Building and Keeping Good Credit
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:
- 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.
- 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
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 Report.com, 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 https://www.annualcreditreport.com
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) |
|www.equifax.com ||www.transunion.com ||www.experian.com |
|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
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
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
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
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:
- 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.
- Pay all of the parts of the bill that are not in dispute.
- 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.
- 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.
- 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.
- 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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