Why Credit is Important

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2 Page 1 Why Credit is Important Page 6 How to Protect Yourself from Identity Theft Page 7 Cosigning and Money Lending Tips Page 8 How to Avoid Credit Card Interest Why Credit is Important Learning to build a successful credit history is vital to your future. Establishing and maintaining excellent credit forms the foundation of your future financial freedom, plus good credit makes your life a lot easier now! What is a Credit Report? A credit report contains detailed information describing your credit history. Your credit history is a record of how you pay all your bills and whether you ve ever been delinquent with your payments. Credit reports list all your loans and your repayment performance. Late payments, past due accounts, collection actions, and bankruptcies all are recorded in your credit report. The information stays on your record for up to 10 years. Prospective lenders review your credit report to decide whether they will lend you any money, and if so, at what interest rate. Basically lenders use your credit report to determine the amount of risk they take by lending to you. For instance, if you apply for a car loan, the car financing company will run your credit report. People with higher credit scores have proven themselves less likely to default on a loan, so they receive better loan terms and easier qualification. That s why you must maintain an excellent credit history. To illustrate how this works, let s take the car loan example a step further. If you have good credit, you will receive a lower interest rate on the car loan. With good credit, for a $25,000 car, you can expect to get a rate of about 6.25%; your monthly payment would be $486 on a five-year loan. But if you have bad credit, your rate would be about 12% and your payment would rise to $556 per month. Ultimately, the person with bad credit will pay $4,200 more for the same car. That sucks, right? So stay on top of all your outstanding bills and loans to make sure your credit doesn t end up in the toilet! A Credit History for Life Maintaining an admirable credit history is important to many aspects of life. Good credit helps you qualify for mortgage, car, and bank loans. Good credit can be the key to getting what you want out of life.

3 Good credit will save you time and money. A good credit history lets you avoid the embarrassment of having a loan application denied. In addition, good credit means you ll have money readily accessible for more opportunities, under the best available terms. Conversely, without an excellent credit rating you ll end up paying loan companies a lot more than you should. People with bad credit pose a higher risk to lenders. They transfer this risk back to you by charging higher interest rates and closing costs. You will be literally giving money away. What is a Credit Bureau? A credit bureau collects and stores credit information on consumers. There are three main credit bureaus: Equifax, Experian, and Trans Union. Each credit bureau maintains its own records and assigns individual credit scores. Get a free copy of your credit report by visiting Money-lending companies want to make sure you have the ability to repay your loans. Your credit report shows a potential lender how you have paid your bills in the past. The credit bureaus give you a score based on this past history. How do Credit Scores Work? Your credit score is like a report card assigning grades to your credit history for the past 7-10 years. The grading system they use is called a FICO score. Just think of it like the grades you received in school. 720 or higher Grade A Excellent Grade B Good Grade C Average Grade D Poor 560 or less Grade F Your credit score will directly impact interest rates you receive on loans. Below is a chart describing typical rates and payments you could expect on a three-year car loan of $20,000 with various credit scores. Grade Rate Payment % $ % $626

4 % $ % $ or lower You re walking! You can see that just by having good credit you can save almost $100 per month! Getting and maintaining good credit is easy, and you ll save big: in the above example, you d save $1,100 each year. Maintaining an excellent credit rating will save you thousands of dollars over your lifetime. Let s explore what the FICO score evaluates. The following five categories of credit data influence your score, to varying degrees: Payment history - 35% Pay your bills on time. You have 30 days from the statement due date before a creditor can report to the credit bureaus that your payment is late. Payment history includes all the activity on your account. To receive good ratings with the credit bureaus, you must actively use credit lines that report to the credit bureaus. For example, if you have a credit card, use it regularly and pay it off IN FULL each month. Amounts currently owed - 30% The current outstanding balances on your revolving credit accounts (credit cards, equity lines, etc.) should be kept at a $0 balance, or less than 25% of your total credit limit. Length of your credit history 15% The longer your credit accounts are open and paid on time, the better your score. New credit 10% This factor takes into account your number of recently-opened accounts. Credit bureaus punish you with a lower score if you have a lot of accounts that are relatively new. Be sure to spread out new applications for credit over time. Types of credit used 10% Your credit score is affected by the types of credit you have. Credit bureaus look at all five of these areas when scoring your credit; payment history and amounts currently owed have the biggest impact. So keep your bills paid on time and your balances low! Credit Affects Employment, Too Many employers now look at credit reports as part of their background checks on prospective employees. They draw their own conclusions from your credit score. If you re responsible with money, they ll be more likely to believe that you d be a responsible employee.

