Credit is defined as confidence in a borrower’s ability and intention to repay. People use the credit they have with financial institutions, businesses, and individuals to obtain loans and they use the loans to buy goods and services. The credit a person has typically determines how much they will be permitted to borrow, for what purpose, for how long, and at what interest rate. Access to credit is a valuable benefit, which a person should protect and manage wisely.
The level of “confidence” lenders have in potential borrowers depends on several factors:
- A person’s income is an indicator of a person’s ability to repay, particularly when compared to the amount of debt they already have.
- The amount of borrowing a person has already done and how well they handled repayment is an indicator of their intention and ability to repay.
- Finally, your credit score is a major factor used in making credit granting decisions.
Why Use Credit?
The reasons people borrow are varied and personal. Loans allow you to obtain goods and services today, such as homes and automobiles or a college education, and spread the cost over time. This makes these purchases more affordable than they might otherwise be. Most Americans could not afford homes or cars without the ability to borrow.
Many people, who have built up their savings, use loans instead, because they consider rebuilding their savings more difficult than repaying the loan. Many people who already have the money to pay for items, use credit cards because it is more convenient and safer than using cash or checks. They just pay the full balance when the bill comes.
What Does Responsible Use Of Credit Mean?
Responsible use of credit revolves around the family budget and how much you can afford to devote to loan payments. As a general guideline, borrowing may be justified for automobiles, homes, recreational vehicles, education, home improvements, and other purchases that have value lasting beyond the time it takes to pay them off. Borrowing to pay for daily expenses, such as groceries, gasoline, and utilities, is often a recipe for trouble. These bills will often accumulate faster than you can pay them off.
Responsible use of credit also refers to living within your means. You should always limit the size of the home you buy, or the price of the car you drive, by the size of the monthly payment you can comfortably afford. You should not use credit cards to “supplement” your monthly income — this could result in a situation where expenses exceed income.
What Are The Different Types Of Credit?
There are three types of credit accounts: revolving, installment and open. Understanding their differences can help you make better decisions on which types to use and how using each of the three could affect your creditworthiness.
1. Installment Credit - Installment credit is when you borrow a specific amount of money from a lender and agree to pay off the loan in regular payments of a fixed amount over a specified time period. Home mortgages, auto loans, and student loans are the most common examples of installment credit.
2. Revolving Credit - If you’re granted revolving credit, it means a lender has extended you credit, up to a certain amount, that you’re free to use repeatedly—so long as the account remains open and you make regular, on-time payments of at least the minimum amount due. Credit cards are the most common type of revolving credit, along with department store and gas cards and home equity lines of credit, loans that allow you to borrow against the value of your home.
Unlike installment credit, which is over and done once you’ve paid back the principal plus any interest owed, revolving credit stays open for you to use over and over again—so long as the account is in good standing.
3. Open Credit - This type of credit contains elements of both installment and revolving credit. With open credit, the amount due is usually different each billing cycle, and that amount is typically due in full. A utilities account—gas, electric, water—is a good example of open credit. The amount you owe each month will vary, depending on how much of the commodity you actually use, and the entire balance is expected to be paid.
Charge cards are another example of open credit. Unlike a credit card, which has a set credit limit, charge cards do not have a preset limit. This doesn’t mean they have no limit; just that the limit may fluctuate frequently over time, depending on your spending patterns, payment history, credit score, and other factors.
Credit Terms to Know
Account Condition - Indicates the present state of the account, but does not indicate the payment history of the account that led to the current state. (i.e. open, paid, charge off, repossession, settled, foreclosed, etc).
Accounts in Good Standing - Credit items that have a positive status and should reflect favorably on your creditworthines
Annual Fee - Credit card issuers often (but not always) require you to pay a special charge once a year for the use of their service, usually between $15 and $55. USSFCU Visa Credit Cards charge no annual fee, ever.
Annual Percentage Rate (APR) - A measure of how much interest credit will cost you, expressed as an annual percentage.
Balloon Payments - A loan with a balloon payment requires that a single, lump-sum payment be made at the end of the loan.
Bankruptcy Code - Federal laws governing the conditions and procedures under which persons claiming inability to repay their debts can seek relief.
