Credit 101

What is Credit?

How Do I Get Credit?

Credit Precautions

Glossary


What is Credit?

Credit is "extended" to you when someone lends you money or assets, and trusts you to pay it back. It gives you the ability to buy today and pay tomorrow.

There are two types of credit:

  • Unsecured: There is no asset or collateral being used to secure the debt. An example of unsecured credit is a credit card.
  • Secured: Some type of collateral is used to secure the debt. This can be a house, car or boat that the lender can take back if the loan isn't paid.

Benefits of Credit

  • Easier to buy a house
  • Easier to finance a car
  • In some cases, necessary to get car insurance
  • Convenience
  • Emergencies
  • Safer than carrying cash
  • Easier to rent an apartment
  • Ability to rent a car
  • Allows you to make purchases over the internet
  • Some jobs may have a credit check requirement
  • Can use it to pay college expenses
  • Necessary to build a credit history

Risks of Credit

  • Easier to make impulse purchases
  • Can accumulate more debt than you can afford
  • Misunderstanding of complicated terms and conditions

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How Do I Get Credit?


Credit History: None, Bad, Good

What type of credit experiences can someone with no credit history expect to have? Lending institutions such as banks and credit unions rarely lend money to people with no credit because they have no history to indicate how likely they will be to pay back the loan.

What type of credit experiences can someone with a bad credit history expect to have? Future borrowing is difficult and in some cases impossible, because there is no basis for a lending institution to trust that the money will be repaid.

What type of credit experiences can someone with a good credit history expect to have? They can be granted credit more easily and with less stringent conditions.


Credit Score Ranges

A credit score determines your credit grade and is based on the data found in your credit report. The credit score broadly refers to a number generated by a credit-scoring model to determine a person's creditworthiness. Commonly, there are six ranges:

  • 720 - 850 A+
  • 700 - 719 A
  • 675 - 699 B+
  • 620 - 674 B
  • 560 - 619 C
  • 500 - 559 D

There is no single cutoff score used by all lenders - and there are additional factors that lenders use - but basically, the higher the score, the higher your creditworthiness and the lower the risk.

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Credit Precautions

The best way to avoid getting into trouble with credit involves advance planning for how it is used and how it is paid.


Ways to Avoid Bad Credit

  • Limit the number of creditors. Many creditors interpret too many open credit accounts as a risk.
  • Spend only what you can afford at the time.
  • Think before you buy. Remember, credit is like a loan. Ask yourself, "Would I really go to the bank for a loan for this?"
  • Stay below the limit. Each lender is different, but for some lenders, you need to be 50% or below your limit to get the best rates.
  • Ensure payments arrive before the due date. Check out payment options such as online, telephone, and automatic payment to avoid late fees.
  • Pay the full balance due each month or at least pay more than the minimum. This will cut down on interest payments.
  • Don't lend out your credit. By adding other's names to your credit cards or adding yourself as a co-applicant to someone else's loan you are allowing others the opportunity to weaken your credit rating. Remember that you are liable for all expenses taken out under your name.

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Glossary


Annual Fees:

A once-a-year charge imposed by many credit card issuers for the privilege of using a credit card. This fee is in addition to the interest charged on purchases and cash advances.


Annual Percentage Rate (APR):

The cost of credit at a yearly rate. The APR includes the interest rate and certain other charges that the borrower is required to pay.


Applicant:

A person applying for credit privileges, employment or some other benefit.


Asset:

Can be any thing you own that has value or use (i.e. a home, car or boat).


Authorized Account User:

A person who has been granted authorization to use an account by the person who signed the contract for the account.


"B" or "C" Loans:

The credit industry term used to describe loans that reflect less than the best possible interest rate, terms, and conditions. Consumers with poorer credit may be offered "B" or "C" loans. These loans always have a higher interest rate and fees.


Bad Credit:

The term commonly used to mean that a person's credit has not been handled responsibly and that obligations have not been met.


