State of Minnesota
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Attorney General
Lori Swanson

Minnesota Attorney General's Office

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445 Minnesota Street
St. Paul, MN 55101

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The Credit Handbook

Credit seems to be the American way of life. Most of us have ready access to credit, and 89 percent of us already use at least one credit card. In fact, the average cardholder's purse or wallet bulges with eight to ten credit cards. Credit can be an excellent tool when it's used well. But unfortunately, the road to easy credit contains some potholes.

This handbook is a guide to using credit cards. It will explain why most of us choose to use credit, provide tips to help you choose the right credit for you, detail the fees and terms to know, explain common pitfalls, and clarify your credit rights.

Chapter 1: The ABCs of Credit

The Credit Handbook

Did You Know?

The average cardholder has three to four bankcards and a total of eight to 10 credit cards.

Credit offers convenience. And, in today's economy, using consumer credit has become a major element of personal money management. Credit cards allow you to buy and use items now, but pay for them later. With credit, you can enjoy a purchase while you're paying for it _ or you can make a purchase when you lack ready cash. But, like other types of credit, there is usually a charge to borrow money. And, money borrowed is money that must be paid back. You can gain a lot from using credit. You can also lose a lot if you don't handle credit well.

Many of us enter into our first consumer credit transaction when we open a credit card account. Below is a list of some of the advantages and disadvantages of using credit cards.

The Case for Credit Cards

Today it's hard to live without credit. Reasons people use credit cards include:

  1. It's a safety net. Having a credit card helps many of us handle emergencies.
  2. It's flexible. Credit cards may be used almost everywhere in the world, and sometimes seem more welcome than a personal check, or even cash.
  3. It offers protections against theft. If a card is lost or stolen, federal law limits your liability.
  4. It's leverage. Chargeback protections are helpful if you are not successful in resolving a complaint about faulty merchandise or poor service. You can tell your credit card issuer that you refuse to pay for a service or product that disappointed you.
  5. It's the way of the world. Credit cards guarantee reservations for hotels and rental cars and let you purchase items by phone or over the Internet.
  6. It's convenient. It's easier to carry one or two credit cards than a lot of cash. This is especially true when traveling.
  7. It can help with money management. You can use your monthly credit card statements to help you budget and track expenses. Also, if you see an item on sale but lack the cash, you can take advantage of a sale price by using credit. (This benefit quickly fades if you pay interest or other fees on your credit card debt.)
  8. It can help you get more credit. Before granting you more credit, credit issuers like to see that you have managed money well in the past. If you have, and your credit report reflects that you have, it will be easier to qualify for a loan or a new credit card.

There are Disadvantages, Too

So, what's to dispute? Credit looks easy! Charge it now, pay for it later _ and just make one easy payment at the end of the month. But if you talk to people who use credit, you'll find that there are drawbacks. Some credit card users find they've spent too much money on too many things. Some can't pay all their credit card bills _ or can't pay their bills on time. And, those who have trouble paying back their debts may find they can't borrow money when they want to make a really important purchase _ like a house or car. Other disadvantages to using credit include:

  1. It almost always costs money. Credit card issuers charge many different fees, and interest payments can really increase the true cost of your purchases.
  2. It can seem too easy. Credit may encourage you to overspend.
  3. It rewards the impulse for instant gratification. Credit may discourage you from comparison shopping or bargain hunting, or delaying a purchase until your finances improve.
  4. It can ruin your reputation. Overuse and a bad repayment record can hurt your ability to get credit in the future.
  5. It ties up your future income. If you have debts to repay, today's income is paying for yesterday's bills.

So, after weighing the advantages and disadvantages to using credit cards, most of us will still choose to keep one or two around. But which credit card is the best? And how do you know what credit is really costing you? Stay tuned. We will explore these issues in the next two chapters.

Is Credit a Trap?

Credit can work for you or against you. It depends how you use it. Let's look at an example. We know the average American family carries credit card debt of $4,500. Let's say a family has this debt on one card. The card has an annual percentage rate of 18 percent and requires a minimum payment per month of 2 percent of the outstanding balance. If the family chooses to make just the minimum payment each month, the family will be paying this debt off for 44 years! That's a long time. The double whammy is that the family will pay a lot, too. The total the family will pay is $16,931. The additional $12,431 is the interest they will pay!

Did You Know?

Nearly three in four U.S. households receive at least one credit card offer every month. Some receive many more. In fact, credit card issuers fired off a total of 2.7 billion offers in 1995. Roughly one and a half in 100 offers are accepted by consumers, meaning that for every 200 credit card offers sent out, credit card companies net three new customers.

Chapter 2: How to Get Good Credit

The Credit Handbook

It seems as if you have to have credit to get credit. That's true in a sense, because financial institutions usually check your credit history to help them decide whether to grant you credit. Your credit history is a written description of how you handle credit.

Where Do I Start?

If you don't have a credit history your first step will be to start building one. Apply for a local store's charge card, or a small loan at a local lending institution. Ask whether the creditor reports accounts to a credit bureau. If the creditor does, and you pay back your debts on time, you will begin building a good credit history.

If you are applying for a loan or credit card from a local bank, you may want to sit down with a banker. The banker may know you personally and can better judge your individual situation. Of course, this is less feasible for most people today, since computers have taken over much of the guesswork involved in granting credit.

What's My Credit Score?

