A SELCO Financial Education Course
Your Credit Scores (English version)
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After you have finished learning all the basics of Understanding Credit, test your knowledge
by taking our short Credit Quiz which is available at the bottom of this page.
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Después de que haya terminado de aprender todo lo básico de Entendiendo su Crédito, pruebe su conocimiento tomando nuestro corto Cuestionario de Crédito que está disponible en la parte de abajo de esta página.
Tome el Examen en Espaņol
What is credit?
Credit is a financial tool that you will use numerous times over the course of your life. Gaining a good understanding of how it works, how it can benefit you, and how to maintain it are very important to maintaining a solid financial history. It will also help you avoid some of the pitfalls common to people who misuse their credit.
Credit is extended when someone (usually a financial institution) loans you money, called principal—in exchange for your promise to pay it back, usually with interest. Interest is the amount you pay to use someone else’s money. The higher the interest rate, the greater the cost of using credit. Generally, credit comes in several forms—as a home loan or mortgage, a consumer loan (for a vehicle, furniture, or some other item), a credit card, or a line of credit.
When you sign a loan application and accept a loan, you are agreeing to the terms and conditions of that agreement. Lenders must put in writing the total cost for using their credit. They must also be truthful in their advertisements. You are responsible for paying back the loan under the agreement. If you fail to keep your part of the bargain, legal action may be taken against you (i.e., collections, judgments or liens).
• Credit Score—a score calculated by a credit-reporting agency based on a consumer’s history in obtaining and repaying various types of credit.
• Collateral—any titled vehicle (auto, motorcycle, boat) that is used for a loan. The credit union or bank would hold the title to that vehicle until the loan is paid in full.
• Collections- efforts by a financial institution to collect on a delinquent debt. Sometimes the loan will be turned over to a collections agency. These actions are reported to credit reporting agencies, and will affect your future credit score.
• Debt ratio—the amount of payments you have in relation to your income. |
• Judgment—when a judge or court rules against you for an unpaid debt. This information will appear on your credit report, and your wages may be garnished to satisfy the loan.
• Lien—when a judgment is made against you, the lender may secure a lien against any real estate or property that you own, to ensure that the outstanding loan amount is paid upon the sale of the property before you can use the money for any other purpose.
• Loan to Value—the loan amount compared to the value of the collateral.
• Revolving Account—another term for a credit card or line of credit, where there is no fixed loan term. Payments for these loans are generally a percentage of the total loan balance for the previous month. |
Annual Percentage Rate
The Annual Percentage Rate (APR) is the most common way that interest rates are quoted and advertised. It is the amount it costs you per year to use credit, expressed as a percentage rate. The APR is used to help borrowers compare the actual cost of obtaining credit because it includes the interest rate as well as other charges like any applicable loan fees, transaction fees, and service charges. For instance, an APR of 9.00% is a lower cost of credit than 9.25%.
Other Costs and Considerations When Using Credit
Annual Fee. A yearly charge for the privilege of using credit (usually associated with credit cards). Annual fees are most often automatically added on to the existing loan or credit card balance when it becomes due.
Origination Fee. A fee commonly charged on home loans and occasionally on other loans where the lender charges a fee when the loan is set up and disbursed to the borrower. |
Application Fee. A fee commonly charged by banks and finance companies for processing a loan request, regardless whether the loan is approved. Application fees are often collected with the loan application.
Finance Charge. The actual dollar cost of obtaining credit over the term of the loan, expressed as a dollar amount. Finance charge includes the interest plus other loan costs, such as loan fees discussed above.
Loan Term/Repayment Period. The amount of time it will take to pay off the loan. While a longer repayment period may mean a lower monthly payment, you often pay more finance charges over the life of the loan because you are borrowing the money for a longer period of time. |
• Allows you to make large purchases—such as for an automobile or a home—and pay them off over time rather than having to pay cash.
• Access to cash in an emergency—for instance, when you need to pay for a tow truck, medical costs, or auto repairs.
• Safe and convenient—for instance, it’s often safer to carry a credit card instead of cash when traveling, because it is easier to replace if lost or stolen.
The first time there is an inquiry by a creditor or you make a transaction that is reported to a credit bureau, your credit report is established. Because your credit report will be with you for your lifetime, it’s important to start out with a positive credit history and keep it that way. This will help you when you need to take out a loan, rent a home or apartment, purchase a home, or even when you apply for certain jobs. It’s basically like a report card that reflects your credit history for the past 7 to 10 years.
What appears on my credit report?
• Credit Inquiries -- Loans that you’ve applied for
• Loan History-- Loans that were granted & the loan amount
• Payment History -- How promptly you made your payments, and if any payments were missed.
A credit score is a calculation that is performed based on the data in your credit report. This score helps lenders evaluate the likelihood that you will pay back your loan. Your credit score is based on the following factors:
• Current or past delinquencies and late payments.
• Capacity of credit lines--how much you owe compared to the available credit limit (used for credit lines and credit cards).
• How old your credit history is.
• Accumulation of debt. How many loans do you have, and how quickly did you take them out?
• Mix of credit between revolving (credit card) and installment (auto loan) accounts.
The higher your credit score, the better lending risk you become. In fact, since many lenders base the interest rate of your loan on your credit score, a good credit score is essential to getting the best loan rates possible. You can see how important it is to build and maintain a positive credit score.