5 Tips for Maintaining Excellent Credit Pay your bills on time. Check your credit once a year. If your credit score is low, hire a professional service to clean up your prior mistakes (including that convertible Pinto!). Keep revolving debt (credit cards, equity lines) low. Keep credit cards open with a zero balance. Credit bureaus will give you a higher rating because you have the ability to access more money. Actively use your credit and pay everything off in full every month. The credit bureaus punish people who have credit they don t use. Avoid having your credit report run often. Each new credit inquiry will lower your score (although a new rule allows you to shop for a mortgage without experiencing this negative effect). Space out new credit. If you apply for and receive several new loans (or credit cards) at once, your credit scores will drop. Build up $25,000 to $40,000 in available credit on various credit cards and maintain a zero balance on each by paying it in full every month. (Don t open a lot of credit cards if you cannot control your spending.)

6 How to Protect Yourself from Identity Theft Identity theft occurs when criminals use your information to make fraudulent purchases in your name. Having your identity stolen can cause you serious credit problems and cost you a lot of money. An identity thief will steal your social security or account numbers and use the information to charge up your accounts. Protect yourself from identity theft by following these basic guidelines: Purchase a shredder and destroy any documents that contain sensitive or confidential information. Keep all account numbers and PINs hidden and safe. Check your credit at least once per year to make sure no one is using your identity fraudulently. If you are already a victim of identity theft, the FTC suggests taking the following steps: Contact the fraud departments with the three consumer reporting companies to place a fraud alert on your credit report. Close the accounts you believe have been tampered with or opened fraudulently. File your complaint with the FTC. File a report with the police department in the community where the identity theft took place. Credit Card Crime What happens if your card is stolen? Usually you will not be held responsible for money charged on a stolen credit card, but you must notify the card company as soon as you realize the card was stolen, or as soon as you notice an unauthorized transaction. Don t fall into the trap of believing this couldn t happen to you identity thieves can steal your account number without stealing your card. Check your credit card and bank statements each month. If you see a purchase for two tickets to the Bahamas, it s likely you ve been robbed (unless you re planning a cool vacation!). Since you do most of your banking online, run frequent (at least monthly) scans on your computer many credit thieves now use computer viruses to obtain your online banking passwords so they can access your account.

7 Co-signing and Money-lending Tips Co-signing for loans or credit cards often causes fights between family members or friends. In most cases, we strongly suggest that you decide not to cosign for anyone else unless you re fully prepared to make the payments yourself. Co-signing for a friend or family member to help them qualify for a loan obligates you to the loan. If the person for whom you co-signed fails to make the monthly payments on time, you ll receive a late payment report on your credit history. Even worse, if the person doesn t pay the bill at all, you become responsible. Co-signing is a major risk that you should avoid (unless you enjoy taking your family or friends to court). If you do consent to cosign, make sure the entire agreement is expressed in writing. Include an arrangement where they pay you, and then you make the payment. Setting it up this way will ensure that payments are made on time and in full. Extending Money to Friends, AKA Lending Money to Friends Money shouldn t cause rifts between friends or family members but it often does. As a general rule, only lend money if you do not expect it back. Money s not worth losing friends over. Protect your relationships by outlining all the loan details in writing to avoid any misunderstandings. When friends or family members need money, that need is often the result of poor money management. Of course emergencies do occur; you may want to treat those situations differently. Yet if people already are unable to pay their bills, there s a good chance they ll be unable to pay you. If you want to help out but don t want to lose money, take some form of collateral as security. Hold onto a bike, a car title, or something else of value. That way they ll have increased motivation to pay you back. Be careful about co-signing or lending money both can cause unwanted disputes between friends or family.

