Credit

To be as financially independent as possible, you need to understand what credit is, the types of credit available, what a credit score is, why the scores are important, and how to manage yours.

What is Credit?

Credit is when you borrow money you need now and agree to pay it back later.

Credit isn’t free. When lenders (also called creditors) give you money, they expect to get more money back in the future. To do this, they charge you interest as a percentage of how much you owe. Think of interest as the cost of borrowing money.

In the end, with the interest, you pay back more than the amount you borrowed. How much more depends on the type of credit you get, the interest rate, and how long it takes you to pay it all back.

Types of Credit

There are three kinds of credit:

• Credit cards let you buy all sorts of things from many places. There’s a limit on how much you can borrow at any one time, you must pay at least a minimum amount each month, and you are charged interest on anything you don’t pay back each month. This is revolving credit.
• With car loans, mortgages, student loans, and other personal loans, you get money to buy a single item and then make monthly payments (plus interest) over a period of time. To calculate your monthly payment, the lender adds together the total amount you are borrowing plus the total interest that you will pay, then divides by the number of months you will be making payments. This is installment credit.
• For your phone, cable, gas, and electric bills, you get the services first and then pay the bill at the end of the month. If you don’t pay, your service may be cut off. This is alternative or non-installment credit.

Pay attention to the details when you sign up for any type of credit. This is a contract between you and the lender, and some rules can cost you money, such as making it easy for the lender to raise the interest rate or charge extra fees. Read the fine print and watch for hidden costs.

Your interest rate (the amount of interest you are charged) is based on your credit history: If lenders think you are likely to pay back a loan, you may get a lower interest rate. If they worry you might not pay it all back (called defaulting on your loan), you may get a higher interest rate.

Your interest rate is also based on your credit score.

What is a Credit Score?

A credit score is a number that is calculated based on your credit history. This includes your credit cards, bank loans, rent, phone, cable, department store accounts, and student loans.

Creditors use your credit score to decide how much money you can borrow, and how low or high your interest rate will be. Insurance companies also use credit scores to decide whether to give you insurance coverage, and how much it costs.

Your Credit Report

A credit report is your personal credit history. It includes:

• Personal identification (address, Social Security number, date of birth)
• Any credit cards and loans that you have now or had in the past
• Public records (like bankruptcies or lawsuits), and
• How many agencies are looking at your credit report.

You can get free copies of your credit report from the top three credit reporting agencies (Experian, TransUnion, and Equifax):

• Online at AnnualCreditReport.com, the only website for the federal free credit report program. Beware of other sites that claim to offer “free credit reports,” “free credit scores,” or “free credit monitoring”.
• By calling 1-877-322-8228
  • If you are blind or visually impaired, call 1-877-322-8228 to request a report in Braille, large print, or audio format
  • If you have a speech or hearing impairment and want to call by TDD, call 7-1-1 and refer the Relay Operator to 1-800-821-7232
• By mail
  • Download the form, print it, fill it out, then mail it to:
    Annual Credit Report Request Service
    P.O. Box 10528
    Atlanta, GA 30348-5181

Credit reports can have mistakes, so check carefully and often. Use this tool to make a plan to get your free credit reports on a regular basis. If you see anything wrong on a report, tell all your creditors and the credit reporting agencies.

You can dispute incorrect information. By law, the credit agency has 30 days to investigate, and then give you a written report of the investigation plus a copy of your new credit report if they make any changes. Use this tool to fix errors on your credit report.

What’s in a Credit Score?

Exactly how a credit score is calculated is secret, but in general, it’s based on five things:

• Payment history: Do you pay on time?
• Amounts owed: How much do you owe? How much of your available credit are you using?
• Length of credit: How old are your oldest and newest accounts? What’s the average age of all your accounts?
• New credit: How many recent applications or new accounts?
• Type of credit used: Can you manage different types of credit?

Use this Credit Report Checklist to read and understand your credit report.

Improving Your Credit Score

Some ways you can boost your credit score:

• Apply for credit at a local business.
• Get a secured credit card (you make a deposit to get the card).
• Comparison shop for the best fees, interest rates, and other costs.
• Only use credit when you can afford something.
• Always pay on time.
• If you can’t pay on time, contact your creditors to work out a payment plan.

Use this checklist to learn how to get and keep a good credit history.

Credit Resources

Get help understanding and managing your credit history and score:

• Consumer Credit Counseling Services (CCCS) offers confidential credit counseling, in-depth credit analysis, debt management plans, and financial education.
• Hands on Banking explains how to build credit, maintain it, and repair it.
• MyCreditUnion.gov has tips for choosing, using, and managing credit cards.
• Practical Money Skills offers a series of articles on understanding credit.
• The World Institute on Disability has an interactive online course on credit (free account registration required).