Using Credit*

Advantages

- To enhance one's lifestyle

- To make purchases more convenient

- To take advantage of sales

- To buy large ticket items (car or furniture)

- To establish a credit history

Disadvantages

- Future earnings committed

- Finance charges may be added to purchase cost

- Too easily used

- Misuse results in poor credit record

- Credit cards may be stolen or lost

Types of Credit

Credit transactions are of four types. A credit card purchase is the most frequently used credit. When Jason Samuels goes shopping and purchases a new suit, he may use a credit card to pay for it. A credit card is an example of "unsecured, open-end" type of credit. In this agreement, the borrower has a line of credit available for a specific limit backed only by his or her creditworthiness. A borrower must make at least a minimum payment each month based on the outstanding balance. The wise consumer will pay the entire balance each month.

Another often used form of credit is a mortgage loan. When Rich and Shelly decide to buy a house, they go to a bank or finance company to take out a mortgage. Mortgage loans are known as "secured, closed-end" credit. The loan is based on collateral and a specific number of payments are scheduled for a specified period of time. A car loan is also this type of credit.

A third form of credit would enable Rich and Shelly to obtain a loan without collateral to make improvements on their home. This "unsecured, closed-end" credit is available when the creditor is willing to make the loan based on the borrower's creditworthiness. It is often referred to as a "signature loan." Payments are for a specific amount for a specified period of time.

Finally, if Rich and Shelly decide to get a loan using their home as collateral, this is type of credit is known as an "open-end equity" or "secured, open-end" loan. These loans are made against a borrower's property and the amount of the loan is based on the equity in the home.

Comparison of Credit Charges

A wise consumer shops for the best credit terms, as though it were any other product or service. The charges for credit cards are based on an annual percentage rate, known as the APR. However, there are different methods to compute finance charges which will vary based on how the balance is calculated.

The three alternative ways of figuring the balance are the average daily balance, the adjusted balance method, and the previous balance method. In determining the average daily balance, lenders apply the APR over the 30 day billing period. For an adjusted balance, the figure is arrived at by subtracting payments made from the total owed. Finally, in the previous balance method, you are charged interest on the amount owed at the beginning of the billing period.

There are variations on these methods. Some lenders provide a "free" or "grace" period between the end of a billing and the date you must pay to avoid a finance charge. Annual fees, late fees, and when you overextend your credit limit--over-the-line fees are also common. In addition, some credit cards have variable rate provisions determined by purchase charges or cash advance charges.

Examine the range of credit terms and select those that best fit your credit needs and payment habits.

Consumer Credit Legislation

Although most lenders use fair credit practices, there are some lenders who may attempt to take advantage of an unknowing consumer. State and federal laws and regulations protect consumers from an unscrupulous lender. Present legislation regulates disclosure of credit information, credit discrimination or denial, credit disputes, errors in credit billing and protection against collector harassment.

This section describes laws that regulate credit disclosure information, protection against discrimination, and credit denial. The National Foundation for Consumer Credit brochure, Are you in a Credit Emergency?, has legal information on credit disputes, errors in credit billing, and protection against collector harassment.

Truth in Lending Act

The Truth in Lending Act requires creditors to provide consumers with accurate and complete credit costs and terms. All terms must be disclosed in a clear and conspicuous manner and in a form available to the purchaser. The creditor must clearly display the finance charge and the annual percentage rate.

The issuer of a credit card or charge account must display the cost of credit, how and when the interest will be charged to the account, any annual fee or service charge, statement of the consumer's billing rights, and other terms and conditions of the credit.

The creditor must send statements on all credit accounts which have a debit or credit balance at the end of the billing cycle. Included on this statement must be the previous balance, debits and credits in that month, periodic rate and corresponding APR finance charge imposed that month, new balance, and explanation of how the new balance was determined.

For a loan with a fixed term, information must be displayed and explained accurately about total cost including the down payment, total dollar amount of payments, payment schedule, and any required collateral in case of default, as well as other terms and conditions of the loan.

Equal Credit Opportunity Act

The Equal Credit Opportunity Act prohibits a creditor from discriminating against a consumer on the basis of age, sex or marital status, and/or reliance on income from a public assistance program.

In addition, a credit application cannot request information pertaining to a consumer's sex, race, color, religion, or national origin. It cannot inquire about birth control practices or intention to have children. In the case of unsecured, individual credit, the creditor may not inquire information about a spouse or former spouse.

If a creditor denies an individual credit, the applicant must be notified within a 30-day time period. Included in the denial shall be a statement of the reason for the denial of credit, an explanation of the Equal Credit Opportunity Act, and the name and address of the agency which enforces the Act.

Fair Credit Reporting Act

When a creditor denies a consumer credit, the creditor must provide the reason for credit denial. If a credit bureau is used, the applicant must also be given the name, address, and telephone number of the bureau which provided the individual's credit history.

If the applicant was denied credit because of derogatory information on the credit file, the applicant may obtain a copy of his file from the credit reporting agency used by the creditor. If the applicant contacts the bureau within 30 days, there is no cost for this service.

Upon contacting the credit bureau, the consumer has the right to know the nature and substance of all information contained on his credit report (except medical information). The consumer also has the right to be informed about the sources of information, as well as the names of employers, creditors, and others who have recently received a credit report.

The consumer may make a written request for an investigation of any inaccurate information. If the credit bureau learns that the information is inaccurate or cannot be verified within the 30 day period, the information must be corrected or deleted. However, if the information is verified at a later date, it can be included again on the credit report. The consumer may also write an explanatory statement of no more than 100 words to be included in all future reports.

If any deletion or notation is made regarding the information, the consumer may request that the new information be sent to any employer who has received a credit report during the past two years and in addition, anyone else who has requested credit information in the previous six months.

Credit bureaus must automatically delete information which is more than seven years old, with the exception that bankruptcy declarations are deleted only after ten years and a judgment, which can be reported for ten years, can remain on the record until satisfied.

Any organization with a legitimate business reason for needing the information can request a consumer's credit history from the bureau to which it subscribes.

Glossary of Credit Terms

Annual Percentage Rate (APR) - rate of interest figured on a yearly basis and expressed in terms of a percentage.

Balance - amount of loan remaining to be paid; sometimes known as the "outstanding balance."

Charge Account - arrangement permitting the customer to buy goods and services now and pay for them later.

Collateral - something of worth which serves as security for a loan.

Credit - based on trust that goods and services received now will be paid for in the future.

Credit Card - plastic card issued by a creditor, representing a type of charge account which allows individuals to obtain cash, goods or services, according to and within the dollar limits of an established credit arrangement.

Credit Union - a cooperative association which extends savings opportunities and credit to members only.

Creditworthiness - ability to obtain and repay debts.

Default - failure to meet a payment or fulfill an obligation.

Disclosure Statement - statement giving all the terms and conditions of the credit transaction.

Equity - the money value of a property or of an interest in the property in excess of claims or liens against it.

Finance Charge - amount charged for the use of credit services.

Interest - amount paid for the use of credit over a period of time, expressed as a percentage.

Line of Credit - dollar amount a lender makes available to a borrower.

Mortgage - pledge of property that accompanies a loan of money that acts as security for payment of the loan and its interest.

Overline - charging more on a line of credit than you have been allowed.

Principal - original sum borrowed.

Revolving Account - line of credit that may be used repeatedly to a specified limit.

Security - something of value pledged to assure loan repayment and subject to seizure upon default.

Source: The information in the document was from the National Foundation for Consumer Credits Publication "User Credit."

* Courtesy of The National Foundation for Consumer Credit