Understanding Your Credit

What is credit? How do I get credit? How can I improve my credit rating?

These are a few simple questions, yet when asked the majority of people simply don’t know the answers. Although I don’t believe I’ve ever met anyone who could truly say they were an expert in understanding credit, in a world where credit determines many aspects of our way of life it’s important that we know and understand what our credit is and how we can maintain and improve it.

What is credit? What is a credit rating?

Credit is defined as the borrowing capacity of an individual or company. An individual, company, or financial institution will typically determine your borrowing capacity based upon income, assets, credit rating, etc. The majority of these things we are familiar with and for the most part have direct control over. However, credit rating is the one that typically eludes us and is what most people are really thinking of when they think of credit.

Your actual credit rating/score is essentially a summary of your credit report converted into numerical form between 150 and 930 and is used in determining your credit worthiness/risk. The higher the number, the less risk of you defaulting on any credit given to you and therefore the better chance of being approved for a loan or other form of credit. This will also usually translate into better interest rates as well.

How do I get credit?

In my profession, I have come across clients who simple haven’t ever established a credit history. In many cases this is because they are just starting out on their own, or have just recently relocated from outside the country. Having no credit isn’t the same as having bad credit, but can just as easily result in being denied a loan. This is because there simply is no way to determine what kind of risk you are, and therefore the safest course of action would be to deny you credit until your risk level can actually be assessed.

Don’t panic though; there are some easy ways to establish credit. By getting a low-interest credit card or small installment loan, you can begin to establish a record of good credit behavior by showing an ability and willingness to make regular payments towards the credit granted to you. These initial accounts will likely have very low limits, and you may even be required to bring in a letter from your utility company stating that you pay your bills on time. You may also want to check with your bank to see if they offer a pre-paid credit card. With this type of account, you would deposit money into an account and then make purchases against that balance and be charged interest on a monthly basis. By paying this bill on time, you can begin to establish a good credit history which will ultimately result in a better credit score/rating.

How can I improve my credit rating?

Ok, so now that you’ve established some credit (or even have bad or moderate credit), now you want to know how to improve it. Although there are many additional steps you can take to improve your credit, the following are a great place to start:

Past due accounts – You will want to make an effort to resolve any past due accounts. This doesn’t mean you need to drain your savings in order to pay off the entire balance. Most companies will be more then willing to work with you on bringing your accounts current and they may be able to offer you a more manageable payment plan. In some cases, you may be able to freeze the account from accruing any additional interest for up to 6 months as long as you stay current on your payment plan.

Increase/Decrease the number of accounts your have – When any particular company is assessing your risk factor based on your credit report, they may be looking at more then just your scores. Even if you are staying current on you monthly payments, the way you use your credit may also be a factor. For instance: when applying for a mortgage, many lenders like to see a minimum of four open lines of credit with at least a 2 year history of being in good standing. However, the reverse can also be true. Some lenders will also frown upon an excess of credit lines, especially if they all have high balances. This can suggest a lack of control when it comes to your spending habits.

Understanding your credit rights – Although this will not necessarily improve your credit rating, knowing your rights and familiarizing yourself with the various credit laws will ultimately help you make smarter and more informed decisions towards a healthier credit report.

Ensuring your credit report is accurate – You will want to review your actual credit report as it is being reported to all three credit bureaus. It is very common to find errors on your credit report that could be contributing towards a lower credit score. You are entitled to receive a free annual credit report from all three major credit bureaus.

And finally, being patient – Do not expect to magically turn your credit rating around overnight. It can take years to establish a good credit history. Also keep in mind that many types of adverse information will remain on your credit report for up to seven or more years. However, by staying vigilant and adhering to healthy credit activity, you will eventually begin to see the benefits.