Credit plays a critical role in many of our lives, allowing us to afford cards, homes, and even college education. It is used as a gauge of financial responsibility that can influence where you live and even where you work. By understanding the basics of credit, you can more easily master this financial necessity and get yourself out a debt or plan for a better financial future.
Credit is borrowed money that you can use to purchase goods and services when you need them. You get credit from a credit grantor, whom you agree to pay back the amount you spent, plus any applicable finance charges, at an agreed-upon time.
There are 4 types of credit:
- Charge cards/accounts
- Revolving credit – credit cards, equity loans
- Installment credit – mortgage, student loan, car loan
- Service contracts – cable, utilities
Credit in and of itself is neither good or bad; it is how you utilize it that can have positive or negative impacts on your financial well-being. Credit can be a convenient way of purchasing items, especially expensive items, without the need for cash. However, credit is a loan and you will be paying more for that purchase in the long run. Also, because of the convenience, it is easy to overspend with the appropriate means to pay back the loan effectively.
All of your credit information is compiled into a credit report by 3 different credit reporting agencies: Experian, TransUnion, and Equifax. Your credit report is made up of:
- identifying information (name, address, social security number)
- Job history (where and how long)
- Creditors; payment history (name of creditor and how long credit has been open)
- Legal actions (liens, collections, foreclosures, bankruptcy)
- Inquiries you initiated (where personally or by a creditor with your permission)
You are entitled to a free credit report every year from each of the 3 reporting agencies so it is best practice to request your report from a different agency every 4 months to ensure your credit report is accurate. If there is an error with your report, you can dispute the error in writing to the credit agency. The agency is required to investigate your dispute within 30 or automatically remove the disputed item from your credit report.
Credit reports and credit scores are often mistakenly assumed to be the same thing, but they are very different and focus on different aspects of your credit situation. The most common credit score is the FICO score which is used by Experian. Each credit reporting agency has its own scores and ways of calculating them. As a general rule of thumb, you credit score is made up of:
- Payment history – 35%
- Accounts owned – 30%
- Length of credit history – 15%
- New credit – 10%
- Credit mix – 10%
Your credit score is often utilized by creditors to determine interested rates while your credit report can be used to determine pre-qualified or pre-approval amounts. Lenders, landlords, insurance companies, and even employers can all look at your credit score. Generally, a credit score of 700 or higher is considered good. There is a new movement to include other information for consideration in your credit score, especially for those with little or no credit history, including payment history for service contracts as well as length of address history.
There are many different ways to establish credit:
- Open a checking or savings account with a credit union
- Put utilities/rent/mortgage in your name
- Get a local department store or gas card
- Have a co-signer for a small personal loan
- Apply for a secured credit card
While your credit report and score are major components that creditors consider, they also look at the 3 C’s of Credit:
- Character – From your credit history, a lender may decide you possess the honesty and reliability to repay a debt
- Capital – A lender will want to know if you have valuable assets such as real estate, personal property, investments, or savings with which to repay debt if income is unavailable
- Capacity – Refers to your ability to repay the debt. The lender will look to see if you have been working regularly in an occupation that is likely to provide enough income to support your credit use
So how to you maintain good credit?
- Create a spending plan and live within it
- Pay your bills on time, all of the time
- Have some credit, but not too much
- Have a mixture of credit types
- Keep credit card balances low
- Use caution when closing accounts
- Be aware of your debt-to-income ratios
- Contact lenders if you fall behind on payments
For more information about managing your credit or to discuss your personal credit situation, please reach out to the Credit Union of New Jersey for a consultation. For a copy of the presentation, please visit https://www.njstatelib.org/wp-content/uploads/2020/01/Understanding-Credit-Compressed.pdf. For a copy of the handouts, please visit https://www.njstatelib.org/wp-content/uploads/2020/01/Understanding-Credit-Handouts.pdf.