Today, computers are usually used to calculate your credit score. Your score is determined by assigning points to such things as your income, how long you've been in your current job, what your work is, whether you own your home or rent, how much credit you have, and more. It boils down to the three "Cs":

  1. Character. Creditors believe that people with "character" will pay their bills even during difficult times.
  2. Capacity. Your ability to get credit is based in part on your ability to repay your debts.
  3. Collateral. These assets reflect how you'll repay debts if your capacity fails. Unlike a mortgage or car loan, credit card debt is unsecured. Your signature is your promise to repay the debt.

Different lenders (or their computers) will look at your situation and score you differently. Therefore it is smart to apply again if you've been turned down. But here's an important tip: don't apply too many places at once. When you apply for credit, this is recorded on your credit report as an "inquiry." Your report lists all the inquiries made by creditors, and too many at once will cause your credit score to go down. Creditors may think that you could have too many open accounts and become overextended.

What if I Get Turned Down?

If you are turned down for credit, ask why. The federal Equal Credit Opportunity Act requires that the creditor give you an explanation, though sometimes you have to ask for it. You may find that the creditor believes your salary is too low, or you haven't been at your current job long enough. Time may resolve these problems, so try again when your situation changes. Also, ask the creditor if a credit scoring system was used. If so, ask the creditor how you can best improve your chances if you apply again.

Sometimes you can be denied credit because of information from a credit report. In this case the federal Fair Credit Reporting Act requires the creditor to tell you which credit bureau supplied the information. You have the right to contact the credit bureau and get a free copy of your credit report within 60 days.

If the creditor says you were turned down because you were too close to your credit limits on your current cards, or that you have too many accounts, you may want to reapply after paying down your balances or closing some accounts.

Co-Signers Can Help

If you are a young person applying for credit for the first time, you may be able to get your first credit card by having your parents co-sign for you. You would qualify for the credit card using your parent's income and good repayment history. You can then make purchases with the credit card, and you or your parents are responsible to pay the bills.

Other people having difficulty getting credit can use a friend or family member as a co-signer as well. This is recommended as a last resort because problems may occur. The co-signer must promise to pay your debts if you don't. Even if you make regular payments, your co-signer's personal credit capacity is reduced by the amount of your credit limit. Worse, a creditor has the right to demand payment in full from your co-signer if you become delinquent in your payments. If you use a co-signer, repay your debts promptly and after a short time try again to get credit on your own.

Try a Secured Credit Card

If you don't qualify for a major credit card, and don't want to ask a co-signer for help, consider a secured credit card. These are major bank credit cards tied to a savings account you hold at the same bank. The money in your savings account is your credit limit. The savings account acts as a security deposit for your credit card. Secured credit cards work and look exactly like regular bankcards. One reminder: make sure your lender makes regular reports to a credit bureau, so your secured credit card will help you build a credit history.

Choices! Choices!

There are three basic types of credit available. These are:

  1. Revolving credit. Most major credit cards and some department store cards
    are revolving credit accounts. You have a credit limit or "line," and your monthly payments are based on how much credit you've used at any time. Most revolving credit is unsecured.
  2. Open 30-day agreements. Charge cards require you to pay off your balance at
    the end of each month, or 30-day agreement period. Your balance depends on your ability to pay and your past usage.
    Interest is only charged on late pay-
    ments. If you make too many late
    payments, you may lose the card.
  3. Installment loans. Mortgage, car, furniture and personal loans are types of installment loans. You borrow a fixed amount of money and are given a period of time to pay it back, usually in equal monthly payments. Most loans are
    secured by the property you are

Do You Really Want to Be a Co-signer?

When you are asked to co-sign a loan, consider the worst case scenario _ that you will be repaying the debt. Then ask yourself whether you can handle additional debt right now. People who co-sign a loan often regret it later. For example, if your girlfriend or boyfriend asks you to co-sign a loan, think twice. The debt could be around longer than the significant other. Also, many grandparents agree to co-sign car loans or student loans for their grandchildren. If the grandchild doesn't pay the debt, the grandparent is stuck with it. Before you co-sign, consider this information:

  • Be sure you can afford to pay the loan. If you're asked to pay and can't, you could be sued or your credit rating could be damaged.
  • Even if you're not asked to repay the debt, your liability for the loan may keep you from getting other credit because creditors will consider the co-signed loan as one of your obligations.
  • Before you pledge property, such as your car or furniture, to secure the loan, make sure you understand the consequences. If the borrower defaults, you could lose these items.
  • Ask the lender to calculate the amount of money you might owe. The lender isn't required to do this, but may if asked. You also may be able to negotiate the specific terms of your obligation. For example, you may want to limit your liability to the principal on the loan, and not include late charges, court costs, or attorney's fees. In this case, ask the lender to include a statement in the contract similar to: "The co-signer will be responsible only for the principal balance on this loan at the time of default."
  • Ask the lender to agree, in writing, to notify you if the borrower misses a payment. That will give you time to deal with the problem or make back payments without having to repay the entire amount immediately.
  • Make sure you get copies of all important papers, such as the loan contract, the Truth-in-Lending Disclosure Statement, and warranties _ if you're co-signing for a purchase. You may need these documents if there's a dispute between the borrower and the seller. The lender is not required to give you these papers; you may have to get copies from the borrower.

If you're thinking about applying for credit, pick up an application today. Review the application to see what information you'll need to gather. Review your credit report, too. Then, when you're ready to apply for credit, you've already done your homework.

Next Page: The Cost of Credit