The definition of credit, the aspects lenders consider before extendingcredit, 10 steps for building credit and rebuilding credit.


Building Good Credit

“Credit now wears the crown in America”
 Mary Rowland, former NYT finance columnist (Source:http://moneycentral.msn.com/content/collegeandfamily/moneyinyour20s/p36954.asp)

Are you interested in:
• getting a good  or better job?
• getting a car or a house?
• getting good insurance rates?

The multi-billion-dollar-a-year industry of credit is part of the answer for most Americans.

What Is Good Credit?
Part of the dictionary definition of credit is “goods or services soldon trust” (Merriam-Webster). Having credit means that a lender truststhat you will pay them in the future as agreed.  Therefore, inpractice, good credit is defined by each lender. There are four mainaspects that most lenders consider in deciding to trust you:
•    Stability.  Your length of employment andlength of residence are important. Lenders will be more assured if youhave a steady job with a reliable income and a permanent address for acertain length of time.
•    Ability to Repay.  Lenders want to see thatyou can repay as agreed, therefore, your income must be greater thanyour expenses.  Specifically, your debt-to-income ratio – theamount of your monthly debt payments (excluding mortgage/rent) comparedto your monthly take-home pay – will have to be below a certain level(perhaps 20%).
•    Net Worth. Lenders want to know your financial networth – the value of what you possess (assets) minus the amounts youowe (liabilities). Lenders will be more likely to extend you credit ifyou have something of value – a house, car, or savings account – thatthey can take if you don’t pay.  These items are referred to ascollateral; they provide the lender some security for the credit. 
•    Credit References. Most lenders will look at yourcredit file with the national credit bureaus to get information aboutyour credit references. Your credit file contains your history ofrepayment – this is one of the most importantconsiderations.   The file also includes your credit limits,your current balances, and how long you have had each account. Each credit bureau has a method for scoring your credit history andthis is one measurement reviewed by lenders.  These scores rangefrom about 300 to 850 and a higher number means that you are consideredto be more likely to pay back a debt.

Why You Want Good Credit
The credit definition, cited previously, shows that credit is abouttrust. Naturally, you want to be considered trustworthy. Credit, then,is a privilege and a convenience. If you have enough income to pay cashfor a house, medical bills, and everything else you want, then youdon’t need to be concerned about credit… so long as nothing happens toyour income. For the rest of us, credit is important because our creditrating will affect both our ability to obtain those goods or servicesas well as the amount we will have to pay for them.

10 Steps To Building Credit
There is no fast lane to good credit. Building credit takes timebecause building trust in any relationship takes time. Here are the topten things to do:

1.     Check your credit reports.  First, makesure that there are no errors on your reports that might be negativelyaffecting your credit rating.  To find out how to check yourcredit reports for free, see the “To Find Out More” section below.
2.     Get and keep a job with a regular paycheck to show a stable income.
3.     Create a spending plan (budget).  Goodcredit will be unreachable if you spend more than you earn.  Aspending plan will also help you with the next three steps. To find outhow to create a successful spending plan, see the last section below.
4.     Open a checking account.  Use itresponsibly; review your statements, balance your checkbook, and besure to never overdraw the account. If the service is available, haveyour paycheck directly deposited into your bank account. Otherwise, make consistent deposits yourself.  Consider bankingwith a credit union.  Credit unions are often more responsive tothe needs of their members.
5.     Pay your bills on time.  If you haveutilities or medical bills in your name, make sure you pay them in fulland before the due date.  Most utility companies offer a no chargeauto-pay service, otherwise allow 5 to 7 days for mailedpayments.  Carefully review and keep your statements.
6.     Open a savings account.  If possible,have a portion of your paycheck automatically deposited to a savingsaccount.  Otherwise, make regular deposits yourself.  If youare going to be applying for a loan and you know approximately what themonthly payment will be, make sure your monthly deposit is at leastthat amount.
7.     Apply for a credit card or a small loan.  The goal is to have between two to four accounts.
•    First consider where you bank. Find out thelender’s requirements and only apply for a card if you think you canqualify. If your application is denied, ask the lender why.
•    Consider a department store or gas creditcard.  They can be easier to get than a bank-issued card, but becareful of high interest rates and finance charges.
•    As a final option, consider getting a secured cardor a co-signer temporarily.  Look into a secured card that has acredit limit based on a deposit you are required to make (for thedeposit funds, you can use the savings account you started). Aco-signer is someone who is willing to be responsible if you don’t makeyour payments.  If you have a relative or friend who is willing totake that risk, make sure they get a copy of your statement each monthand tell them you will get a new account solely in your name as soon asyou can.
8.     Avoid unnecessary finance charges. If youget a credit card, use it only for things you need and can afford topay in full each month.  For the first month, however, leave a $20balance to make sure that the account is reported to the creditbureaus.  If you get a small loan, be careful of the terms (lookfor no prepayment penalty and for simple interest).  Again, use astrategy to minimize your interest charges while you create a positivepayment history.  If possible, pay most of the balance with thefirst payment (let’s say all but an amount equal to 5 monthly minimumpayments), then make the minimum payment to pay it off in full. 
9.     Limit your requests for credit.  Yourcredit file shows these requests and having more than four per yearwill not be favorable.
10.    Stay put and be patient for a while.  Showstability in your place of residence and stick with thiscredit-building program for four to six months before you re-check yourcredit score or re-apply for credit.  For 19 ways to raise yourcredit score, see the “To Find Out More” section below.

To Rebuild Credit
All of the steps in the previous section apply to rebuildingcredit.  Review each one thoroughly. In the first step – checkingyour credit reports – there will be more work to do.  If yourreports contain any negative information, you will have to addressit.  If you find any errors, dispute them with the creditbureaus.  For information on how to do that, see the last sectionof this article. If the debt is accurate, take care of it (payit).  Finally, if you’re having trouble doing that on your own,consider consulting a reputable non-profit credit counseling service.

Credit Repair Scams
Be cautious of “credit repair” offers.  The Federal TradeCommission has stated, “the truth is, they can’t deliver… Everything aCredit Repair Clinic can do for you legally, you can do for yourself atlittle or no cost.” (Source:www.ftc.gov/bcp/conline/pubs/credit/repair.htm)

Credit Myths
1.    You can have it now even if you don’t have themoney now. Fact: That line of thinking leads to overspending or livingbeyond your means, which will lead to major debt trouble.
2.    You’re fine if you just pay the minimum payment.Fact: Minimum payments are designed to keep you in debt 15 to 20 yearson average.
3.    Paying late is no big deal.  Fact: If you areone day late with your payment, you will be charged a late fee.  A$30 late fee on a $1000 balance is equivalent to an APR of 360%.
4.    You can’t have too much credit.  Fact: Too many credit lines will bring your credit score down.
5.    Checking your credit reports is not critical.Fact: 4 out of 5 credit reports contain errors.  Credit reporterrors can keep you from getting a mortgage, apartment, credit card, oreven a job.

To Find Out More
• For a free copy of your credit reports visit www.annualcreditreport.com or call 1-877-322-8228.
• Read the following articles available at our website www.knowdebt.org/education.php:
How To Check Your Credit Reports
The Spending Plan
Raising Your Credit Scores
How To Dispute Errors On Your Credit Reports

© 2005 Alliance Credit Counseling.