Consumer Credit Basics

consumer credit basics to manage your financial life

Your financial situation is different from anyone else. You should take the time to review this consumer credit basics guide to find the best solution for your needs and goals.

What Is Consumer Credit?

Consumer Credit is simply the ability for a consumer to be able to borrow money in order to purchase a product or service. Borrowed money can take many forms, such as credit cards for product purchases. a student loan, a personal loan, car loan or home mortgage.

Consumer Credit Basics

Consumer credit basics are straightforward.  When you receive credit from a creditor, for example from a bank, you are assuming debt. Debt is the other side of credit. You will need to pay back the full amount of this debt, interest and possible late fees depending upon the terms of the credit agreement.

Having access to credit means you can buy something before you pay for it. This ability to borrow gives you the flexibility in planning your purchases and makes it possible to pay for a large purchase over time. However, you also pay interest on the purchase amount, so use credit wisely, and only borrow money to make necessary purchases.

Types Of Credit

Today there are many different types of consumer credit that are available from a wide variety of sources. Some loan agreements specify equal monthly or annual payments, while others require a large single payment of both principal and interest. Some loans require nothing more than a borrower’s promise to pay. Others require that the borrower pledge certain assets as collateral to guarantee repayment of the loan.

Consumer credit can be divided into two broad categories: installment credit and non-installment credit.

Installment Credit or closed-end credit, are loans that require you to repay the principal amount in equal periodic payments, usually monthly. An automobile loan is an example of installment credit. Installment credit is also a popular method of financing expensive items like appliances and electronics. The lender will ordinarily retain the title to the property until the loan is paid completely. If not paid off, the property is repossessed.

Non-installment Credit, is comprised of single-payment loans and loans that permit the borrower to make irregular payments and to borrow additional funds without submitting a new credit application. This latter type of loan is also known as revolving or open-end credit.

Single-payment loans (or term loans) require the repayment on a specified date of the entire amount that was borrowed plus interest charges.

Open-end credit allows the borrower to draw out additional funds as they’re needed, so long as the total outstanding loan balance doesn’t exceed a predetermined limit, known as the credit limit or line of credit. Charge accounts (Sears and J.C. Penny) and credit card accounts (MasterCard and Visa) are the most common examples of open-end credit.

These types of accounts permit a continuous source of credit. The borrower reduces the debt by making payments and can also add to it by borrowing, or charging, addition amounts without having to reapply for credit. Generally, open-end credit accounts allow irregular or partial payments to be made subject to a predetermined periodic minimum amount established by the lender.

How The Lender Views You

All lenders have a responsibility to determine the amount of financial risk associated with extending credit to a borrower. The lender, of course, expects and needs to be paid back the credit extended (the loan) in the time-frame agreed to by the borrower.

The lender takes into consideration the type of loan, secured with property (a car loan) or unsecured (a credit card) as part of determining the financial risk of the loan. If the loan is secured with property, there is less risk to the lender. When it is an unsecured loan, the lender will place more emphasis in evaluating you, the borrower.

The lender evaluates you based on the Three C’s of Credit – Character, Capital and Capacity in making a decision about whether to take you on as a borrower.

Character – From your credit history, the lender attempts to determine if you possess the honesty and reliability to repay the debt.

  • Have you used credit before?
  • Do you pay your bills on time?
  • Do you have a good credit report?
  • Can you provide character references?
  • How long at your current address?
  • What type and how long at your present job?

Capital – The lender will want to know if you have any valuable assets such as real estate, personal property like an automobile, or savings and investments that could be used to repay unsecured credit debts if income is unavailable.

  • What property do you own to secure the loan?
  • Do you have a savings account?
  • Have you investments to use as collateral?

Capacity – This refers to your ability to repay the debt. The lender will look to see if you have been working regularly in an occupation that is likely to provide enough income to support your credit use.

  • Do you have a steady job? If so, what is your salary?
  • How many other loan payments do you have?
  • What are your current living expenses?

How Is My Credit Worthiness Determined?

Your financial life is defined by the contents in your credit reports that are generated by the national credit bureaus.  Whenever you have requested credit from a lender, for whatever reason, that is noted in your credit reports.  Each payment or non-payment that you have made to a creditor is recorded in your credit reports.  All of these credit activities are retained in your credit reports for a period of seven to ten years before rolling off.  In the eyes of a potential lender, your credit report defines you.

