The Basics of Credit

By: Omar Elayan

Credit Cards

  • Credit - the ability of a customer to obtain goods or services before payment, based on the trust that payment will be made in the future.

  • Forms of credit

  • Loans: let you borrow money that must be repaid with interest. You can obtain a loan for a specific purpose, such as financing a new car, paying college tuition and buying or renovating a home. You can get a debt consolidation loan, which combines all current debts from various creditors into a single reduced-interest payment plan. You can also get a credit limit linked to your checking account that gives you bounce-proof protection in case you write a check for an amount that exceeds your account balance.

Loans are generally divided into two types: secured and unsecured.

  • Secured loans: are guaranteed by collateral, which is an item of equal or greater value than the amount

  • of the loan, such as a car, home or cash deposit.

  • Unsecured loans: do not require collateral and are made based on your credit score and ability to repay.

  • Installment loans: are made for a fixed amount at the time of your application and approval. This type of loan is repaid in fixed monthly payments over a specific period of time. The interest charges are included in the payments. Auto loans and mortgages are examples of installment loans.

  • Credit cards: are perhaps the most common type of personal credit. Unlike installment loans, credit cards allow repeated transactions up to a maximum credit limit, also known as your available credit limit. Each time you charge something, you are borrowing the money until you pay it back. If you decide to pay the money back over time, the credit card company adds interest charges to your account. Each month, you will pay a calculated amount until the borrowed amount is repaid

  • Costs are associated with accepting credit cards

The primary costs associated with credit cards are the discount fee charged by the credit card processing company and the up-front cost of purchasing the equipment. The fee varies, among other things, on the type of card accepted and the method used to enter the transaction. Generally, swiping a card that is presented by the customer yields the lowest cost. On the other hand, accepting credit cards over the phone yields a higher rate due to the increased possibility of credit card fraud.

  • Credit Score Determined

A credit score is a complex mathematical model that evaluates many types of information in a credit file to determine your financial reliability or credit risk; that is, how likely you are to repay a loan and make your loan payments on time. Many factors influence your score, with the two most important being how you pay your debts and how much debt you owe. For example, late payments on loans, a past bankruptcy, debt collections or a court judgment ordering you to pay money as a result of a lawsuit will negatively affect your credit score.

According to the Fair Isaac Corporation that calculates the popular “FICO score”, the following factors (and weighting) determine your credit score.

  • Payment History (35%) , which includes account payment information, bankruptcy or judgments, how long overdue payments are, amount past due, and the time since any adverse occurrences.

  • Amounts Owed (30%) , which includes the amounts owed on accounts individually and totaled together as a whole, number of accounts with balances, proportion of credit line used and proportion of installment loan amounts still owed.

  • Length of Credit History (15%) , which includes the time since you accounts have been open as well as the time since your accounts have been active.

  • New Credit (10%) , which includes the number of and time since recently opened accounts and proportion to total accounts, number of and time since recent credit inquiries, and the re-establishment of positive credit history following past payment problems.

  • Types of Credit Used (10%) , which includes the number of various types of accounts, like credit cards, retail accounts, installment loans, mortgage, etc.

Credit scores change over time to accurately reflect your current financial behavior and length of credit history. Accurate negative information can be reported for 7 years, with the exceptions of bankruptcy (10 years), lawsuits or judgments (7 years or until the statute of limitations runs out, whichever is longer), or information based on an application for a job with a salary of more than $20,000 (no time limitation). Since your credit score is a “snapshot”, it’s unlikely that your credit score a month ago is the same as it is today.

In order to ensure that credit reports are fair for everyone, certain factors are not included in your score. To name just a few, race, religion, national origin, sex, age, salary, and any other information not proven to be predictive of future credit performance are never included in calculating your score.

  • Vocabulary

  • Credit: the ability of a customer to obtain goods or services before payment, based on the trust that payment will be made in the future.

  • Credit Score: a number assigned to a person that indicates to lenders their capacity to repay a loan.

  • Credit Bureau: a company that collects information relating to the credit ratings of individuals and makes it available to credit card companies, financial institutions, etc.

  • Credit Report: A detailed report of an individual's credit history prepared by a credit bureau and used by a lender to in determining a loan applicant's creditworthiness, including: 1.

  • Creditworthiness: An assessment of the likelihood that a borrower will default on their debt obligations. It is based upon factors, such as their history of repayment and their credit score.

  • Interest (APR): The annual rate that is charged for borrowing (or made by investing), expressed as a single percentage number that represents the actual yearly cost of funds over the term of a loan. This includes any fees or additional costs associated with the transaction.

  • Lender: an organization or person that lends money.

  • Credit Cards: a small plastic card issued by a bank, business, etc., allowing the holder to purchase goods or services on credit.

  • Personal Loans: is an unsecured loan, meaning the borrower does not put up any collateral or security to guarantee the repayment of the loan. For this reason, personal loans tend to carry high interest rates. If a borrower owns a home, a lower interest rate alternative is a home equity loan.

Vocabulary Watch

What You Need to Know

  • What is a credit card? a small plastic card issued by a bank, business, etc., allowing the holder to purchase goods or services on credit.

  • What are the benefits and costs of using credit cards?

  • Use it to stay on top of your day-to-day spending

  • Your credit card can help you keep track of your expenses. Save your receipts and check them against your monthly statement. Notify your credit card company right away if you spot any errors.

  • If your credit card is missing or if you notice suspicious charges, call the number on your statement or the back of your card immediately. In most cases, you won’t be held responsible for any charges if your card or account number has been stolen.

  • If you have online access to your account and your credit card issuer offers optional security alerts, sign up to be automatically notified of any unusual activity on your account

  • Check with your credit card issuer about damage protection. Some credit cards provide protection if you buy merchandise that turns out to be defective.

  • Many credit card companies offer payment due date reminders. Sign up for these reminders to avoid being charged a late fee.

  • Use it to build your credit history

  • Use it to save money

  • Use it to get rewards

Don’t Fall Into the Credit Card Trap

1.Don’t give your account number over the phone unless you’ve initiated the call. If you’ve dialed a wrong number, don’t give it out at all.

2.Get a card that has added security features, like a photo ID. Your mom will be so proud.

3.Never write your account number or PIN on the outside of an envelope or postcard. Grandma doesn’t need to know your PIN.

4.Draw a line through blank spaces on charge slips above the total to prevent any changes. You want to tip well, but not that well.

5.Don’t sign a blank charge slip unless absolutely necessary, and only if it’s in an actual store. Never sign a slip handed to you by Dave from down the hall.

6.Save receipts. Pretend they’re old concert tickets.

7.Always check receipts against your monthly statements. If anything looks fishy, report it within 60 days of the statement’s mailing date. Unless you actually bought fish with your card, in which case, don’t report it.

8.Make a list of card numbers, expiration dates, and the toll-free numbers of your credit card companies. Keep this record in a safe place, separate from where you keep your cards. Use this information if you ever have to report your cards lost or stolen.

9.Carry only the cards you need, especially when traveling. To clarify: you may need 1 or 2 cards. You will not need 6.

10.Never lend your card to anyone, and don’t leave cards or receipts lying around your room, no matter where you live. We know, we know, Omega House is the safest house on campus.