What, exactly, is credit?

Simply put, credit is a system by which you can buy and enjoy goods and services now, and pay for them later. There are many different types of credit accounts available – personal loans, credit cards, home mortgages, merchant charge accounts, lines of credit, and the list goes on.

How can I determine the cost of credit?

It's very important that you calculate and compare the actual costs of credit. And since they can vary significantly from one lender to the next, you'll need to be an informed credit consumer. The Federal Truth-In-Lending Act requires creditors to provide you with basic information about their credit costs. This information includes the total amount financed, the finance charges, and the annual percentage rate (APR). Furthermore, when applying for open-ended credit (credit cards, merchant accounts, etc.), the creditor must also inform you of the method used to calculate the finance charges, and when those charges will accrue. You should receive this information in writing before you sign any credit agreement. Many of these notifications must also be disclosed in any advertisements that mention credit.

With this data in hand you'll be able to effectively compare credit offers, which is absolutely critical to uncovering the most advantageous deal for you, and not the lender. Generally, most people don't shop around for credit as they should. They may, for instance, diligently compare the prices of new cars, but not carefully evaluate the finance charges on their automobile purchase. And with the vast number of credit arrangements available today, it's important to all weigh your options – including whether or not you can obtain better financing on your current credit agreements.

Is it true that you need to have credit to build credit?

Yes, this is a true statement. Some people do pay cash for everything, but as a result they have no credit history. And without a credit history there's no way for a prospective creditor to know how likely you are to pay if you are granted credit. Therefore, it's wise that everyone have at least a few credit transactions on file in order to establish their creditworthiness.

Are credit problems really that common?

Although there are no precise statistics, it's nonetheless plainly obvious that many, many people have problems with their credit files. So, if yours is less-than-perfect, you're certainly not alone. Unfortunately, the fact of the matter is that far too many individuals and businesses have credit or debt problems. A poor economy can be cited as one cause; unemployment affects millions of families. Nor can be overlooked the incredible numbers of people that, for a wide variety of reasons, file bankruptcy each year.

Can you really repair 'bad' credit?

Yes, you most certainly can. And not only is it possible, it's definitely in your best interest to do so. No matter how poor your current credit is, you can restore your file and improve your score until you qualify for an excellent credit rating. It may take a little time, but once you develop the good credit habits that will build a strong history, you'll be able to obtain whatever credit you reasonably need.

What are the most common reasons for poor credit?

Most credit problems fall into one of two major categories. The first category is comprised of people who've never before established credit. Those who've had their credit history damaged make up the other group. Credit can be damaged by any number of causes: poor money management or lack of financial discipline, divorce, business failure, job loss, unexpected medical bills, and falling victim to financial scams, to name just a few. Additionally, in more recent years, bad credit ratings have also increasingly resulted from identity theft or errors by creditors or the credit reporting agencies themselves.

Is there only one kind of credit?

While there are many different ways to borrow money (in other words, many different types of credit accounts), there are actually only four types of credit: secured- and unsecured credit, and installment- or non-installment credit. Secured credit is backed by collateral. In other words, you pledge an asset to the lender and if you fail to repay the loan, the lender can seize and sell your collateral. Items that may be used as collateral include your car, real estate, jewelry, a securities investment, or any other asset that you and the lender both find acceptable. Because you've pledged collateral, the lender has less risk, and therefore secured credit is often the easiest credit to obtain. A home mortgage and car loan are common examples of secured credit.

Conversely, with unsecured credit, the lender extends you a loan based upon your ability and willingness to repay. You pledge no collateral, so the creditor assumes a greater risk of loss if you don't pay. The lender must have a greater level of confidence both in you personally and your track record. Therefore, unsecured credit is primarily granted based upon your credit history and current financial condition. If you default, the lender must go to court to sue you, and only after a judgment is obtained can it seize some asset of yours to recover its money.

Installment credit can be either secured by collateral or unsecured. This kind of debt is repaid in periodic installments (hence the name) over a specified period of time. One variation of this type of credit is known as 'open-ended-' or 'revolving credit,' where each payment automatically makes available an equal amount of new credit. Other common examples of installment credit are automobile, personal, and education loans. Similarly, non-installment credit can be either secured or unsecured, as well. However, instead of installments, it's payable in one lump-sum amount by a specified date. A statement reading 'Payable In Full Upon Receipt' is an example of non-installment credit. Telephone bills and doctors' charges, among others, typically fall into this category.

Are there specific times to use credit and specific times when it's better to pay cash?

The general rule of thumb is that when you can afford it, it's usually wiser to pay cash for your purchases. However, that may not always be possible, and it's likely that you'll need at least some credit in some situations, such as:

  • To buy a home, automobile, or other expensive purchase for which you don't have sufficient cash.
  • When you need an essential item but don't have the available cash.
  • For travel accommodations (hotels, rental cars, etc.).
  • When you want the transaction to come under the consumer protection provisions of the Federal Fair Credit Billing Act.
  • When you want to buy online.
  • When emergencies arise for which you have insufficient cash on hand.

How does our credit system work?

A network of credit reporting agencies track the credit transactions of every individual. Whenever you apply for credit, the prospective lender will first check your credit file through one or more of these bureaus. There are nearly two thousand credit agencies throughout the United States; however, only three national bureaus centralize America's credit information: Experian, TransUnion and Equifax. Experian (the largest of the three), for example, processes millions of credit profiles annually and discloses this information to millions of business subscribers such as the banks, lenders and virtually every other type of business that extends credit. Subscribers pay the credit bureaus a fee to obtain the reports. They view credit history as the best indicator of individual (or business) creditworthiness, and can also use the files to verify information on credit applications. Subscribers who receive new credit information may also exchange it with the credit bureaus. For instance, whenever you apply for additional credit, your information may be forwarded to one or more of the agencies. This constant updating between subscribers and the credit bureaus helps to keep credit files current.

Collectively, the three national credit reporting agencies maintain credit files on hundreds of millions of Americans and over ten million businesses. Each of the three bureaus can individually track the credit history of any American, regardless of where he or she may relocate to. And each one of the credit bureaus is also likely to have its own credit report on you, although their credit information will not necessarily be exactly the same. Information that appears on one agency's report may not be on another. For this reason a more diligent creditor will check the reports from all three bureaus to get a more complete picture of an applicant's credit history.

Subscribers who most commonly receive and issue credit information include the commercial banks (including their credit card departments), other credit card companies, larger savings and loan institutions, major department stores, and finance companies. However, not every subscriber reports credit data to the credit bureaus, and some subscribers do not report an individual's entire credit file. The less-frequently reporting subscribers tend to be hospitals, utility companies, credit unions, merchant and oil company credit card issuers, and bank checking and savings departments. It's for this reason that a bounced check will likely not appear on your credit report.

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