The information in your credit reports are numerically analyzed by the credit scoring companies.  Based on their financial models they assign you a credit score that is used by a lender as a predictor of consistent, on time repayment of credit debt.    The financial models that the credit scoring companies use do not take into consider any personal information of the debtor.  In that sense your credit score is completely impersonal.  Right or wrong, good or bad, your credit score determines your credit worthiness. 

Credit Reports

There are three major US credit bureaus: Experian, TransUnion and Equifax. The credit bureaus maintain records of your credit data and other identifying information. These are your consumer credit reports.

There are two major US credit score providers: FICOScore and VantageScore. FICOScore is the market leader and are used in over 90% of US lending decisions. These are your consumer credit scores.

When you get a new loan or credit card, make or miss a payment, apply for a car loan, etc., your lenders will report this information to the credit bureaus. Since it is up to your lenders what information they report to the credit bureaus, and which credit bureaus they report to, it is not uncommon for your credit reports to be slightly different at each bureau.

And since your credit scores are calculated from the credit data on your credit reports, it is also common for your credit scores at each credit bureau to be slightly different. Yes, you have multiple credit scores. And, different lenders use industry specific credit scores when evaluating your credit. For example, there are credit score versions for auto, home mortgage and credit cards.

All consumer credit reports contain the same four categories of information.

Personal Information – Your name, address, Social Security number, date of birth and employment information. This information is NOT used in calculating your credit score.

Accounts – Your credit accounts, organized by type (bankcard, auto loan, mortgage, etc.), date opened, credit limit or loan amount, account balance and payment history.

Inquiries – Requests for your credit report within the last two years. There are two types of inquiries: hard inquiries and soft inquiries. A hard inquiry occurs when a lender or other third party checks your credit report or score when you apply for credit with them. A soft inquiry typically occurs when your credit reports and scores are pulled without you applying for credit (like when a credit card issuer sends you a pre-approved offer), or when you pull your own credit reports. Your credit scores only consider hard inquiries.

Negative Items – Delinquency information from missed payments that have been reported by lenders. This also includes information on overdue debt from collections agencies, and public record information (bankruptcies and foreclosures).

Your Credit Scores

A credit score is a statistical summary of the information contained in a consumer’s credit report usually graded on a scale ranging from 300 to 850. Your credit score represents your financial reputation. It is used by lenders, landlords, employers and others to determine your level of credit risk, responsibility, and overall character.

Credit scores are calculated using information in your credit reports, including your payment history, the amount of debt you have, and the length of your credit history. Higher scores mean you have demonstrated responsible credit behavior in the past, which may make potential lenders and creditors more confident when evaluating a request for credit, like a loan or a credit card.

Here is a general look at credit score ranges:

  • Excellent – 800-850
  • Very good – 740-799
  • Good – 670-739
  • Fair – 580-669
  • Poor – 300-579

Credit scores may vary according to the scoring model used and which credit bureau furnishes the credit report used for the data. That is because not all creditors report to all three three nationwide credit bureaus (Equifax, Experian and TransUnion). Some may report to only two, one or none at all. Also, lenders may also use a blended credit score from the three major credit bureaus.

The types of credit scores used by lenders and creditors may vary based on their industry. For example, an auto lender might use a credit score that places more emphasis on your payment history when it comes to auto loans.

Since everyone’s financial and credit situation is different, lenders may also have different criteria when it comes to granting credit, for example, including your income as a factor.

Consumer Credit Basics Review

Americans are living beyond their means. The average American household carries $137,063 in debt, according to the Federal Reserve’s latest numbers. Yet the U.S. Census Bureau reports that the median household income was just $59,039 last year.  That means many Americans are living beyond their means.

There are good and bad uses of credit.  Consumers primarily have a problem managing their credit card debt.  Good use of your credit cards should be for their convenience, ease of use, and relative safety.  Bad use of your credit cards is if you are using them to make everyday purchases that you cannot afford to pay in cash.  Then you are on the verge of debt trouble.

One of the principal consumer credit basics is that you need to live within your means.   Use credit responsibly.  Don’t be a debt statistic.