8 How to Avoid Credit Card Interest To avoid paying interest on credit cards, you want the credit card companies to refer to you as a deadbeat or a freeloader. Being given those labels might not sound like a good thing, but it is that s what banking industry insiders call people who carry no credit debt and pay off their credit card balances in full each month. To understand why these financially-savvy customers are called deadbeats, let s look at the situation from the credit card company s point of view. Credit card companies want customers who are revolvers that is, customers who carry college and credit card debt over time. Revolvers are how the credit card companies make their money. To the companies, ideal customers are those who make just the minimum payments each month people who carry their credit card debt for a long time. Depending on the interest rate, it could take you more than 15 years to pay off a credit card debt if you make only the minimum payments. And all that interest you pay ends up in the credit card companies pockets. Credit card companies also like customers who frequently make their payments late and go over-limit. If you pay late, credit card companies can jack up your interest rates and charge you additional fees. Going over-limit can have the same consequences. The credit card companies can force you to bring your balance below the limit or risk having fees add up month after month; or they can close the account, which also looks very bad on your credit report. So strive to be a deadbeat and a freeloader. Be the credit card company s worst customer! This is the first step to planning your long-term financial success. Use Credit Cards to Build Your Credit Score Before you empty your wallet or purse and destroy all your credit cards, first understand the benefits of keeping revolving credit open. Of course credit cards offer convenience; they make it easy to reserve a hotel room or rent a car. But it s important to understand that credit cards do a lot more. Credit cards can function as an important tool in your financial toolbox. Credit cards used effectively can help raise your credit scores. You already know that a good credit score will help you qualify for loans, and help you receive lower rates and lower closing costs. And good credit helps you avoid the embarrassment of having a loan application denied. Here s how credit cards can help boost your credit score. Credit bureaus grade customers based on their ability to repay loans (debt). So if you ve never established or maintained any credit transactions, your credit scores will be lower. If you always pay cash and have never had loans, your credit will be poor.

9 Credit bureaus rate you the same way teachers used to grade you in school. If you never took a test or quiz or completed an assignment, how would the teacher decide how to grade you? By the same token, you are responsible to prove to the credit bureaus that you have the ability to repay debt. If you use your credit card and pay it off in full each month, you ll be rewarded with a higher credit rating. Take these simple steps to use credit cards wisely to raise your credit score: 1) Once you have a working budget and money saved, build up $25,000 to $45,000 worth of available revolving credit. 2) Use your credit each month and pay every card off in full. Do not carry any balance over if you do, you ll have to pay interest on the amount you owe. Paying in full before the next month avoids being charged interest by the credit card companies. Before you begin using credit cards to build your credit score, take the necessary safety precautions. Make sure you re financially secure. Before you get your first credit card make sure you have: Six months of bills saved. You should have an emergency fund equal to six months worth of your monthly bills. Set this money aside in your savings account. For example, if your monthly bills total $1,500, you should have $9,000 in savings. Your emergency fund means you ll avoid the credit card debt plague if something unexpected occurs. A working budget. Apply this easy test to determine whether your budget is working: can you save money each month? In other words, do you bring home more money than you spend? If so, your budget is working. Automated bill payment method. Set up an online automatic bill payment for every bill that s reported to the credit bureaus. With an automated system in place, you won t have to worry about forgetting a bill, which is easy to do. Remember, one late payment will haunt you for 7 years. You are in control of your spending. If you re the type who spends money whenever you have it, you probably should consider waiting before you get a credit card. Work on improving your spending habits and make sure you re in control. Protect your identity. Make sure to destroy all financial statements. Shred sensitive documents before throwing them away in the trash. Plenty of dumpster divers would love to get hold of your personal information. Also be careful when submitting personal information online. Those five steps will help you become a great deadbeat a deadbeat with a great credit score!