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Building and Keeping Good Credit

Filed under Personal Finances. Fact checked on May 24, 2012.

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A good credit rating is essential for your financial well-being. In order to develop one, you'll need to learn how to monitor your credit, correct discrepancies and spend wisely.

When you are ready to apply for credit, you should know what creditors think is important in deciding whether you are creditworthy. You should also know what they cannot legally consider in their decisions. 

The Equal Credit Opportunity Act (ECOA) in designed to put credit applicants off on the same footing. It states that race, color, age, sex, marital status and certain other factors may not be used to discriminate against you in any part of a credit dealing.

When a lender extends credit to its customers, it recognizes that some customers will be unable or unwilling to pay for their purchases. Therefore, lenders must establish policies for determining who will receive credit. Most lenders build their credit policies around the five C's of credit: character, capacity, capital, collateral and conditions.


By character, we mean your attitude toward your credit obligations. Lenders often see this attitude as the important factor in predicting whether a borrower will make regular payments and repay the loan on time. In judging a borrower's character, the following items are considered: Is the borrower prompt in paying bills? Have other lenders had to dun the borrower with overdue notices before receiving payments? Have lenders been forced to take the borrower to court to obtain payments? Has the borrower ever filed for bankruptcy? If so, did the borrower make an attempt to repay the debts voluntarily?


By capacity, we mean your financial ability to meet credit obligations, that is, to make regular loan payments as scheduled in the credit agreement. The lender checks your salary and outstanding financial obligations before credit is approved. For example, the lender wants to know your occupation, how long you have worked, and how much you earn. The lender also wants to know your expenses, how many dependents you have, and whether you pay or receive alimony or child support. Because this is one of the key factors in determining whether you can obtain the credit you need, we discuss it in more detail below.


Capital refers to your assets or net worth. The greater your capital, the greater your ability to repay the loan of a specific size. Information on net worth can be obtained by requiring that you complete a credit application. You must also authorize employers and financial institutions to release information to confirm the claims made in the application.


For large amounts of credit, and especially for large loans, the lender may require some type of collateral. Collateral is a valuable asset pledged to assure loan repayment and is subject to seizure upon default. That means, if you fail to live up to the terms of the credit agreement, the collateral can be sold to pay off the debt.


The term "conditions" refers to the general economic conditions that can affect your ability to repay a loan or other credit obligation. The basic question of conditions focuses on the security of both your job and the company for which you work.

Creditors Weigh Factors Differently

Creditors use different combinations of the above facts to reach their decision. Some creditors set unusually high standards, and other simply do not make certain kinds of loans. Creditors also use different kinds of rating systems. Some rely strictly on their own instinct and experience. Others use a credit-scoring or statistical system to predict whether you are a good credit risk.

Small business owners often have more trouble than employees in obtaining personal credit. One of the reasons for this is that creditors may feel that the income stream from a small business is less secure than income received as an employee. Also, the creditors may worry about verifying the amount of income actually generated by the small business.

Faced with these difficulties in obtaining credit, some small business owners may be tempted to "fudge" their income numbers, that is, inflate the amount received from their businesses. Such "creative accounting" is ill-advised: not only can a loan be denied if untrue information is supplied, but the applicant be criminally prosecuted.

Taking Responsibility for Your Credit Rating

If you apply for a charge card, credit card, car loan, personal loan or mortgage, your credit experience—or lack of it—will be a major factor considered by the creditor. Your credit experience may even affect your ability to get a job or buy life insurance.

A good credit rating is a valuable asset that should be nurtured and protected. If you want a good rating, you must use credit with discretion: You must limit your borrowing to your capacity to repay and live up to the terms of your contracts. The quality of your credit rating is entirely up to you.

How Much Credit Can You Afford?

Unless you have been on another planet since 2008, you are well aware of the collapse of the housing market and the adverse effect that excessive consumer debt has had on every sector of the economy. As a small business owner, you may have seen your own business revenue drop as over-leveraged consumers struggled to keep their homes and buy only the basic necessities for life. Many experts are now saving that no consumer debt—excepting, perhaps, a mortgage—is the optimal amount of debt. Plans and strategies to "live debt free" abound.

However, not everyone can live debt-free, nor does everyone agree that's the optimum strategy for living. But, everyone agrees that taking on more debt than you can afford and sacrificing future security for immediate gratification is inadvisable. Most people want to walk the middle road and use credit wisely.

