PF2 - Credit Lesson

Credit

Credit Reports

Image of a black man using a credit cardCredit bureaus issue credit reports about consumers. A credit report is a written statement of a consumer’s credit history. You can order a copy of your credit report online at the credit bureau’s website. The big three national credit bureaus are:

  • TransUnion
  • Experian
  • Equifax

Credit bureaus base credit ratings on a points system. They add up all your point to determine your credit score, which tells potential creditors the likelihood you will repay debt as agreed. The higher your score, the greater the chance you will be a good credit risk. Your credit score is calculated based on five categories: payment history (35%), amounts owed (30%), length of credit history (15%), recent credit applications (10%), and types of credit used (10%). Your income is not included in your credit report or credit score, but lenders may look at the ratio of your debt to income as it indicates whether you will be able to repay a loan. A better credit score means a lower interest rate. An excellent credit score is 800-950. Below 500 is considered a poor credit score.

Credit Score

Credit Score

What it means

800-950

Excellent credit

700-799

Good credit

500-699

Fair credit

Below 500

Poor credit

Two kinds of credit exist. Installment credit gives borrowers a lump sum, and fixed, scheduled payments are made until the loan is paid in full. Examples of installment credit are mortgages, auto loans, and student loans. Revolving credit allows a borrower to spend the money they have borrowed, repay it, and borrow again as needed. Credit cards are examples of revolving credit.

Credit Score Practice

Credit Worthiness

Before issuing a credit card or making a loan, a lender will establish the credit worthiness of a borrower according to the 3 C's. 

  • Character - Lenders will examine credit reports and look at bill paying history to assess whether the person is reliable and dependable. They look for a high credit score. 
  • Capacity -Lenders may get employer verification or ask for income tax returns to determine if the borrower has sufficient income to pay the bill or loan. They will want to know how long the borrower has been at the present employer or in the business. 
  • Capital (sometimes indicated as collateral) - Lenders want to know if borrowers have valuable assets such as real estate or investments that can be used to pay off the loan if the borrower loses his/her job or source of income.

What do credit cards cost the consumer? Before you apply for a credit card read and understand your offer. Know the answers to the following questions.

  1. Is there an annual fee, a charge each year for being able to use the card?
  2. Do my charges have to be paid within 30 days or can I carry a balance?
  3. What is the late payment policy, and what are the penalties and fees?
  4. What is the credit limit?
  5. What are the over the credit limit fees?
  6. What is the Annual Percentage Rate (APR)?

Think carefully before you pull out the "plastic" to pay for pizzas, a new outfit for the homecoming dance, or a spring break trip. You do not want to be paying for these goods and services for years after they were consumed.

Bankruptcy

Bankruptcy is a legal process that relieves debtors of the responsibility of paying their debts or protects them while they try to repay. The major causes of personal bankruptcy are job loss, emotional spending, failure to budget and plan, and catastrophic injury or illness. Declaring bankruptcy has positive and negative consequences. First, your debts are erased; however, your credit is destroyed for a long time (seven to ten years). Second, exempted assets or those necessary for survival can be retained; however, most of your property will be taken away and sold to pay your debts. Third, certain incomes like Social Security, unemployment compensation, and disability payments are unaffected; however, some debts, like income taxes and student loans will remain. Fourth, the cost is small compared to the financial relief; however, you may not get the fresh start you need.

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