Credit basics
What is credit?
Whether it is a car loan, a mortgage, or credit card of some type, you are borrowing money to buy something. This is credit. Credit is not extra income—it is money that must be paid back.
Lenders usually charge interest for the money you borrow. The interest rate you are charged may be fixed or variable. While a fixed rate will not change, a variable rate may move up or down based on changes in the underlying rate index.
A lender may structure your credit as an installment loan or as a revolving account. Revolving credit generally has higher interest rates than installment loans.
Installment loans help you purchase big-ticket items with level payments made for an established period of time. Car loans and mortgages are typically installment loans.
Revolving credit, like a credit card, is a loan with a credit limit against which you may make purchases at any time. Your account balance may go up or down over any given time period and your scheduled payment will vary accordingly.
Do your research when considering credit of any kind
Credit is about money—yours. Credit can be a real business tool, but like all tools, its performance has to support its cost. When you speak with lenders, ask these questions:
- What is the interest rate?
- Is the interest rate fixed or variable?
- What are the loan terms?
- What fees and penalties are associated with the credit?
- What is the total cost of the loan?
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Your credit score and report reflect your credit history
A credit score and credit report reflect your payment history, amount you owe, how long you have used credit, how much new credit you have, and the types of credit you have used.
Credit scores generally range from 350-850, with most people scoring in the 600-700 range. The higher your score, the better your credit. Lenders will review your credit score to determine whether you qualify for credit, at what interest rate, and for what amount.
There are three major credit reporting bureaus: Equifax, Experian, and TransUnion. It is worth taking the time to review your credit report from each bureau at least annually to ensure it is accurate. If you find an error in your credit report, notify the credit bureau and ask them to investigate. If you are denied for credit on the basis of a credit bureau’s report, you are entitled to a free copy from the credit bureau. The lender that denied your application will provide you with the name and address of the credit bureau. You are also entitled to a free copy of your credit report once a year. Visit www.annualcreditreport.com to request one.
You can build a strong credit score and report by:
- Making on time payments to all creditors.
- Building a credit history, if you don’t have one, by applying for a small, easily manageable loan at the bank or credit union where you have checking and savings accounts, or at a department store, where it is generally easier to apply for credit.
- Reviewing your credit report every year to ensure it is error-free.
- Avoiding “maxing out” credit cards by approaching or going over your account’s credit limit.
- Paying off each balance and try not to transfer balances to another card.
- Limiting the number of new accounts you apply for and open.
- Being cautious when considering co-signing or co-borrowing. Payments made late by your fellow borrower on such accounts can negatively affect your credit score.
- Establishing a good credit record can sometimes take a few years, because you have to demonstrate over time that you are able to make your payments.
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Using credit to support your financial health
When used wisely, you can use credit to establish a valuable financial history. If you have never used credit but wish to do so as you open a business, you may be turned down for a loan because the lender is unable to ascertain your financial responsibility. Credit can be used in your business to make large purchases such as for equipment or office space, and it can also be useful in times of decreased cash flow, unexpected situations, or the start-up phase of your business.
When you are in need of credit to start a business, you will benefit from having a solid business plan in place. Banks and other lenders will require you to demonstrate that your business is a good credit risk. If you have no credit history or less-than-perfect credit, you may need to broaden your search for business credit. ACCION New Mexico • Arizona • Colorado is a great place to start this discussion!
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Overcoming credit challenges
Credit can easily become overwhelming. The first thing to remember is to not ignore credit difficulties! Even though it can be intimidating, by making an effort to correct your credit, you will eventually get on a path to a solid credit history.
If you cannot make payments on a loan or credit card, begin by calling the lender. Explain the situation and see if they are willing to negotiate different payment terms such as a temporarily or permanently reduced monthly payment.
If you are having serious problems with credit or money management, consider working with a credit counseling agency. A credit counseling agency will typically provide you with money management advice, help budgeting monthly income and expenses, and can negotiate with your creditors to modify payment terms. It is vital that you ensure you are working with a reputable credit counseling agency. The National Foundation for Credit Counseling (NFCC) is a good first step to learning more about credit and finding reputable credit counseling member agencies.
Useful links:
Credit 101 and Credit Counseling:
The National Foundation for Credit Counseling
www.debtadvice.org
Credit Reporting Agencies:
Equifax, Inc.
1-800-997-2493
www.equifax.com
Experian
1-888-397-3742
www.experian.com
TransUnion
1-800-888-4213
www.transunion.com
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