Although it is difficult to precisely measure your credit capacity, there are certain rules of thumb that you can follow. Experts suggest that you spend no more than 20 percent of your net (after-tax) income on credit purchases. Thus, if your take-home pay is $5,000 a month, you should spend no more than $1,000 a month for consumer debt payments, not including payments on mortgages or home equity loans.

Another excellent rule of thumb is to spend no more on credit purchases than you can afford to pay off in 12 to 18 months, making exception for car loans or education expenses.


You have balances outstanding on two credit cards that total $3,000 on which you are paying $150 per month. You would have to increase the payments to, at least, $250 plus the new interest accruing each month in order to pay off the loans within 12 months.

Before you take a loan, ask yourself whether you can meet all of your essential expenses and still afford the monthly loan payments. You can make this calculations in two ways:

  1. Add up all of your basic monthly expenses and then to subtract this total from monthly disposable income—the amount left after all your existing bills and obligations are paid each month. If the difference will not cover the monthly payment and still leave funds for other expenses, you cannot afford the loan.
  2. Ask yourself what you plan to give up in order to make the monthly loan payment. If you currently save a portion of your income greater than the monthly payment, then you can use these savings to pay off the loan. But if you do not, you will have to forego spending on entertainment, new appliances, or perhaps even necessities. Are you prepared to make this trade-off?

Only you, based on the money you earn, your current obligations and your financial plans for the future, can determine the exact amount of credit you need. You must be your own credit manager.

How Credit Bureaus Affect Your Credit Rating

Credit bureaus are private, for-profit businesses that collect and collate credit information and make it available to businesses that subscribe to their service. They make no credit decisions. They do not deny credit; they merely report the information they have gathered.

Many credit bureaus are connected to centralized computer files that contain data about millions of individuals. From these files, a credit bureau can produce for a subscribing creditor, almost instantaneously, a report about your past and present credit activity.

Credit bureaus obtain their data from banks, finance companies, merchants, credit card companies and other creditors. These sources regularly send reports to credit bureaus containing information about the kinds of credit they extend to customers, the amount and terms of that credit, and the customers' paying habits. Credit bureaus also collect some information on any bankruptcies, tax liens and court judgments from other sources, such as public records.

Equifax, Experian and Trans-Union

At the center of the credit reporting system are three national credit bureaus—Equifax, Experian and Trans-Union—along with about 1,500 local and regional bureaus. Your credit file will be maintained by one or more of the three national bureaus, and by local credit bureaus as well. As a debtor, you have the right to examine credit files held by credit bureaus, and you have specific rights and procedures for correcting mistaken information and for contesting a credit billing.

Keep a Watchful Eye on Your Credit File

Your credit bureau file contains your name, address, Social Security number and birth date. It may include information about your past and current employers, positions and incomes and whether you own or rent your home. Your credit file may also contain detailed credit information.

Credit file information is continuously updated, but old details disappear slowly. Each time you buy from a reporting store on credit or take out a loan, a credit bureau is informed of your account number and of the date, amount, terms and type of credit.

As you make payments, your file is updated to show the outstanding balance, the number and the amounts of payments past due, and the frequency of 30-, 60-, or 90-day lateness. Your record may indicate the largest amount of credit you have had and the maximum limit permitted by the creditor. Also, each inquiry about you may be recorded. Any suits, judgments or tax liens against you may appear as well. If you have been refused credit, that may also be entered into your file. If this has happened frequently, a creditor may be wary; he or she will at least want to consider the reasons for the refusals.


Anyone turning you down for credit must send you a written rejection notice within 30 days of the decision stating the specific reasons for the rejection. They must also give you the name and address of any credit bureau that issued a report and if other information was used in making the decision, you have the right to learn about that information.

Time Limits on Adverse Data

Most of the information in your credit file may be reported for only seven years. If you have declared personal bankruptcy, however, that fact may be reported for 10 years. 

After seven or 10 years, the information in your credit file can't be disclosed by a credit reporting agency unless you are being investigated for a credit application of $50,000 or more, for an application to purchase life insurance for $50,000 or more, or for employment at an annual salary of $20,000 or more. In those situations, the time limits on releasing the information in your credit file do not apply. Nor do those time limits apply if the creditor chooses to use prior adverse information to deny a credit application.

Who May Obtain Your Credit Report?

