The Importance of Good

Credit

The good, the bad, and the important things to know about credit.
The world seems to run on credit nowadays. Many of us have school, car and even
home loans. And we likely all have one or more credit cards in our wallet. The problem
is we dont give credit the amount of thought we should.
At its best, credit can help us manage our financial lives. At its worst, it can get us into
serious financial trouble.
Your credit history is something that stays with you for a long time and
can impact everything from buying a home to getting a job.
Its an important source of information that people who grant loans use to determine if
theyll lend you money, how much and under what terms. The better your credit history,
the more likely youll be able to obtain the financing you need at favorable terms. So,
needless to say, having good credit is of great importance.
What exactly do you need to know?
Lets start with a quick test. In your opinion, which of these statements about credit is
true?
Credit is the temporary use of someone elses money
Credit is a measure of your financial trustworthiness
Credit is a financial obligation you have to repay
Credit is debt accumulated from a credit card or loan
All of the statements describe credit. Credit is any debt youve accumulated either from
using a credit card, borrowing through a student loan or car loan, a line of credit,
mortgage, home equity loan, or personal loan.
Basically, having credit means youve been given the ability to borrow
money from someone and youve agreed to pay it back over time,
usually with interest.
Having a cell phone account or an apartment lease doesnt mean you have a credit
history. While you do need to pay your phone bill and your rent, doing so doesnt have
much of an impact on your credit rating. The twist? NOT paying those things could show
up negatively on your credit history because youve failed to pay as agreed.
Why having good credit is important
This probably isnt anything you dont already know. But its all worth repeating. Among
other things you may need good credit to:
Qualify for various education loan programs
Get the job you want
Obtain affordable insurance
Achieve financial goals like buying a home or financing a professional practice
Simply, your credit history is one of the primary tools that credit grantors use to
determine if theyll lend you money, how much, and under what terms. It makes sense
that the better your credit history, the more likely youll be able to obtain the financing
you need at favorable terms when you need it. And its important to think about the
future. You dont want your credit history to get in the way of achieving personal or
professional goals.






Getting Credit

To obtain credit you have to be financially responsible and you may need to meet a
minimum age requirement. You may also need to prove that:
Youve been repaying your debts and managing credit in the past
You have sufficient collateral from which you could repay your debt if necessary
You have sufficient income to repay what you borrow
The 3 Cs of credit
This is a fast and easy way to remember what it takes to get credit. The 3Cs
summarize your ability to get credit.
The 3Cs are:
Character
Capital
Capacity
Character refers to your history of handling credit. Are you honest and reliable? Do you
pay your bills on time? Good credit management will show up on your credit report.
Lenders want to know if you pay your bills on time (particularly your debts), how much
debt you currently owe, how long youve had credit, how frequently you apply for new
credit and what types of credit youve obtained in the past.
Capital refers to assets that you own such as real estate, personal property, savings,
automobiles, and other collateral that can be used to repay credit debts if income is
not available.
Capacity is a measure of your ability to repay a debt. Do you have a steady source of
income and is it enough to repay all that you owe as well as the new loan youre trying
to borrow? And will that income also be enough to meet your other monthly expenses
such as rent, food and transportation?
A creditor may not evaluate all three Cs in all cases because credit products vary. For
example, Capacity is not usually considered in the case of student loans.
If you are not able to show that you have the 3Cs, does it mean that you wont be able
to get credit? Not necessarily, but it might make getting credit more difficult and/or more
expensive.
How to find out if you have a credit history?
If you want to check to see if you have a credit history, go to AnnualCreditReport.com.
You are entitled to a free credit report from each of the three national consumer
reporting agencies (Equifax, Experian and TransUnion) once every 12 months. Be
careful and watch out for other ways that claim to provide you with a free credit report
as there is typically a hidden fee associated with additional services such as credit
monitoring.
A credit card can help you establish credit.
This is one of the upsides of having a credit cardassuming you manage your account
wisely! Having a credit card can allow you to establish a positive payment history
without going into debt.
Remember, you dont have to use your card a lot. Charge one thing a
month (a bag of groceries) and then pay the bill in full when its due.
Over time this will help you establish a good payment history, and
therefore, good credit.
Whats more, doing the right thing with a credit card can help to offset the impact of
having increasing student loan debt. And sorry, but we have to say it again: use credit
cards for convenience not for credit! (There, we feel better.) Building up credit card debt
that you cannot afford to repay will negate any of the benefits of positive payment
behavior.