Credit Repair | Identity Theft

Frequently Asked Questions

Consumer Credit Score

Credit scores for married couples are treated separately. They do not have joint credit scores. Each has their own individual scores. If you are unmarried you only need to worry about your credit habits and profile. However, if you are married your spouse’s credit habits and profile have an impact on yours. For example, if you have a credit card in both of your names and it does not get paid on time, that can adversely affect both of your credit scores.

A credit score minimum requirements, in order to qualify to receive one, your credit report must have:

  • At least one account opened for six months or more;
  • At least one account reported to the credit bureau within the past six months
  • No indication of deceased on the credit report

Credit score changes, in general, do not change that much over time. Your credit score is calculated each time it is requested;. This can be a lender request or by you. Each time your credit score is calculated it takes into consideration the information that is on your credit report at that time. As the the information on your credit report changes, your credit score can also change.

There can be delays by your creditors in reporting information to the credit bureaus. Also, the type of changes in information will affect your credit score. For example, opening a new credit card account will be more significant a change than simply having paid your bills on time the previous month. Also, something dramatic like a bankruptcy judgement will have a significant impact in the calculation of your credit score.

Credit scores are different between the national credit bureaus. In the U.S., the three national credit bureaus compete to capture, update and store credit histories on most U.S. consumers. While most of the information collected by the three credit bureaus is similar, there are differences.

All of your credit information may not be reported to all three credit bureaus. The information on your credit report is supplied by lenders, collection agencies and court records. You should not assume that each credit bureau has the same information pertaining to your credit history.

A bankruptcy affects credit scores negatively. It will always be considered a very negative event by your credit score. The negative impact it will have on your score will depend on your entire credit profile. For example, someone with a high credit score could expect a huge drop. Alternatively, someone with many negative items already listed on their credit report might only see a modest drop in their score. Also, the more accounts included in the bankruptcy filing, the more of an impact on your credit score.

Does spending less improve credit scores? It depends. If the money saved goes into your bank account, this will not improve your credit scores. Your credit scores do not consider the amount of disposable cash you have at any given time.

However, if the money saved is used to consistently payoff your credit accounts, you will notice an improvement in your credit score. Your credit score factors in the balance on your revolving credit accounts such as your credit cards. As you pay the balances down, your debt versus credit (credit utilization ratio) should decline, which is positive for your credit scores.

Do inquires affect credit scores? Yes they do. Credit inquiries are requests by a “legitimate business” to check your credit. These inquires are reported to the credit bureaus which are then included in your credit reports. There are two types of credit inquiries that are classified as either “hard inquiries” or “soft inquiries.” Only hard inquiries have an affect on your credit scores.

Soft inquiries are all credit inquiries where your credit is NOT being reviewed by a prospective lender. These include inquiries when you are checking your own credit reports and credit checks made by businesses to offer you goods or services.

Hard inquiries are credit inquiries where a potential lender is reviewing your credit because you have applied for credit with them. For example, when you have applied for an auto loan, mortgage or credit card. Each of these types of credit checks count as a single credit inquiry. The exception is when you are “rate shopping” for the best deal on a loan. In this case all all inquiries within a 45-day period for a mortgage, an auto loan or a student loan are classified as a single credit inquiry.

Most likely your credit report has errors.

The Federal Trade Commission reported in a study conducted in 2012 that 26% of the credit reports they analyzed had errors. Of those with errors, 5% who disputed these errors increased their credit scores at least 25 points. That is a significant change in a credit score.

You should not assume that your credit reports are completely accurate.

No. Your credit report is independent of your spouse. The same is true of your credit scores. However…

A lender will likely take into consideration both of your credit reports when deciding on a home mortgage, for example. If your credit report is bad and your spouse’s good you may find that the loan, if approved, has a higher interest rate than if both were good.

It certainly can. Many employers will do a credit check of a potential employee to determine the stability of the job candidate. For job positions that entail financial responsibility, it is most likely you would experience a credit report check.

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Consumer Credit Repair

The Fair Credit Reporting Act (FCRA) was written in 1970 as an amendment to the Consumer Credit Protection Act. The FCRA provides additional measures of consumer protection in the areas of fairness, accuracy, and privacy of the information collected by the credit bureaus. It also allows you to personally engage in credit repair and maintenance processes, verifying that the information in your credit report is correct.

