Chapter 4: Credit and Credit Reports

When used wisely, credit can be a helpful financial tool. It provides convenience, consumer protection, and sometimes rewards for usage. However, despite all the advantages, there are problems associated with credit use. In particular, credit can be expensive and the convenience can lead to overspending.

How Much Debt is OK?

Because living within your means is the primary rule of successfully managing your money, it is best to pay your balances in full each month. If you find that more than 15 percent of your net (take home) income is committed to making unsecured debt payments each month, revisit your budget to make positive changes.

Shopping For Credit

Not all credit cards are created equal. When shopping for an unsecured credit card, look for:

• Low or no annual fee
• Low interest rate
• Long grace period
• Reasonable credit limit

Establishing (or reestablishing) credit

If you have never had a credit card, or have a damaged credit history, you may find that the cards with the best features are unavailable to you. A good way to start – or start again – is with a secured credit card.

Secured credit cards work just like regular credit cards, except that you must leave a deposit with the issuing financial institution as collateral. If you default on your payments, the financial institution takes the money owed out of your deposit. The interest rate and annual fees are often a bit higher than on a regular card. Look for one that does not charge an application fee, and confirm with the issuer that they will report your payment performance to at least one of the three major credit reporting bureaus.

Credit bureaus

In the United States there are three major credit bureaus: Experian, TransUnion, and Equifax. These companies acquire and maintain credit files on almost every US adult.

Check your report

It is a good idea to review your credit report from time to time. This is particularly important before seeking a rental, making a career change, or applying for credit for a large purchase.

You may receive a free copy of your credit report once a year. The three credit bureaus have established one central website, telephone number, and mailing address to use for ordering your report:

Annual Credit Report Request Service
P.O. Box 105281
Atlanta, GA 30348-5281
www.annualcreditreport.com
(877) 322-8228

What is on the report

Because the three credit bureaus are separate, private companies, the information contained on each report may be slightly different. All, however, are divided into the same sections:

• Identification – Most credit reports begin with your personal data, such as your name and any former names or aliases. It also lists your address and former addresses, employment history, changes in marital status, date of birth, and your social security number.
  
  
• Public records – The public records section reflects all lawsuits to which you are a party, as well as any liens or legal claims on your property. Any type of activity that is recorded with the county will be reflected here, including bankruptcies, judgments, foreclosures, and court-ordered child support collections.
  
  
• Trade lines – The bulk of a credit report provides detailed information about your credit history:
  • The names of your creditors and their partial account numbers
  • The dates of last payment activity
  • The date you opened each account
  • Your payment history
  • Each account’s current balance
  • Whether accounts are held jointly, or individually
  • Whether accounts are open, closed, or in collections
  • The credit limit for each account
    
    
• Inquiries – The final section of your report is a list of anyone who has accessed it in the past two years.

How long information may remain on a credit report

Positive information will remain on a credit report indefinitely, which is good because it proves credit worthiness. Most negative information on a credit report can remain for a maximum of seven years from the time it was first reported:

• Lawsuits
• Judgments
• Liens
• Foreclosures
• Chapter 13 bankruptcy (from the filing date)
• Late payments
• Charged-off accounts (from the date the account was written off by the original creditor and sent to the collection agency)

Some information may stay on longer or even indefinitely (if it is not repaid):

• Chapter 7 bankruptcy – ten years
• Child support arrears – until paid
• Student loan debt – until paid

Credit Scores

A credit score is a risk assessment based on the information available in your credit report. If you are in the market for a home, loan, or credit card a high credit score is important, as lenders will look to it to assess their risk in lending you money. Even potential landlords may look at your credit score to help them determine their risk in renting to you.

A common scoring model is one developed by Fair, Isaac and Company- a FICO score. There are many categories of credit information used to determine your FICO score, though some are much more significant in their impact than others. In order of importance, they are:

• Payment history
• Amounts owed
• Length of credit history
• New credit
• Types of credit in use

If your score isn't where you want it to be, you can take steps to improve it:

• Obtain copies of your credit report to check for and correct errors.
• Pay down your debt.
• Pay on time, every time.
• Avoid aggressively transferring balances to new cards.
• Keep your credit card balances well under the maximum available limit.
• Only apply for the credit you need and close cards you don't use.
• Repay old accounts

Recent information matters most – so the faster you do all the right things, the faster you can repair damage. And avoid "credit repair clinics," as they can't do anything you can't do for yourself for free.