Your credit report may be issued only to properly identified persons for approved purposes. It may be furnished in response to a court order or in accordance with your own written request. It may also be provided to someone who will use it in connection with:

  • a credit transaction
  • an employment application
  • the underwriting of insurance
  • some other legitimate business need
  • the determination of eligibility for a license or other benefit granted by a governmental agency

Your friends or neighbors may not obtain credit information about you. If they request such information, they will be subject to fine and possibly even imprisonment.

How to Obtain a Copy of Your Own Report

You are legally entitled to obtain a free credit report every year, from each of the big three credit reporting agencies. Do not pay a company to obtain these free copies for you. The process to request a copy is very straightforward and can be handled online for the most efficient service.

You can request reports from one of the major bureaus or from all three at Annual Credit, a centralized service created by the three nationwide consumer credit reporting companies.


Identity theft and phishing scams are serious. The best way to protect yourself from a "spoofed" website (one that appears real, but actually is used to steal financial information) is to type the URL directly into your browser, rather than following a link from another site. In this case, you'd type directly into the address bar on your browser. Annual Credit Report Request Service also indicates that they never send you an email directly--so if you get an email inviting you to check your credit report, be very cautious!

If you prefer, you can make your request by calling (877) 322-8228. You can also download a request form from the website and mail it to

Annual Credit Report Request Service
P.O. Box 105281
Atlanta, GA 30348-5281

If you have extra time on your hands, you can also contact each company individually at the following addresses:

Equifax Trans-Union LLC Experian (formerly TRW)
P.O. Box 740256 P.O. Box 6790 P.O. Box 9554
Atlanta, GA 30374 Fullerton, CA 92834 Allen, Texas 75013

If you send a written request, include your Social Security number, present and past addresses, and other names you have used.

Review Your File Annually

Check your file each year to ensure no errors have slipped in. The minimal time investment is always worth it.


The Wall Street Journal reported that about 25 percent people who requested a credit report challenged the information they received as incorrect or outdated. Another survey found that 48 percent of the credit reports it reviewed contained errors. The most common errors are:

  • confusing you with someone else with the same name or a similar Social Security number
  • including incorrect information
  • failing to incorporate comments or changes based on information you or your creditor supplied
  • failing to remove damaging information after the issue has been resolved

A federal law protects your rights if the information in your credit file is erroneous. You can see that fair and accurate credit reporting is vital to both creditors and consumers. Therefore, Congress enacted the Fair Credit Reporting Act which regulates the use of credit reports, requires the deletion of obsolete information and gives the consumer access to his or her file and the right to have erroneous data corrected. Furthermore, only authorized persons are allowed to obtain your credit report.

Avoiding and Correcting Mistakes in Credit File

The best way to maintain your credit standing is to repay your debts on time. But there may still be complications. To protect your credit and to save your time, your money and your future credit rating, you should learn how to correct the mistakes and misunderstandings that may tangle your credit accounts. 

If there is a snag, first try to deal directly with the creditor. The credit laws can help you settle your complaints.


A lot can go wrong with a credit card, even if you stay within your limits and pay promptly.  To help spot errors or unauthorized charges, keep your receipts and match them against your monthly statement..

Dispute Incorrect Information in Your Credit File

Credit bureaus are required to follow reasonable procedures to ensure that subscribing creditors report information accurately. However, mistakes do occur. Your file may contain erroneous data or records of someone with a similar name. When you notify the credit bureau to dispute the accuracy of information, it must investigate and modify or remove inaccurate data.

You should give the credit bureau any pertinent data you have concerning an error. When you run your credit report online, you can often click a "Dispute" button and choose from the most common dispute categories. You'll also have the opportunity to write a brief description of the error.

If the investigation does not resolve the dispute to your satisfaction, you may place a statement of 100 words or less in your file, explaining why you think the record is inaccurate. You may also want to place a statement in your file to explain a period of delinquency caused by some unexpected hardship, such as serious illness, a catastrophe or unemployment, that cut off or drastically reduced your income. 

The credit bureau must include your statement about disputed data or a coded version of that statement with any report it issues about you. At your request, the credit bureau must also send a correction to any recipient of a report in the preceding six months if the report was for a credit check, or in the preceding two years if the report was for employment purposes.

You have to be persistent at challenging an item in your credit file. Be sure to keep track of the names and dates of the people you contacted at the bureau. And, once the credit bureau says your record has been changed, be sure to get a copy of your new record just to make sure.

What Are Your Legal Remedies?