Bankruptcy:

A proceeding in U.S. Federal Court that may legally release a person from repaying debts owed. Bankruptcy can seriously impact the ability to borrow money. The law contains several chapters that relate to different methods of relief:

  • Chapter 7 - Straight Bankruptcy (total liquidation of assets)
  • Chapter 11 - Business Reorganizations
  • Chapter 12 - Farm Debt Bankruptcy
  • Chapter 13 - Wage Earner Repayment Plan

Bankruptcy Discharged:

A court order ending the debtor's obligation to pay all included debt.


Bankruptcy Dismissed:

A court order that denied a bankruptcy petition, making the debtor still liable for all debts.


Budget:

A financial plan for saving and spending money.


Charge Card:

A card that requires payment in full upon receipt of the statement.


Charge Off:

An accounting term to indicate that the creditor does not expect to collect the balance owed on an account and has written it off as a loss.


Collection Account:

An account that has been transferred from routine debt to the collection department of a creditor's firm or to a separate professional debt-collecting firm.


Consolidation Loan:

A loan usually obtained for the purpose of reducing the amount of the payments of bills owed by consolidating the bills into one loan payment. The consumer pays off several bills with the proceeds from one loan and is left with one consolidated monthly payment.


Collateral:

Property acceptable as security for a loan or other obligation.


Consumer:

Person who uses and/or buys goods and services for family or personal use.


Consumer Credit Counseling Service:

Organizations that help consumers find a way to repay debts through careful budgeting and management of funds. These are usually nonprofit organizations, funded by creditors. By requesting that creditors accept a longer payoff period, the counseling services can often design a successful repayment plan.


Cosigner:

Person responsible for repaying a debt if the borrower defaults.


Credit:

A promise to pay later for goods or services purchased today.


Credit Bureau:

A company that gathers information on consumers who use credit and sells that information in the form of a credit report to credit lenders. Also known as a credit reporting agency.


Credit Card:

A card issued by a bank or lender, on behalf of the party named on the card, which can be used instead of cash or checks authorizing payment for goods and services.


Credit History:

A record of how a consumer has paid credit accounts in the past. It is used as a guide to determine whether the consumer is likely to pay accounts on time in the future.


Credit Limit:

The maximum amount of money that can be charged on a particular credit account.


Credit Practice Rule:

A federal law that requires creditors to provide a written notice to potential cosigners about their liability if the other person fails to pay; it prohibits late charges in some situations and prohibits creditors from using certain contract provisions that the government found to be unfair to consumers.


Credit Repair Companies:

Individuals or companies that promise to "clean up" or "erase" a consumer's bad credit and give him/her a fresh start. Also known as Credit Clinics.


Credit Report:

A record or file maintained by a credit bureau that contains information about a person, such as where the person works and lives, information from creditors regarding money borrowed and payments made, and public record information, such as whether the person has filed for bankruptcy. Used by a prospective lender or employer to help determine the creditworthiness of a prospective borrower.


Credit Reporting Agency:

A company that gathers, files, and sells information to creditors and/or employers to facilitate their decisions to extend credit or to hire. Also known as a credit bureau.


Credit Risk:

The credit industry term meaning the level of risk or likelihood of future default by an individual borrower.


Credit Score:

A computer-generated number, based on a statistical model that summarizes an individual's credit record and predicts the likelihood that a borrower will repay future obligations.


Creditor:

The person or institution providing credit or a loan to a borrower at specific terms and conditions. May be used interchangeably with the term lender.


Creditworthiness:

The ability to qualify for credit and repay debts.


Debit Card:

A bank-issued card that enables purchases to be deducted directly from the consumer's personal checking account.


Equal Credit Opportunity Act (ECOA):

A federal law that requires lenders and other creditors to make credit equally available without discrimination based on race, color, religion, national origin, age, sex, marital status, or receipt of income from public assistance programs.


Equifax:

One of the three major credit reporting agencies.


Experian:

One of the three major credit reporting agencies, formerly known as TRW.


Fair Credit Reporting Act:

A federal law, established in 1971, and revised in 1997, which enables consumers to learn what information credit reporting agencies have on file about them, and to dispute inaccurate data in the file. It also establishes specific permissible purposes for which credit reports may be requested, and places time limits on how long adverse information may be reported.


Fees:

The money you pay the financial institution for a service.


Finance Charge:

The amount charged for the use of credit services.