Capacity - Factor in determining creditworthiness. Capacity is assessed by weighing a borrower's earning ability and the likelihood of continuing income against the amount of debt the borrower carries at the time the application for credit is made. While capacity may be considered in a credit decision, the credit report does not contain information about earning ability or the likelihood of continuing income.
Chapter 7 Bankruptcy - Chapter of the Bankruptcy Code that provides for court administered liquidation of the assets of a financially troubled individual or business.
Chapter 11 Bankruptcy - Chapter of the Bankruptcy Code that is usually used for the reorganization of a financially troubled business. Used as an alternative to liquidation under Chapter 7. The U.S. Supreme Court has held that an individual may also use Chapter 11.
Chapter 12 Bankruptcy - Chapter of the Bankruptcy Code adopted to address the financial crisis of the nation's farming community. Cases under this chapter are administered like Chapter 11 cases, but with special protections to meet the special conditions of family farm operations.
Chapter 13 Bankruptcy - Chapter of the Bankruptcy Code in which debtors repay debts according to a plan accepted by the debtor, the creditors and the court. Plan payments usually come from the debtor's future income and are paid to creditors through the court system and the bankruptcy trustee.
Charge Off - Action of transferring accounts deemed uncollectible to a category such as bad debt or loss. Collectors will usually continue to solicit payments, but the accounts are no longer considered part of a company's receivable or profit picture.
Closed Date - The date an account was closed.
Cosigner - Person who pledges in writing as part of a credit contract to repay the debt if the borrower fails to do so. The account displays on both the borrower's and the cosigner's credit reports.
Credit Limit - The maximum amount a borrower can draw upon or the maximum that an account can show as outstanding.
Credit Report - Confidential report on a consumer's payment habits as reported by their creditors to a consumer credit reporting agency.
Credit Scoring - Tool used by credit grantors to provide an objective means of determining risks in granting credit. Credit scoring increases efficiency and timely res
Equifax - One of the three national credit reporting agencies, headquartered in Atlanta, Ga. The other two are Experian and TransUnion.
Experian - One of the three national credit reporting agencies, with U.S. headquarters in Costa Mesa, CA. The other two are Equifax and TransUnion.
Fair Credit Reporting Act (FCRA) - Federal legislation governing the actions of credit reporting agencies.
Finance Charge - Amount of interest. Finance charges are usually included in the monthly payment total.
Grace Period - The time period you have to pay a bill in full and avoid interest charges.
Guarantor - Person responsible for paying a bill.
Installment Credit - Credit accounts in which the debt is divided into amounts to be paid successively at specified intervals.
Investigative Consumer Reports - These are consumer reports that are usually done for background checks, security clearances and other sensitive jobs. An investigative consumer report might contain information obtained from a credit report, but it is more comprehensive than a credit report. It contains subjective material on an individual's character, habits and mode of living, which is obtained through interviews of associates. Experian does not provide investigative consumer reports.
Involuntary Bankruptcy - A petition filed by certain credit grantors to have a debtor judged bankrupt. If the bankruptcy is granted, it is known as an involuntary bankruptcy.
Last Reported - On the credit report, the date the creditor last reported information about the account.
Liability Amount - Amount for which you are legally obligated to a creditor.
Lien - Legal document used to create a security interest in another's property. A lien is often given as a security for the payment of a debt. A lien can be placed against a consumer for failure to pay the city, county, state or federal government money that is owed. It means that the consumer's property is being used as collateral during repayment of the money that is owed.
Most Recent Date - The date of the recent account condition or payment status. This date is also the balance date.
Obsolescence - A term used to describe how long negative information should stay in a credit file before it's not relevant to the credit granting decision. The FCRA has determined the obsolescence period to be 10 years in the case of bankruptcy and 7 years in all other instances.
Opt In - The ability of a consumer who has opted out to have their name re-added to prescreened credit and insurance offer lists, direct marketing lists and individual reference service lists. Consumers who have previously opted out of receiving prescreened offers may have their names added to prescreened lists for credit and insurance offers by calling 1 888 5OPTOUT (1 888 567 8688).
Opt Out - The ability of the consumer to notify credit reporting agencies, direct marketers and list compilers to remove their name from all future lists. Consumers may opt out of prescreened credit and insurance offer lists by calling 1 888 5OPTOUT (1 888.567.8688).