What if you want to get your first credit card?
Current wisdom suggests that you first open a checking or savings account. Then
create a spending plan. Once youve established your budget, apply for a credit card
and charge a purchase or purchases. Dont open numerous accounts just because you
can. One will do. Most importantly, make your credit card payment on time and pay the
balance in full each month to avoid accumulating debt!
How exactly do you go about getting your first card? It has actually become more
difficult for young people to qualify for a credit card. The Credit Card Accountability
Responsibility and Disclosure (CARD) Act of 2009, also known as the Credit Card Bill of
Rights, has made it harder for anyone under the age of 21 to get a credit card. If youre
under 21 you must have:
A creditworthy cosigner who is at least 21, or
Sufficient income or other financial resources to repay the debt
And, the issuer may impose other eligibility criteria
If youre 21 or older you still have to meet the issuers credit requirements that will likely
include a review of your credit history.













Establishing Good Credit

The Golden Rule of Credit: Pay all of your bills on time.
If you live by certain rules, you will put yourself in the best position to develop and
maintain a good credit history.
Pay all of your bills on time.
This is the MOST important thing you can do. This doesnt only refer to paying credit
card bills, but all of your bills such as mortgage, car payments and student loan
payments. In fact, its not just about your debts.
If your rent, cable, phone or utility bills become seriously delinquent, that could show up
on your credit history and cause problems for you. Non-payment or late payment could
impact your ability to obtain credit in the future. Missing a payment by just one month
can end up as a negative mark on your credit report, something you may find yourself
having to explain years later.
It is recommended that you make bill paying as systematic a process as you can. Keep
your bills in a safe place and keep track of all payment due dates. Schedule a regular
time to sit down and pay your bills. Of course, be sure you have sufficient funds to cover
the payments, and keep a record of when you paid. You should also consider using
auto-pay features and online payment options.
Notify all creditors promptly of changes in address, etc.
Limit your use of credit cards for credit, and when you use them, pay the bills in
full each month. Its okay to use credit cards for convenience. Its not okay to use them
for credit which can put you in debt.
Minimize your debt, especially from credit cards.
And finally, be sure to review your credit reports annually for accuracy, and to be
certain that you havent become a victim of identity theft.
Tip:

QUESTION: Is paying your credit card bills on time each month both necessary and
sufficient for having good credit?
ANSWER: No. Paying your bills on time is necessary but its not enough. All of the
information in regard to your handling of your credit accounts will affect your credit
history. It will take into consideration things like how long youve had a credit card(s),
whether youve had outstanding debt, how often you use credit, the frequency with
which you open new accounts, and so on.
















Credit Scoring

What is credit scoring?
Your credit score is frequently used as a measure of your credit risk based on
information in your credit report.
Why is it used? Its all inclusive. It captures all of the information reported in your credit
report about your credit accounts and how youve managed those accounts.
Its not enough to look at the amount of your total credit card debt. Your debt can
influence risk, but it ignores other factors such as your payment history. Your debt-to-
income ratio impacts credit risk and is a good measure of risk, but it relies in part on
information that is not included in your credit report: your income. And, the number of
loans youve borrowed can affect your credit score, but once again it ignores other
factors that influence risk, such as payment history.
So, its all about your credit score.
Your credit score is a numerical forecast of the likelihood that you will
successfully repay a future loan on time. Its an automated credit
evaluation tool that is based on credit account information in your
credit report.
The actual method and model first used to generate credit scores was developed by
Fair Isaac Corporation, and is proprietary. The scoring is based on statistical modeling
and the most general (generic) version developed by Fair Isaac Corporation is known
as a FICO

score.
Scores do NOT increase arithmetically. For example, its much harder to increase your
FICO score from 750 to 800 than it is to increase it from 700 to 750.
Determining Your Credit
Score
Certain credit account information is better at predicting credit risk than other
information. To arrive at your FICO Score, information is weighted.

