What is credit?
Why do I need it? How do I get it? These are very important questions. Credit has a major impact on your lifestyle and flexibility of choice in this world of ours. This chapter is a detailed exploration of credit and its significance in our lives.
Credit is one of those words that have many different definitions. For our purposes, it has two main definitions:
- Confidence on the lenders part of your ability and intention to repay any obligations you incur and
- The time allowed for payment of goods obtained on trust.
In simple English, credit is your ability to get a loan from a lender or get a credit card and a measure of your ability to repay that loan in a timely manner.
Credit In Everyday Life
A large percentage of Americans operate some pact of their lives on a credit basis. You may have a car loan or a credit card. These are credit instruments. You may have a house, the major credit purchase in most peoples lives. Even utility payments are a credit transaction because you use the utility services before paying for them.
Since credit is so prevalent in all our lives, it is vital that we maintain a good credit rating if we want our lives to run smoothly. While it is possible to live with no credit or even bad credit, it severely limits your options in today’s society.
How To Get Good Credit
Given credits importance in society, how do you go about getting credit? How does your application get evaluated?
To get credit, you must make an application to a lender for credit. You fill out a form that asks for information about you, your job, your income, and sometimes your financial obligations (like the cost of rent/home mortgage, etc.). This information is analyzed by the creditor and if it is deemed positive, you are granted the credit you requested.
Types Of Credit
In general, there are two types of credit you can obtain; secured and unsecured. Secured credit means that the loan is secured by the merchandise purchased with that loan. For example, if you buy a car, that is a secured credit transaction because the lender can repossess the car if you do not repay the loan in a timely manner. Even credit card purchases are secured. This is because the credit card issuer can legally take back the merchandise you purchased if you default on the payments. But this is very rarely done for credit cards. The credit cud issuer doesn’t want books and TVs, not to mention the meals and gas, etc. you charged on your credit card. So credit card issuers usually treat a default in the same manner as unsecured credit is treated, Unsecured credit means that you were lent money on the strength of your signature. This is usually called a signature loan. There is no specific merchandise backing the loan, just the lender’s belief that you will repay the money.
The first step in getting credit is figuring out what you need it for. Are you trying to get a car, boat, credit card, or something else? Generally, if it is a major purchase, your lender (the car dealership, home mortgage lender, etc.) will help you fill out all the paperwork. If it is just a credit card you are applying for, you must shop around on your own. Find a bank offering a low-interest rate. Ask them for a copy of their application. Then fill out all the information they are asking for as accurately as you can.
How You Are Evaluated For Credit
The lender will then use this information for two things. First, the application will be used to get a copy of your credit report from one or mom credit reporting agencies. (In general, for larger loans, like a car Or house, two credit reporting agencies will be contacted and for smaller loans, like credit cards, only one credit reporting agency will be contacted). Second, your application, along with your credit report, will be used to “score” you. Creditors use a scorecard to evaluate your creditworthiness. If you score high enough and, in their eyes, can handle the additional debt load, you are granted the loan. If you score too low, you are rejected. If you are in the gray middle zone, it becomes a judgment call by the lender. If the lender feels comfortable about you, your marginal status will turn into an approval. If the lender feels uncomfortable with you, your marginal status will turn into a rejection.
Creditors like to see the following information items listed on your credit application in order of importance to them when evaluating your credit request:
- A positive, up to date credit report
- A home with a mortgage and up to date payments
- An American Express and/or Diners Club card
- A job you have had for more than one year
- An address you have resided at for at least one year which is in your name.
- A current or paid off bank loan
- A Master Card or Visa card
- A department store credit card
- A telephone/utility bill in your name
From these items and whatever additional information your lender uses, a decision will be made on whether or not to extend you credit. If you are just starting out or if you have bad credit, it becomes much tougher because you don’t score very many points on the lender’s scorecard. Chapter 9 discusses many methods of getting credit if this situation affects you.
Credit And Employment
One other surprising place you may find your credit report used is as part of an employment application. The law allows potential employers to examine your credit report as part of your employment interview process. They use the information provided in your credit report as part of their evaluation of you. Credit reports are being used by more and more companies to check out a potential employee’s “stability”. With all the job shifting going on now, this is another very vital reason to keep your credit report as healthy as possible.
What is negative credit? How is it repaired? Negative credit is created when you do not live up to your contractual obligations. It finds its way onto your credit report in many different ways. The majority of negative items are due to fiscal missteps by you such as paying your credit card late. A much smaller but still significant number of entries comes from errors, fraud, and other abuses of the system. Let’s look at each of these categories in a bit more detail.
Fiscal missteps, the most common cause of negative credit, are caused by actions often originated by you. This could be something as innocent as misplacing a bill and missing a payment as a consequence or it could be something as devastating as the loss of a job which leads to your house being foreclosed upon or you needing to declare bankruptcy. Anything you do which generates a late payment or causes a collection action to be taken against you will probably show up as a negative item in at least one credit reporting agencies report on you.
Errors can be caused in many ways. A loan payment is made on time but the bank made an error when they credited it. Or perhaps a credit reporting agency entered incorrect information on your credit report. These are both examples of the types of errors that may occur.
Fraud occurs whenever someone else uses your social security number on a credit application. By doing this, the lender is accessing your credit report and will make a decision based upon it. If the person doing this is committing fraud, that person will use that credit card until it is full and then walk away from it. When the bank doesn’t get paid, it reports to the credit reporting agencies that you are in default and you now have a negative credit entry through no fault of your own.
Abuses are a subset of fiscal missteps. Basically, abuses are usually credit card abuses. Some people have trouble controlling their spending and soon find that they have $20,000 or more in credit card debt and not enough money to cover the bills. These abuses generally end in bankruptcy and destroy a person’s credit rating for a very long time. The good news is that no matter which combination of the above problems faces you there are solutions. You can definitely remove 100% of all efforts and frauds with a few letters. Any you will find that many of your personal problems can also be removed fairly easily. And, if you are not 100% successful, there are always simple ways to rebuild your credit in a reasonably short period of time.
Protecting Your Credit
Given the turbulent nature of the economy where losing a job is a very real possibility, what can you do to further protect yourself. The best way is to build a sizable nest egg to ride out the bumps that may get put in your path. But, that is hard for many people to do.
It is not the purpose of this book to discuss this matter in detail. There are many excellent personal financial management books on the bookshelves that deal with this situation. What this book can discuss is a way to protect your credit rating and decrease your expenses during this difficult, transitional time.
If you ever get laid off or otherwise find your source of income has dried up, contact everyone to whom you make payments. I mean everyone! Call your credit card companies, the bank with your car loan, the bank with your home mortgage, your utility and phone company, etc. Talk to the credit manager or equivalent person at each place. Explain your situation and ask if you can skip a few payments.
You may state something like “I just was laid off from my job and don’t have an income. Its going to take some time for me to get a new job and get back on my feet. Is there a way I can skip a few payments until I get that new job and can start paying you again?”
After this, let the lender talk. He or she will discuss options with you. Some will not be able to give you any bargaining room while others may give you a 1-6 month grace period from payments. You don’t know what you can get until you ask.
After calling them all, you now know what bills you have to pay and what ones can wait for several months. If your unemployment and savings can cover the “must pay” bills, your credit rating will stay healthy. And, if you find that replacement job in time, your good credit rating is preserved, just as though there were no financial crunch.
With this disaster planning and a bit of luck in the job market, you will get through these troubles with your good credit intact. And, if things don’t work out well and it takes a bit longer than expected to get back to work, this method will at least minimize the damage done to your credit rating. And this will make the subsequent cleanup of your credit report much easier to accomplish.