Original Amount - The original amount owed to a creditor.
Payment Status - Reflects the previous history of the account, including any delinquencies or derogatory conditions occurring during the previous seven years (i.e., Current account, delinquent 30, current was 60, redeemed repossession, charge-off — now paying, etc.)
Personal Statement - You may request that a general explanation about the information on your report be added to your report. The statement remains for two years and displays to anyone who reviews your credit information.
Potentially Negative Items - Any potentially negative credit items or public records that may have an effect on your creditworthiness as viewed by creditors.
Public Record Data - Included as part of the credit report, this information is limited to lawsuits and judgments that relate to the consumer's debt obligations.
Recent Balance - The most recent balance owed on an account as reported by the creditor.
Recent Payment - The most recent amount paid on an account as reported by the creditor.
Released - This means that a lien has been satisfied in full.
Reported Since - On the credit report, the date the creditor started reporting the account to Experian.
Request an Investigation - If you believe that information on your report is inaccurate, we will ask the sources of the information to check their records at no cost to you. Incorrect information will be corrected; information that cannot be verified will be deleted. Experian cannot remove accurate information. An investigation may take up to 30 days. When it is complete, we'll send you the results.
Request for Your Credit History - When a credit grantor, direct marketer or potential employer makes a request for information from a consumer's credit report, an inquiry is shown on the report. Grantors only see credit inquiries generated by other grantors as a result of an application of some kind, while consumers see all listed inquiries including prescreened and direct marketing offers, as well as employment inquiries. According to the Fair Credit Reporting Act, credit grantors with a permissible purpose may inquire about your credit information prior to your consent. This section also includes the date of the inquiry and how long the inquiry will remain on your report.
Responsibility - Indicates who is responsible for an account; can be single, joint, cosigner, etc.
Revolving Account - Credit automatically available up to a predetermined maximum limit so long as a customer makes regular payments.
Risk Scoring Models - A numerical determination of a consumer's creditworthiness. Tool used by credit grantors to predict future payment behavior of a consumer.
Satisfied - If the consumer has paid all of the money the court says he owes, the public record item is satisfied.
Secured Credit - Loan for which some form of acceptable collateral, such as a house or automobile has been pledged.
Security - Real or personal property that a borrower pledges for the term of a loan. Should the borrower fail to repay, the creditor may take ownership of the property by following legally mandated procedures.
Service Credit - Agreements with service providers. You receive goods, such as electricity, and services, such as apartment rental and health club memberships, with the agreement that you will pay for them each month. Your contract may require payments for a specific number of months, even if you stop the service.
Terms - This refers to the debt repayment terms of your agreement with a creditor, such as 60 months, 48 months, etc.
Tradeline - Entry by a credit grantor to a consumer's credit history maintained by a credit reporting agency. A tradeline describes the consumer's account status and activity. Tradeline information includes names of companies where the applicant has accounts, dates accounts were opened, credit limits, types of accounts, balances owed and payment histories.
Transaction Fees - Fees charged for certain use of your credit line — for example, to get a cash advance from an ATM.
TransUnion - One of three national credit reporting agencies. The other two are Experian and Equifax.
Type - This refers to the type of credit agreement made with a creditor; for example, a revolving account or installment loan.
Unsecured Credit - Credit for which no collateral has been pledged. Loans made under this arrangement are sometimes called signature loans; in other words, a loan is granted based only on the customer's words, through signing an agreement that the loan amount will be paid.
Variable Rate - An annual percentage rate that may change over time as the prime lending rate varies or according to your contract with the lender.
Verification - Verifying whether data in a credit report is correct or not. Initiated by consumers when they question some information in their file. Credit reporting agencies will accept authentic documentation from the consumer that will help in the verification.
Victim Statement - A statement that can be added to a consumer's credit report to alert credit grantors that a consumer's identification has been used fraudulently to obtain credit. The statement requests the credit grantor to contact the consumer by telephone before issuing credit. It remains on file for 7 years unless the consumer requests that it be removed.
Voluntary Bankruptcy - If a consumer files the bankruptcy on his own, it is known as voluntary bankruptcy.
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