Payment history (35%)
Your payment history has been found to be the most important factor in determining
your credit risk and your credit score. Generally, it accounts for 35% of your FICO
score. Payment history takes into account whether youve paid your accounts on time or
not. It also looks for the presence of any adverse public records, collection accounts
and/or delinquency. If there is any delinquency, your history will detail the severity,
taking into consideration the amounts past due, the number of past due accounts, and
so on.
Amounts owed (30%)
The next most influential factor in determining your FICO score is the Amounts Owed
as shown on your credit report. This factor typically accounts for 30% of your score. It
focuses on the total amount you owe on all credit accounts; the amount owed on
specific types of accounts, particularly credit cards (revolving credit accounts); the
number of accounts with balances; and your utilization of revolving credit accounts as
measured by your total outstanding credit card balances as a percentage of your total
available limit on each of your credit card accounts.
The more you owe on your accounts, the more accounts you have with balances, and
the higher the percentage of your credit card utilization, the higher your credit risk. As
such, as these factors increase they will tend to have a negative impact on your score.
Length of credit history (15%)
A third factor influencing your FICO score is the length of your credit history. It accounts
for about 15% of your score. It factors in the length of time since you opened your first
credit account. It also looks at the length of time youve had specific types of accounts
such as credit cards and a mortgage. And it factors in when the most recent account
activity was reported. In general, the older your credit history, the more reliable it is at
providing information about your possible future credit behavior. It simply has more
data, and as such, gives a better prediction of credit risk.
Consequently, you want to make sure that if you plan to close an account (such as a
credit card you no longer use) you make certain it is not the oldest account on your
credit history. If it is, closing that account may result in the length of your history
becoming shorter and this could have a negative impact on your score (albeit a small
one).
New credit and account mix (10% each)
Two other factors account for the remaining 20% of your score (each accounting for
10% on average). They are New Credit and Account Mix. New credit is measured
by the number of recently opened accounts and the proportion of accounts that are
recently opened, by type. It also looks at the number of recent requests for your credit
report or inquiries for the purpose of obtaining additional credit. In addition, information
about new credit includes the length of time since you opened your most recent
account, by type of account. The more frequently you obtain new credit, the higher your
credit risk, and this can lower your score.
Your account mix factors in the various types of credit accounts currently listed on your
credit report, e.g., credit card(s), revolving credit, retail account(s), installment loan(s),
mortgage(s), consumer finance account(s). The more variety you have, the lower your
credit risk and the higher your score based on this factor.
Putting it all together
But remember, your credit score is based on the interaction of all the credit account
information in your credit history. And although some factors generally have more
impact on your score than others, all information can have an impact. And how much
one factor ultimately impacts your particular situation will depend on how you have
managed the other factors. For example, if you miss a payment for the first time but
have had credit for a long time (say at least 20 years), you likely will have a smaller
reduction on your credit score because of the missed payment than someone who has
a shorter credit history.
Impact of student loans
Education loan debt does not necessarily result in a low credit score. Because
education loans are installment debt, they are typically viewed more favorably
than revolving debt in credit scoring.
And although increasing your level of debt (including from student loans) does increase
your credit risk to a future creditor, it does not necessarily cause a significant drop in
your credit score. How much your credit score might fall due to increasing your level of
debt will also depend on how youve managed the other factors in your credit history. As
mentioned above, these factors include your payment behavior (are you paying all your
credit accounts on time); how long youve had a credit history; the frequency with which
you apply for new credit; and the mix of your credit accounts.
The only time this can create a problem for you is if you have thin credit files, which
means you have three or fewer accounts (also known as trade lines) being reported or
you have less than 24 months of account history on those trade lines.
What are credit inquiries?
Inquiries are requests to see your credit score. There are two types of inquiries on
your credit score, hard (voluntary) and soft (involuntary).
Hard inquiries occur when a lender requests your credit report because youve applied
for credit from them. Hard inquiries could have a negative impact on your credit score,
especially if more than three have been made within the past 12 months.
This is because statistics show that those individuals who are trying to get more credit
on a frequent basis are more of a credit risk than those who are not doing so.
Soft or involuntary inquiries, on the other hand, do not indicate youre trying to get
more credit. And as such, they are not included in the scoring process. Although they
will be reported in the Inquiry Section of any credit report you request, they will not be
included on reports sent to any other party.
These inquiries can include your requests for a copy of your credit report (self inquiries),
promotional inquiries such as those where a credit card company obtains information
from your credit history as part of a marketing campaign to obtain new customers,
administrative inquiries by a consumer reporting agency or your existing creditors, and
inquiries from prospective employers or landlords.
There is an exception regarding the impact of hard inquiries when it comes to certain
types of installment loans, particularly automobile loans and home mortgages. This is
because of the nature of shopping around for these types of loans. Credit scoring
models do not tend to penalize you for rate shopping. This is particularly true in those
cases where it seems clear that youre shopping for a single new loan. For example,
FICO scores consider all inquires for an auto loan or mortgage within any two week
period as a single inquiry.
Maximizing Your Credit
Score
Obtaining the highest credit score you can is simply a matter of good financial
management.
Here are four smart strategies:
1. Dont procrastinate. Pay all of your bills on time.
2. Keep your credit card debt as low as possible.
3. Maximize the length of your credit history. Older credit accounts are scored more
favorably. The older your credit history, the more reliable it is at providing information
about your possible future credit behavior. It simply has more data, and as such, gives a
better prediction of credit risk.
4. Minimize the opening of new credit accounts especially credit cards.







