Credit Management 101

more detail information about credit management at our affiliated site: SayGoodCredit.com

First: What is Credit?

• Credit allows you to "buy now, pay later".
  
• We use "credit" to buy things now with an agreement to repay the "credit" over a period of time.
  
  For example, the car you need may cost $12,000. Instead of waiting to save enough money to purchase the car with cash, you will use "credit" to finance the purchase. You will then sign an agreement to repay the "credit" over a period of years (months).
  
  Try our credit financing calculators to run some numbers.

Why Good Credit

• Credit cards are the most common forms of credit. Other credit plans include home mortgages, auto loans, student loans, small business loans, trade financing, etc.
  
• Credit is an important component in everyday life. You will use credit to reserve hotels, rent a car, book an airline ticket, get a home mortgage, and in some cases, apply for a job.
  
• Maintaining a strong credit rating is very important.
  
  Businesses will review your credit history when they evaluate your request for loans, insurance, employment, and even leases. They may choose to grant or deny your request based on your credit history provided that you receive fair and equal treatment.
  

What is a Credit History?

• Credit history is a record of all of your credit cards, loans, and other credit obligations that you have assumed over a period of time. It shows how much you have borrowed (or the amount of your credit limit), the number of payments made, and whether you have met the obligations of the repayment terms.
  
  Credit histories are maintained by credit bureaus that lenders use when evaluating applications for credit. We have more information about credit bureaus.

Next: What is the Cost of Credit

• Credit comes with a price: interest rate charges.
  
• Banks and other lenders are willing to give you credit in exchange for interest rate charges on the "credit amount" that you borrow.
  
  For example: let's say you need to borrow $1,000. The lender agrees to give you credit for $1,000 under an agreement that you will repay the borrowed amount in full after one year at an interest rate charge of 10%.
  
  At the end of the year, you will need to repay the debt of $1,000 and interest rate charges of $100 for the use of the money. Your total repayment will be: $1,100.
  
  
• Most credit plans use repayment terms of 3, 5, and even 10 years or more. Home mortgage repayment plans can be as high as 30 years or more.
  
• Lenders will use "amortization schedules" when setting up credit repayment plans. The "amortization schedule" will calculate how much each month you will need to pay in order to reduce your borrowed amount with interest charges to zero over the repayment term of the loan.
  
  You can also download FREE this amortization schedule worksheet to calculate and analyze loan repayment plans: click here

Applying for Credit:

• Lenders (or creditors) generally make an evaluation on your "application for credit" using three criteria known as the "three Cs":
  
  
  1. Character: the measurement of your "willingness" to repay the debt (measured by your past credit experiences, length of employment, length of residence, etc.)
     
  2. Capacity: the measurement of your "ability" to repay the debt (measured by your employment, income, current outstanding debts, monthly expenses, etc.).
     
     see example calculation of capacity ratios
     
  3. Collateral: the measurement of available "resources" that the lender can assume in the event that you fail to repay the debt (savings, property or investment).
     
     
• Creditors often merge the "three Cs" into a sophisticated computerized models to help them determine whether to grant or deny you credit.
  
• A credit scoring system awards points for each factor that predicts who is most likely to repay a debt.
  
• Using statistical programs, creditors compare your information to the credit performance of consumers with similar profiles. A total number of points — a credit score — helps predict how creditworthy you are, that is, how likely it is that you will repay a loan and make the payments when due.

Tell Me More About Credit Scoring

• The credit score is a numeric scoring system at a particular point in time. Lenders use the score to speed up the loan process and provide an unbiased assessment of your loan application.
  
  
• Although lenders and credit agencies have their own proprietary scoring systems, the most common scoring model used among lenders and agencies for consistency is the Fair Issac Company (FICO) model.
  
  You can find more information about the Fair Issac Company.
  
  

• FICO will grade your risk by analyzing the following credit factors:
  
  
1. Your Payment History:
   analyzes your payment of debts, whether they are delinquent or late
   
   
2. Your Amount of Outstanding Debt:
   considers the number of balances recently reported, the average balance among all credit lines or loans, and the relationship between the total balance and total credit limit.
   
   
3. Your Credit History:
   looks at the history of your accounts, the total number of "inquiries" made and new accounts opened over a period of time
   
   
4. The Types of Credit:
   looks at the type of credit you use such as mortgage loans, personal loans, credit cards, retail cards, travel cards, etc.
   
   
5. Negative Information:
   looks for bankruptcies, delinquencies or late payments, collections, too many credit lines charged to the maximum limit.
   
   
• These credit factors are compiled into sophisticated models that have analyzed credit behavior over the years. It generates a score, which in theory states that, the higher the credit score the less likely the lender is at risk that you will default on a loan.
  
  
• Every lender has a different credit tolerance level. One lender may reject your application because of a score while another lender approves it. Your score may be too low for one lending product but passes another.
  
  
• Basically, the score lets the lender know how to treat your application. If your score falls below their minimum threshold, they may require additional information in order to make an approval decision. Again, score determination varies by lender.

• Let us emphasize one more time: it is extremely important to build a strong credit history over time to be granted credit at favorable interest rates for home mortgages, consumer loans, consumer credit, business credit, insurance, and in many cases, good employment.
  
  
• More information about credit scoring:
  www.ftc.gov