What “Credit” Really Means
The word “Credit” can mean anything from recognizing others for their contribution, to accounting terms for posting, and for purchasing power (buying now but paying later). For the purpose of article, we will focus on the latter and a person’s ability to purchase goods based on their character and good standing.
Even though buying on credit is convenient, it is not always a good decision. Once a person crosses that line, of buying now and paying later, the process becomes more tempting to buy items we do not need or items that are on sale.
Instead we should be asking ourselves, “Can I pay off the debt in a month before interest is added?” “What is the long-term benefit of this purchase?” “Will I end up paying more (in the long run) for the item than it is worth?” “If I had the cash, would I make that purchase?” “Is it a need or a want?”
The wise reasons for not using credit cards are:
- The interest is too high
- Credit cards become debt traps
- Unless, the balance can be paid within the month (before interest is added), there is a risk of the balance growing
- Creditors can change the interest amount at any time (read the fine print).
- It is too easy to end up excessive debt or “bad credit”.
If people have bad credit it means:
- They are not paying other bills or lenders on time. A lender would assume that, “If they aren’t paying other lenders, they won’t pay me.”
- They are not allowed additional credit.
- They are labeled as untrustworthy or a risk.
- Their credit report will show their standing for years.
Good credit (including a credit card) is needed for many reasons:
- To get a job – employers are checking background and credit (especially in positions where the employee will be handling money).
- To buy a car – lenders will check credit to determine eligibility along with what type of interest rates to set.
- To buy a home – the same is true with a home; lenders will check credit and scores.
- To rent a home – many landlords consider the lease like a loan and they want to be sure the renter can and will pay.
- To rent a car – rental companies require a credit card to rent even if the renter pays cash.
- To open accounts with Utility Companies – they check credit for judgments or other signs that the customer is unworthy before approving them.
- To approach education lenders.
- To book travel – hotels, travel agents, and airlines (online or by phone) will require a credit card.
- To get a room at hotels – they require a credit card to attach should there be damage to or theft in the room.
- To run a business – in order get a loan to start or expand the business, the principal party or owner needs good credit.
Years ago, “no credit” was like “good credit.” Today “no credit” is like “bad credit.” Lenders want to see how people pay before taking chances on them. So, if you do not have credit, it is important to establish it. With that said, be careful not to go on a spending frenzy and run up your debt. Too much debt is as bad as “bad credit.”
To build credit, these are things to consider:
- Most credit card companies have “lower limits” for people who have “no credit.”
- A credit card with a lower limit (like $500 or $1000) controls what a new card holder can spend.
Limits are raised after a period of time, when the card holder proves his/her ability to pay.
- Keep the card active by charging, but make sure you can pay off the balance monthly to avoid interest rates.
- Many times lenders will ask landlords about your renting practices (late payments, etc.). Be sure to pay rent on time because that is a source for credit feedback.
- Lenders may look at utility bills (again, how well you pay). So, be sure to pay all your bills on time.
- Jewelry and appliance stores usually have in-store contracts and can be a good source of credit. If you make a purchase, these can be credit references.
It is as important to maintain good credit as it is to establish it. Stay on top of your debt. Too much debt hurts your ability to pay and hurts your credit in the process. Lenders look at the “debt to income ratio”, which means what percentage of debt do you have. That ratio is calculated by dividing your debt (not expenses) by income. If you own a home, lenders do not want to see more that 35% of debt. If you rent, about 25% or less (these ratios can change as the economy changes so check to see what your lenders require).
Check your credit report each year for anything negative and be sure to remove anything that is not yours. There are three credit report companies who provide free credit reports each year. It is recommended that you get each one at a different time in order to stay on top of your credit all year long (for free):
- TransUnion, Experian, and Equifax
- Go to https://www.annualcreditreport.com/cra/index.jsp
The recipient’s credit score will not show up on the free credit report but for about $8, you can order one. The Credit Score is called the FICO (Fair Isaac Credit Corporation) Score which was named after its founder– the originating credit scoring company.
A Credit Report is broken down into several sections. The first section is where you’ll find your Personal Information. It will list:
- The credit report number and date it was issued (usually at the top of the credit report).
- Your name, social security number, date of birth, addresses, and phone numbers.
- Any alias’s (names you may have used like maiden name, first and middle initial, first name and middle initial of your maiden name, nicknames, and so on).
- Employers for whom you have worked.
Be sure to check all the information carefully because there have been cases where other social security numbers or names, not belonging to the recipient, appeared on a report.
The next section, Accounts in Good Standing, will have information on all your current and active accounts, like:
- Installment accounts
- Mortgage accounts
- Revolving accounts (credit card companies)
Information on all of the accounts will be broken down so that the lender or reviewer can see: If the account is an individual or joint account; Who made the account; When was it made; How long has it been open; What was the last activity; What was the highest balance; How is/was the account being paid (satisfactory, delinquent); Is the account open or closed; and How many months has the account ever been behind (30-days late; 60-days late; 90+).
An important section (often overlooked) lists Inquiries made on your credit history:
- It includes inquiries from a bank, department store, auto dealers, apartment managers, or finance companies requesting a copy of your credit report, or
- Promotional inquiries which include any requests done by other companies to see if you are credit-worthy so they can offer you a credit card.
Those inquiries that are not approved by you (promotional) do not affect your credit score. If you approve a lender or automobile dealer to access your credit, but you do not make a loan or use that facility, your score will go down.
Another section on the report will be the Public Record Information, listing items like judgments, liens, foreclosures, defaulted student loans, etc. These can stay on the report for anywhere from seven years to 15 years or life (student loans).
There is also a section that covers adverse or negative information like collections, charge off, and repossessions, which stay on the report for seven years.
The reasons your credit score can go up and down include:
- Making payments on time (goes up); not making on time (goes down)
- Keeping low balances (up); high balances (down)
- Keeping low debt (paying off accounts makes it go up); high debt (down)
- Keeping the same account for years (old accounts tend to make the credit limits go higher); closing accounts (makes it go down)
- Keeping bad inquiries low
- Having too many credit cards or accounts (taking out a lot of small contracts that have no interest or payments for a year) makes your score go down. Even if they are paid off quickly, they remain on your credit report and paint a picture that you use various types of credit often.
Think of credit as “your good name”. You would not want people to misuse your name or to ruin your reputation. Be wise how you use credit. It is better to put that money in your own pocket or savings (which will build quickly over time) than to put it into someone else’s pocket. However, if you use credit, be aware that:
- Wealth is usually built by working hard, planning and saving.
- Credit cards are in business to make money (read that fine print and realize that credit cards can go up on their interest at any time).
- It is especially important in this day and age to be savvy.