Whats In Your Credit
Report
These are the kinds of things youll find in your credit report.
Personal Identifying Information: This is your basic demographic information. It may
include your name, current and previous addresses, telephone number, Social Security
Number, date of birth, current and former employers and the name of your spouse (if
youre married).
Alerts: This is where any fraud alerts, indicating youve been a victim of identity theft,
are reported.
Credit Summary: This is an overview of how youve managed your credit accounts.
Account History: Your credit accounts are often referred to as Trade Lines. Lenders
report on each trade line or account youve established. Its kind of a running tally.
Your account will include certain basic information, but the exact information contained
in each account history could differ from one consumer reporting agency to another.
Youll see two kinds of inquiries. There are voluntary or hard inquiries and
involuntary or soft inquiries.
The hard inquiries are those created because you have requested a new credit account
or additional credit on an existing account. Soft or involuntary inquiries can include your
requests for a copy of your credit report (self inquiries), promotional inquiries such as
those where a credit card company obtains information from your credit history as part
of a marketing campaign to obtain new customers, administrative inquiries by the
consumer reporting agency or existing creditors and inquiries from prospective
employers or landlords.
Collections: This is a listing of any credit accounts that have been sent to a collection
agency by a creditor.
Public Records: This includes bankruptcies, foreclosures, collections, wage
attachments or garnishment, liens and judgments.
Dispute File Information: You have the right to request that a consumer reporting
agency include your written statement disputing a reported item if, after review, the
disputed item is not resolved to your satisfaction. This does not mean, however, that
you can include explanations as to why you might have missed a payment or some
other derogatory item that is not in dispute.
Whats not in your credit report.
Current Federal law prohibits lenders from using certain personal information about you,
including (but not limited to) your race, gender, religion, or national origin in making a
credit decision.
So there is no reason for that information to be in your credit report. Information about
your sexual orientation, income/earnings, medical history, checking and savings
accounts and the interest you might be paying on your debts are not included in your
credit history, so they wont appear on your credit report either.















Understanding Credit Cards

Most people understand the basics of credit cards. We use them to pay for things we
want or need and then we pay the bills when they come in the mail or online. Still, its a
very good idea to backtrack for a minute and really understand what credit cards are all
about. You may already know a lot of this information, but a refresher course is not a
bad idea. It will serve to remind us that these are very powerful pieces of plastic.
Credit cards are revolving credit accounts.
A revolving account means the amount you owe at any point in time can fluctuate up or
down, based on your use. It is essentially a line of credit that lets you make purchases
and pay for them over time, with interest.
Interest rates on credit cards can be fixed or variable.
A fixed rate doesnt change unless youre notified in advance by the card issuer.
A variable rate is calculated as the sum of an index plus a spread. An example of this is
the Prime rate plus a spread of 2%. The rate will change, without notification to you,
whenever the index changes.
Also, creditors can change your rate due to bad behavior on your account. When this
occurs, however, you must be notified in advance of the change with an explanation as
to why the change is occurring and any options you may have regarding that change.
See Fees and Rates for more information.


Credit cards v. charge cards v. debit cards.
There are important differences between cards.
Credit cards let you charge something now and pay for it over time. You can carry a
balance from month to month.
Charge cards, (think American Express) allow you to purchase something now, but you
have to pay for it in full when the monthly bill is due. You cant carry a balance.
And debit cards are NOT a form of credit at all and dont serve to establish a credit
history. When you buy something with a debit card, the funds are deducted
electronically from your checking or savings account as soon as the transaction is
posted.
Do you know your limits?
The limit is the maximum amount that the card issuer lets you owe as an outstanding
balance at any one time. If you manage your account responsibly, the issuer may
increase your limit at some point. But did you know that you do not have to accept the
credit increase? Saying no to a credit limit increase is a good way to stay within
yourself.
Another feature of credit cards is the grace period. This is the time during which you
can avoid finance charges if you pay the amount owed in full by the due date. If there is
no grace period, it means that every use of your credit card will begin accruing finance
charges as soon as the transaction is posted to your account.
Here are some credit card ABCs.
A credit card is helpful for emergencies, but emergencies rarely happen at the
shopping mall.
Buying on SALE is still SPENDING, not SAVING.
Cash advances on your credit cards are very expensive and a bad, bad idea.
Debt from credit cards will make it harder to invest for the future.



Managing Your Credit
Cards
Paying the minimum adds upthe wrong way.
Whats the impact of paying only the minimum on your monthly credit card bill? Heres
an example to illustrate the effect.
Lets assume:
You have a credit card balance of $5,000
The Annual Percentage Rate (APR) is 15%
Your minimum payment = interest + 1% of your balance
Heres what would happen:
Your total time to repay the balance would be 269 months (22.4 years!)
The total interest youll pay is $5,798 (thats just interest!)
This assumes you STOP using the credit card.
If you want to calculate how long it would take to pay off your current credit card debt,
paying only the minimum required amount, go to BankRate.com.
True or False?
You need to carry a balance on your credit card from month-to-month in order to
establish a good credit history.
FALSE! FALSE! FALSE! In fact, youll have a better credit history if you pay your credit
card bill in full each month.