Friday, January 22, 2010
Credit; your friend, your enemy
Every American knows the term good credit. A person's credit rating is a numerical score obtained by statistically analyzing the person's use or misuse of credit. The most widely used credit score in America is the FICO score, which ranges from 300 to 850. A person with a credit score of 300 is considered extremely untrustworthy by lenders and most of the time they are denied credit by lenders, or are only granted extremely high interest loans by payday loan companies and other predatory lenders.
A person with a credit score of 720 to 850 is considered a safe bet by lenders. Not only do they have access to easy credit, but they also receive very low interest rates on their loans. Some car companies even go as far as giving 5 year 0% interest loans to individuals with good credit, while giving those with just fair credit, loans of 19% interest over five years.
Let us analyze the effect of good credit in a hypothetical situation. Two consumers Titus and Joshua both come to a car dealership to purchase a $10000.00 car. Titus has a credit score of 825 and qualifies for the manufacturers 0% interest over five years promotion. At the end of five years he pays $10000.00 and zero interest. The total repayment is therefore $10000.00 and the total cost of the loan to Titus over the five years was zero. Joshua on the other hand has a credit score of 600 and is considered a poor to fair risk. The dealership is able to obtain financing for him at an interest rate of 19.9% over the five years, which is the American version of saying 20%.
After five years, Joshua will pay the $10000.00 loan amount and 20% of the $10000.00 each year as interest, as the interest is calculated on the day the loan is given. Joshua therefore pays 20% of 10000 dollars each year as interest which is $2000.00!! At the end of five years Joshua would have paid the initial $10000.00 on the car plus 5x $2000.00 in interest, making it a total of $20000.00! So poor interest not only prevents you from getting loans, in the short or long term it is also very expensive.
In the housing market, credit can make or break your future financial happiness. Housing loans or mortgages are huge loans, and getting these loans at high interest rates can affect a person's financial health for years as these loans typically have to be paid back over a period of 30 years. For those with bad to fair credit, my typical advice is not to buy a house at all until your credit has been repaired by you or with the help of a non profit credit counselor. Never go to those credit repair agencies that advertise everywhere as they will just make your situation worse . People with fair credit usually get adjustable rates mortgages or ARMs. Typically with ARMs you will pay low mortgages for a few years and then, when you are just about to get comfortable, your interest rate will be pushed up, increasing your monthly mortgage payment. In a lot of cases the monthly payment is so high that it simply becomes unbearable, leading to the house owner not being able to make future payments and the bank repossessing the house. The typical advice I will give to house buyers is this; if you do not qualify for a fixed-rate mortgage, DON'T BUY A HOUSE!
So how do you get good credit? Well first you have to get credit. You start by paying your rent on time, and having a steady job. Apply for store cards or secure credit cards initially. Secure credit cards are cards issued against your savings in a bank. Make your card payments on time and soon your credit score will start to grow. Always keep low balances on your cards as they indicate that you use credit wisely. When you start getting major credit cards, my advice is to use your credit cards for purchases to build your credit, but making sure you pay the balances every month to avoid paying interest. Car loans must be paid promptly.
If you use credit wisely, credit will become your best friend in America. If you do not, there will be no greater enemy than bad credit. The law now allows consumers to obtain a free copy of their credit report every year from each of the three major reporting agencies; Transunion, Equifax, and Experian. These reports can be obtained from the website annualcreditreport.com and the individual does not have to pay a dime. All other credit sites will charge a fee.
Take good care of your credit and you will be on the road to financial security.