureaus are part of one of the three automated reporting systems: Equifax Credit Information Services; Trans Union Corporation; and Experian.

When you have been denied credit, you will want to check the accuracy of your credit file, not only in the initial bureau, but also in the other two reporting systems. You will not be charged a fee.

Who Are the Credit Reporting Agencies?

Experian (Formerly TRW) National Consumer Assistance Center 1-888-397-3742
Equifax Equifax Information Services Center P.O. Box 740241 Atlanta, GA 30374 1-800-685-1111
TransUnion Corporation National Consumer Disclosure Center P.O. Box 7000 North Olmstead, OH 44070 1-800-888-4213
You may also visit Annualcreditreport.com for your free credit report.

Know Your Credit Rights

Truth in Lending Act - Requires all credit grantors to provide you with the annual percentage rate (APR) of any loan prior to signing. APR reflects the true cost of the credit.

Equal Credit Opportunity Act - Prohibits discrimination against you because of age, sex, marital status, race, color, religion, national origin or receipt of public assistance.

Fair Credit Billing Act - Allows for the prompt correction of errors on a credit account and prevents damage to your credit record while you are settling disputes.

Fair Credit Reporting Act - Protects consumers from incorrect credit reporting to credit bureaus. Allows for privacy. Permits the consumer to put a written explanation limited statement in their credit report. Provides for removal of outdated information after 7 years (bankruptcy after 10 years). Credit reporting agency subscribers comprised of banks and merchants, etc., may not access and individual's credit record unless authorized. This authorization is standard procedure when you sign credit and loan applications, life insurance applications, employment applications, security clearance requests, etc. Read the fineprint on the applications for more details.

Fair Debt Collection Practices Act - Prohibits debt collection agencies from abusive collection practices. Allows consumers to dispute a debt and to stop any unreasonable collection activities such as: calling before 8AM or after 9PM, harassment (vs. strong collection tactics), false statements, threatening action that isn't permissible, and unfair practices.