Building a credit history takes time. There are several ways to start building your credit history:
• Investigate getting a credit card or a jewelry store charge account with a small credit limit and pay off your purchases quickly.
• For your first loan, you can also try a share-secured loan, where the money you have in your savings account can act as security for the loan.
• You can also have a someone with well established credit act as a co-signer for your loan. Remember that a co-signer is responsible for the loan and will experience collection efforts from the lending institution if you default. Their credit report will also reflect your loan as their obligation even if you make all the payments.
Auto and Other Collateralized Loans
When you borrow money for a car, boat, or motorcycle, generally the loan is collateralized—meaning that the item that you are purchasing will be used to secure the loan. If the loan goes into default, the lender reserves the right to repossess the collateral. In the case of a collateralized loan, you must also maintain the condition of the collateral and obtain the necessary insurance in case of an accident so that the collateral can be restored to its original condition at the time of purchase.
Vehicle loans have a fixed number of payments over the repayment period, and the interest rate is often fixed for the entire loan term. Here is an example of a typical auto loan:
APR 9% on an auto loan with a minimum payment of $249.00 |
Balance |
Time to Pay Off |
Finance Charge |
Total Cost |
$10,000 |
4 years |
$1,950 |
$11,950 |
You can see that by borrowing this amount, the cost of the car is increased by about 20%. On a loan such as this, you also want to check for some potential hidden costs. Some loans include “pre-payment” penalties. These are charges that off-set the amount of
interest you would have paid over the remainder of the loan. So even if you pay it off early, you may not save much on the finance charges.
Because you are paying off your vehicle over time, it is important that you choose a vehicle that will remain as dependable as possible during the entire loan term. Shop around, do your research online, and have your mechanic check out the vehicle that you want to purchase so that you can reduce the chances of any expensive surprises.
Credit Cards
One popular way to borrow money is through a credit card or revolving account. In addition to many nationally accepted credit cards, like Visa or MasterCard, consumers can also obtain credit lines through their favorite department stores (such as Sears or Meier & Frank), variety stores (Such as Target and Wal-Mart), and gas stations.
Benefits of Credit Cards
There are many benefits to credit cards, including the ability to make a major purchase and pay it off over a longer period of time. It’s also more flexible than a traditional loan because you can make small purchases over time rather than receive your loan amount in a lump sum. In addition, using a credit card while traveling can help you avoid problems with using out-of-state checks or not having the correct identification.
Dangers of Credit Cards
This flexibility has a price, however. With so many companies telling us to buy now and pay later, it’s easy to make additional purchases before you’ve paid off your previous purchases. Then, instead of paying off the entire loan amount, you may begin making only minimum payments while the balances continue to increase. This is where our earlier lesson about the costs of using credit comes in—the longer it takes you to pay off your loan, the more you pay for the goods or services you’ve purchased.
Here is an example of what can happen when you only make the minimum payment on your credit card loan:
APR 18% Minimum payment of 2% or $20.00 |
Balance |
Time to Pay Off |
Finance Charge |
Total |
$500.00 |
Almost 4 years |
$180.00 |
$680.00 |
APR 18% Minimum payment of 2% or $20.00 |
Balance |
Time to Pay Off |
Finance Charge |
Total |
$2,000.00 |
More than 18 years |
$3,500.00 |
$5,500.00 |
Wow! That’s a long time to take to pay off a purchase! When you consider making a credit card purchase, ask yourself this question: “By the time I pay off my balance, will I still be using the item I’ve purchased?” This can help you resist the temptation to use your credit card for instant gratification.
Things to Look for in a Credit Card
• Look carefully at the interest rates and fees.
• Also be careful of cards that have low introductory rates, but shoot up after a given period of time, or in the event of a late or missed payment.
• Read the fine print to make sure you’re getting the best deal possible.
Final Word on Credit Cards
As soon as you receive one credit card, you are likely to receive many more offers in the mail. Having the discipline to keep your credit cards to a minimum, and use them sparingly, is essential to building a successful budget and credit score.
If you charge beyond your means and find yourself with too much debt, here are a few tips:
• Stop using your credit cards; don’t create a larger hole to climb out of.
• Even if you can only make small payments above the minimum payment, concentrate on paying off the highest-rate cards first, not the ones with the largest balances.
• If you are unable to make even minimum payments, seek the advice of a non-profit credit counseling organization. Your bank or credit union should be able to recommend a reputable firm. Don’t work with organizations that charge large fees or promise to “correct” your credit score.
• Bankruptcy is never a solution to a spending problem—seek help in managing your debts before you resort to something as harmful to your credit report as a bankruptcy filing.
• What credit is and how it works
• The costs and responsibilities of using credit
• The types and sources of credit
• How your credit score is calculated
• The main questions you should ask before using credit
• What happens if you misuse credit
Now that you've learned all the basics of Understanding Credit, test your knowledge with our Credit Quiz.
| Click the Credit Quiz button to begin taking the quiz: |
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Ahora que ha aprendido todo lo básico de Entendiendo su Crédito, pruebe su conocimiento con nuestro Cuestionario de Crédito.
| Para Español, click en el botón de Examen de Crédito: |
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What is credit?
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