Any consumer reporting agency or user of reported information that willfully or through negligence fails to comply with the provisions of the Fair Credit Reporting Act may be sued by the consumer. If the agency or the user is found to have violated provisions of this law, the consumer may be awarded actual damages, court costs, and attorney's fees, and in the case of willful noncompliance, punitive damages as allowed by the court. The action must be brought within two years of the occurrence or within two years after the discovery of material and willful misrepresentation of information.

An unauthorized person who obtains a credit report under false pretenses may be fined up to $5,000 or imprisoned for one year, or both. The same penalties apply to anyone who willfully provides credit information to someone not authorized to receive it.

Lost or Stolen Cards

If you report a missing card immediately by calling the number on the back of the statement, you aren't responsible for any charges. The most that you'll owe even if you don't report losing your cards is $50 per card. But, if you're like most consumers who, on average, carry 10 cards, that adds up to $500.

A scam that many thieves use after they have stolen your wallet is to call you to say they have "found" your wallet and will mail or bring it to you. This is really just an effort to stop you from notifying the companies of the lost cards so the thief has more time to use the cards without being challenged. Don't fall for it. Notify the card issuers immediately. This is easy if you keep an up-to-date list of all your cards, account numbers, their respective websites and emergency phone numbers.

Take Action to Resolve Billing Disputes

The Fair Credit Billing Act defines a billing error as any charge for something you did not buy or for something bought by a person not authorized to use your account. Also included among billing errors is any charge that is:

  • not properly identified on your bill
  • for an amount different from the actual purchase price
  • entered on a date different from the purchase date
  • for something that you did not accept on delivery or that was not delivered according to agreement

Beyond erroneous chargers, billing errors include:

  • errors in arithmetic
  • a statement failing to reflect a payment or other credit to your account
  • failure to mail the statement to your current address, provided you notified the creditor of an address change at least 20 days before the end of the billing period
  • questionable items or items on which you need additional information

If you think your bill is wrong or you want more information about it, follow these steps:

  1. Notify the creditor in writing within 60 days after the bill was mailed. Be sure to write to the address that the creditor lists for billing inquiries, to give the creditor your name and account number and to say that you believe the bill contains an error and what you believe the error to be. State the suspected amount of the error or the item you want explained.
  2. Pay all of the parts of the bill that are not in dispute.
  3. While waiting for an answer, you do not have to pay the disputed amount or any minimum payments or finance charges that apply to it.
  4. The creditor must acknowledge your letter within 30 days unless your bill can be corrected sooner. Within two billing periods, but in no case longer than 90 days, either your account must be corrected or you must be told why the creditor believes the bill is correct. If the creditor made a mistake, you do not pay any finance charges on the disputed amount. Your account must be corrected and you must be sent an explanation of any amount you still owe.
  5. If no error is found, the creditor must promptly send you an explanation of the reasons for that determination and a statement of what you owe, which may include any finance charges that have accumulated and any minimum payments that you missed while you were questioning the bill. You then have the time usually given on your type of account to pay any balance.
  6. If you are still not satisfied, you should notify the creditor within the time allowed to pay your bill.

Know the Rules for Defective Goods and Services

The Fair Credit Billing Act provides that you may withhold payment on any damaged or shoddy goods or poor services that you have purchased with a credit card as long as you have made a real attempt to solve the problem with the merchant. This right may be limited if the card was a bank credit card or a travel and entertainment card or any other credit card not issued by the store where you made your purchase. In such cases, the sale must have been for more than $50 and it must have taken place in your home state or within 100 miles of your home address.


Merchants cannot charge your account if you write a check and it bounces. Therefore, there is no reason to write your credit card number on your check. And no need to put your name, address or phone number on a credit card receipt. In some states, it's illegal for merchants to demand this information. Also, make sure you destroy all carbons. Thieves can use your account number to charge purchases or order new cards over the phone.

A creditor may not threaten your credit rating while you are resolving a billing dispute. Once you have written about a possible error, a creditor is prohibited from giving out information that would damage your credit reputation to other creditors or credit bureaus. And until your complaint has been answered, the creditor may not take any action to collect the disputed amount.

After the creditor has explained the bill, you may be reported as delinquent on the amount in dispute, and the creditor may take action to collect if you do not pay in the time allowed. Even so, you can still disagree in writing. Then the creditor must report that you have challenged your bill and give you the name and address of each recipient of information about your account. When the matter has been settled, the creditor must report the outcome to each recipient of information. Remember, you may also place your version in your credit record.

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