Credit - what is it, how do I get it and how is it used?
What is credit?
Credit is the ability to get something of value now and agreeing to pay for it over a specified period of time. Credit is your reputation as a borrower. It tells others how likely you are to repay your loans.
How do you get credit?
Typically, a person must be at least 18 years of age to receive credit. For first time borrowers it can seem impossible. The best way to get credit is to apply for credit intended for a first time borrowers. Many banks offer loans with collateral such as a savings account or certificate of deposit. These are usually low interest rate options to establish credit. You may also want to ask about applying for a credit card for someone with limited credit history, such as a secured credit card. Sometimes it is easier to obtain a department store credit card rather than a major credit card like VISA, MasterCard or Discover. The only drawback is that department store cards often have higher costs. One other tip to remember: avoid making multiple applications for credit; every inquiry shows up on your credit history making it appear as if you are desperate. And once you obtain credit use it wisely.
How is credit used?
Your credit history is one of the most important financial tools that you will have. A good credit history can give you access to more borrowing options at the best interest rates or terms. In addition, many employers, insurance companies, landlords, cell phone providers and utility companies use your credit history when they make their decision about you.
Credit Bureaus, Reports and Scores
There are three (3) different national bureaus: Equifax, Experian and TransUnion. Each of the agencies operates independently so you will have a unique credit report and credit score through each one. Each lender has a choice of which bureau(s) they use to obtain a credit report, and some lenders choose all three (3) bureaus to get an average score for you.
A credit report includes information about your past and present credit agreements. Some of these will include credit card accounts, mortgages, automobile loans and student loans. It will also provide a list of inquiries that have been made during a given time period. It provides information as to how long your accounts have been established, how much you owe, how much you are obligated to pay and your history of payments. Credit reports may also list derogatory information such as collection items, court judgments, tax liens or bankruptcy filings.
Credit scores are like a grade on a report card; the higher the number the better you are doing at managing your credit. Your score is a 3 digit number ranging from 300 to 850 (depending upon which bureau is used). Your score starts with a Fair Isaac Corporation (FICO) score and is increased or decreased depending upon certain key factors that each of the reporting agencies use. Your FICO score is broken down into certain percentages:
- 35% is your payment history
- Payment information on many types of accounts
- Public record and collection items- reports of events such as bankruptcies, foreclosures, suits, wage attachments, liens and judgments
- Details on late or missed payments (delinquencies) and public record collection items
- Number of accounts showing no late payments
- 30% is the amount owed to creditors
- The amount owed on all accounts
- The amount owed on all accounts, and on different types of accounts
- Whether or not you are showing a balance on certain types of accounts
- How many accounts have balances
- How much of the total credit line is being used on credit cards and other revolving credit accounts
- Balance of installment loan accounts still owed, compared with the original loan amounts
- 15% is length of credit history
- How long your credit accounts have been established
- How long specific credit accounts have been established
- How long it has been since you used certain accounts
- 10% is new credit
- How many new accounts you have
- How long it has been since you opened a new account
- How many recent requests for credit you have made, as indicated by inquiries to the credit reporting agencies
- Length of time since the credit report inquiries were made by lenders
- Whether you have a good recent credit history, following past payment problems
- 10% is types of credit currently in use
- What kinds of credit accounts you have
- How many of each
How to access your credit report and credit score
The Fair Credit Reporting Act allows consumers to access one free credit report annually from each of the three credit reporting agencies. The credit report is available at www.annualcreditreport.com. This free credit report will not provide you with your credit score; however you can contact the credit reporting agency (Experian, Equifax or TransUnion) to obtain your credit score. In some cases a fee may apply. There are also credit monitoring services that can provide this for you; however a fee may apply.
What affects your credit report?
Once you start to establish credit it is extremely important that you continue to make payments on time. It is very hard to repair or rebuild credit once it has been damaged. Some of the actions that can damage your credit are:
- Paying late or missing payments- your payment history makes up approximately 35% of your credit score
- Exceeding your credit limit on revolving accounts- you can maximize your credit score by keeping your usage to less than 30% of your credit limits
- Collections, loan defaults, bankruptcies, or foreclosures
- Legal judgments or tax liens
What to consider before you borrow?
The 5 C’s of credit that most lenders will review for borrowers:
- Credit History - your credit report plays a huge role in the decision- making process of whether to approve your loan request or not
- Capacity - lenders need to know whether or not you can manage your payments. Your employment history, income amount, stability, and type are good indicators of your ability to repay outstanding debt. Your Debt-to-Income Ratio (DTI) also plays a large part in the decision making process. Your DTI ratio is calculated by taking your existing and new monthly debts and dividing those total debts by your pre-tax income (gross monthly pay).
- Collateral - Used when applying for a secured loan. Collateral is something you pledge that you own. The value of the collateral will be evaluated and any existing debt secured by that collateral is subtracted from the value. The remaining equity plays a factor in the loan decision process.
- Capital - Your household income is expected to be the primary source of repayment. There are other types of assets that can help repay the loan. Some of these include savings, investments, an IRA or 401K. These assets also help the lender make or support a certain decision in the loan process.
- Conditions - The lender will need to know how you plan to use the money. The loan purpose plays a key role in the loan decision evaluation process.
Please contact a member of the Fleetwood Bank lending staff if you have any questions on the above listed information. We can be reached during normal business hours at 610-944-7666.