A credit bureau – sometimes called a “consumer reporting agency” – is a business that collects relevant consumer information from creditors and courthouses, and then sells that information to interested parties such as potential lenders. Such information is sold in the form of a credit report. In the U.S., the three major credit bureaus are TransUnion, Experian, and Equifax.

Normally negative items will remain on your credit report for seven years, with the exception of bankruptcy (ten years). You may choose to dispute a negative item, but if it is accurate, the dispute will be rejected and the item will remain on your credit report. However, if the negative item violated consumer protection laws, it may be removed.

When an account is unpaid for more than 180 days, a creditor usually writes off the debt as a loss on their financial statements. This is known as a charge off. Once a debt is charged off, it is either transferred to an in-house collections department or sold to a third-party collection agency who will likely contact you in attempt to recoup the balance.

The time it takes to repair your credit is completely dependent upon your personal situation. Six months should be your guide if you have many issues with your credit report.

It is a common myth that negative items must remain on your credit report for a minimum number of years. In fact, there is no minimum time-frame. Creditors control the information they provide to the credit bureaus. They can also choose to remove negative items as well. The Fair Credit Reporting Act requires all reported information to be fair, accurate, and substantiated. If these conditions are not met, the credit bureaus are required to remove it.

Credit Repair is actually the process of removing inaccurate, unfounded, out of date, false, and erroneous information from your credit report.  Your credit report dictates your credit score.  The 3 major credit bureaus collect information from lenders, creditors, and debt collectors and apply it to your credit report.  Based on that information, your credit score is determined.  This information could include the balances on loans or credit cards, credit inquiries, debt to income ratio, and most importantly, credit utilization (the percentage of debt you have to available credit)

This is determined by what your goal is.  Perhaps you are trying to buy a house.  If this is the case, you might want to get started at least 6-9 months before you plan on purchasing.  If you plan on purchasing a car, then you might to get started in 2-3 months.

You have the ability to dispute any information on your credit report you deem as inaccurate, unfounded, or incorrect.  However many consumers have tried doing this themselves only to find out that the process takes too long, is confusing, and full of challenges they deem too stressful to deal with themselves.  A third-party credit repair company can take the burden of disputing off your hands and have the ability to speed up the process through their experience.  Think of a third-party credit repair company like you would think of a Tax preparer, Legal Service, or even a plumber.  You could probably do it yourself, but perhaps not with the same end results. We highly suggest that all of our clients and prospective clients take some time to learn about their credit, credit reports, as well as the process of repairing their own credit.  You may feel doing it yourself is the better route for you and your situation.

A good credit score helps you obtain low interest rates and long term loans, like home loans or car loans. Lenders may charge high interest rates or impose undesirable repayment plans for you. Given the stakes and the consequences involved, it is clearly to your advantage to work toward recovering from a bad credit rating.

Credit Bureaus are companies that maintain records of your credit lines and performance. Records can go back for up to ten years, in the case of bankruptcy data. Creditors, banks, mortgage companies and other financial institutions supply this information to the credit bureaus. The credit bureaus then compile this data into your a credit report. A credit report has details of how you have managed credit in the past, so other lenders can judge your credit worthiness.

Most likely your credit report has errors.

The Federal Trade Commission reported in a study conducted in 2012 that 26% of the credit reports they analyzed had errors. Of those with errors, 5% who disputed these errors increased their credit scores at least 25 points. That is a significant change in a credit score.

You should not assume that your credit reports are completely accurate.

No. Your credit report is independent of your spouse. The same is true of your credit scores. However…

A lender will likely take into consideration both of your credit reports when deciding on a home mortgage, for example. If your credit report is bad and your spouse’s good you may find that the loan, if approved, has a higher interest rate than if both were good.

It certainly can. Many employers will do a credit check of a potential employee to determine the stability of the job candidate. For job positions that entail financial responsibility, it is most likely you would experience a credit report check.

When you are initially contacted by a debt collector regarding an unpaid debt, you have the right to request proof of the debt within 30 days of initial contact. This is called debt validation. Unless the debt collector can validate that you are responsible for the debt, they must stop all further collection efforts.

The debt validation letter from collector needs to include: 1) Proof the debt exists; 2) Proof that you are responsible for the debt; and 3) Proof that the debt collector has legal right to collect on the debt.

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