Garnishment:

Legal process whereby a creditor that has obtained judgment on a debt may obtain full or partial payment by seizure of a portion of a debtor's assets (wages, bank account, etc.).


Good Credit:

The term commonly used to mean that a person's credit has been handled responsibly and that payments have been made on time.


Grace Period:

The period allowed by the lender to avoid any finance charges by paying off the balance in full before the due date.


Home Equity Loan:

A loan based on the difference of the amount of equity paid on a home and the home's current market value.


Installment Loan:

A credit account in which the amount of the payment and the number of payments are predetermined or fixed.


Interest:

The cost of borrowing or lending money, usually a percentage of the amount borrowed or loaned. This also can be the money that a financial institution pays you for keeping your money there.


Introductory Rate Offers:

Favorable rates that usually only apply to a new credit card agreement and for a limited amount of time before the regular, and usually higher, rate applies.


Judgment:

The official court decision of an action or suit. This public record may be listed on a credit report in matters of money and debts owed.


Late Fees:

Charges incurred by not paying at least the minimum payment by the due date on your statement.


Late Payments:

Loan or credit payments that do not reach the lender or creditor on or before the payment due date. The indication of late payments on a credit report are damaging to an individual's credit history.


Lease:

A written document containing the conditions under which the possession and use of real and/or personal property are given by the owner to another for a stated period and for a stated price and stated conditions.


Lender:

The person or institution providing credit or a loan to a borrower at specific terms and conditions. May be used interchangeably with the term creditor.


Lien:

A legal hold or claim of one person on the property of another as security for a debt or charge; the right given by law to satisfy debt. A lien must be paid and released.


Mortgage:

A lien or claim against real property given by the buyer to the lender as security for money borrowed.


1st Mortgage:

Also known as the "primary" mortgage as priority over the claims of subsequent lenders for the same property.


2nd Mortgage:

Also known as the "secondary" mortgage as a loan secured by mortgage or trust deed, which lien is "junior" to another mortgage or trust.


Needs:

The things in life that are required for basic survival, such as shelter, food, and clothing.


Net Income:

Your take-home pay after taxes and other deductions. It is the amount of money that you actually received in your paycheck.


Payment Due Date:

Contract language specifying when payments are due on money borrowed. The due date is always indicated and means that the payment must be received on or before the specified date. Grace periods do not eliminate the responsibility of making sure that the lender receives payments by the due date. In most cases, lenders or creditors add a late charge and/or additional interest and fees when a payment is past the due date.


Permissible Purposes:

As defined in section 604 of the Fair Credit Reporting Act, only the named reasons for requesting a credit report are deemed "permissible." Requests not meeting these criteria must be denied.


Personal Line of Credit:

The maximum amount one can owe at any time, based on income, debt and credit history.


Personal Loan:

A loan based on a consumer's income, debt and credit history.


Principal:

The outstanding balance of a loan, exclusive of interest and other charges.


Public Record:

Information obtained by the credit reporting agency from court records, such as liens, bankruptcy filings and judgments. Public records are open to any person who requests them. The presence of public record information on a credit report is viewed negatively by the credit industry.


Repossession:

Forced, or voluntary surrender of merchandise as a result of the customer's failure to pay as promised.


Revolving Account:

A type of credit account that requires at least a specified minimum payment each month, plus a service charge on the balance. As the balance declines, the amount of the service charge, or interest, also declines. Examples include department stores, gas and oil companies, and bank-issued credit cards.


Savings:

Money set aside into an interest-bearing or investment account.


Secured Credit Card:

A credit card backed by a savings account that has been established in advance by the borrower. The amount in the savings account usually determines the limit on the credit card. These accounts present no real risk factor for creditors and are therefore much easier to obtain.


Terms:

The period of time and the interest rate agreed upon between the creditor and the borrower to repay a loan or credit obligation.


Trans Union:

One of the three major credit reporting agencies.


Truth in Lending Act:

A federal law that requires that, before you sign an agreement, creditors give you written disclosure of important terms of the credit agreement, such as APR, total finance charges, monthly payment amount, payment due dates, total amount being financed, length of the credit agreement, and any charges for late payment.


Wants:

The things in life that are not essential for survival, but are desired for comfort, convenience, or status.

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