Credit is a financial agreement in which a creditor, a person or institution (lender, bank, merchant, or credit card company), lends an amount of money to a borrower, another person or institution. To ensure the terms of this agreement, both parties must sign a contract where the borrower promises to pay back the amount loaned plus interest and any other fees within a defined period.
When you apply for a credit, you’re building a relationship of trust as a responsible borrower and agreeing to make all of your payments on time. Breaking this agreement can affect your credit score and lead to financial hurdles in the future.
We invite you to learn more about the benefits of having a high credit score and the downfalls of having a lower one.
The benefits and risks of credit
Access to credit can help you achieve your financial goals. To avoid risking your financial stability, it’s best to use credit in a responsible manner. That’s why it’s so important to understand the benefits and risks of using credit before applying for a loan.
- Requesting credit allows you to shop without paying full price at the time of purchase.
- It offers the option to pay for your items in monthly installments.
- Credit makes high ticket items more accessible. This includes buying a car, owning a home, starting a business, or financing your children’s education.
- You don’t have to carry cash in your wallet when you can use your credit card.
- If you do your research, you can find credit options with competitive interest rates and low monthly payments.
- Requesting credit for amounts that are larger than what you can afford can cause you to fall into debt.
- It increases the chances of making impulse purchases that you’ll eventually have to pay for.
- Failure to pay on time can cause an increase in your interest rate.
- Overusing your ability to borrow money can lower your credit score and your chances to take out loans in the future.
Types of Credit
There are a number of reasons to request a line of credit or a loan, however, the most common justification is to purchase something that the borrower cannot afford to pay in one lump sum. This is particularly true for more substantial purchases, such as a car or a house, which are typically purchased with the help of specialized forms of credit.
In order to help you better navigate this system we’ve put together a list of the most common types of credit in the market.
Credit cards are instruments issued by a financial institution that provide access to a line of credit, which can be used to purchase goods or services.
How to choose a credit card?
Before applying for a credit card at your bank, we suggest that you consider asking the following questions to ensure that the credit card you apply for is best suited to you.
- What is the annual fee?
- What is the annual percentage rate (APR)?
- What is the interest rate?
- Is there a grace period before the payment deadline?
- How is the billing period defined?
- What is the cash withdrawal fee?
- What is the credit limit?
- What is the late payment fee?
- What incentives (points, miles, cashback or other reward programs) can I get when using this card?
We suggest you choose your credit card based on the answers provided and matching those to your current financial needs.
How do credit cards work?
Once you’ve selected and been approved for your preferred credit card, the next step is using it! We’ve outlined the typical steps involved in doing so below:
- Purchase the goods or services you’re needing during the billing period.
- The bank uses their funds to pay the vendors you’ve purchased from.
- At the end of the billing period, the bank sends you a statement with a summary of your purchases.
- You’ll need to make a payment to reduce or completely close out your credit card balance before the set deadline.
What's the difference between a debit card and credit card?
Debit and credit cards are tools that help us manage our finances and are used in place of cash. The primary difference between the two is that the debit card pulls from your existing bank funds, while credit cards borrow money from the institution that provided it. Your choice of when to use which is dependent on your financial goals. To better understand each of these options we’ve put together a list of the main differences.
- Directly associated with your checking or savings account.
- Can be used to withdraw cash at ATMs. (We suggest you try to only use in-network ATMs to avoid fees.)
- Can be used to make purchases online or at local businesses that accept your type of card.
- If you have automatic withdrawals/payments set up, you may incur fees if you do not have sufficient funds in your account. We suggest you always keep a baseline of funds in your checking account.
- Typically do not have as robust fraud protection measures as credit cards do.
- If this is your first credit card and you have no credit score, you’ll need to prove to the creditor that you have a stable income. You can show this with your paycheck stubs or pension payments.
- You don’t need to have funds in your account to use your credit card. It has its own credit limit that’s independent from your primary bank account.
- Whatever you pay for with your credit card must be paid back, however, you have the option to either pay it all off at the end of the month or do so in several installments over time.
- If you do not pay the full amount owed, you’ll need to pay a minimum or risk a penalty. At the end of the month whatever is left to pay off will incur interest charge. We suggest you keep a close eye on your credit card balance.
- Cash can be withdrawn from ATMs, but this is not recommended as the fees for doing so are usually quite high.
- Includes very robust fraud protection measures.
A mortgage is a specialized loan used to buy a property, or in some cases, is a loan that’s guaranteed by the value of your property. When signing a mortgage contract, the borrower acquires the obligation to pay the creditor the borrowed money plus the corresponding interest and fees in installments.
Types of mortgages
Mortgage types vary depending on the financial institution providing the loan. The most important types of mortgage creditors are:
- Government agencies. For these types of mortgages, the following government agencies provide the loan(s):
- The Federal Housing Administration (FHA). FHA mortgages require a minimum of 580 points on your credit score, and the down payment is usually 3.5% of the total price of the home. In other words, the FHA finances 96.5% of the price of the property.
- The U.S. Department of Agriculture (USDA). USDA mortgages are aimed at individuals looking for a property in rural areas. The borrower is not required to have a credit score and, in many cases, 100% of the cost of the property is financed, without the need for a down payment.
- The Department of Veteran Affairs (VA). VA Home Loans are available for current members of the armed forces and veterans. A minimum credit score is also not required for eligible borrowers, and 100% of the cost of the property can be financed without a down payment.
- Government-sponsored enterprises (GSEs). To qualify for a GSE mortgage, the prospective borrower needs a credit score of at least 620 points. GSEs usually finance up to 97% of the price of the property; therefore, the down payment is typically 3% of the total cost. The two main GSEs are Fannie Mae and Freddie Mac.
- Private banks. Private bank mortgages are usually higher than government-financed mortgages. A credit score of at least 700 points is required for these loans. In addition, the required down payment is typically 20% of the price of the property.
Keep in mind: Can I apply for a mortgage without a social security number (SSN)? This is one of the most common questions we recieve, and the answer is yes! In lieu of a SSN you’ll need a Personal Taxpayer Identification Number (ITIN) and a good credit score. It is important to know that for these types of mortgages, the interest rates will be around 6% and the down payment required will be about 15%.
How to apply for a mortgage
The Consumer Financial Protection Bureau (CFPB) recommends the following steps for obtaining a mortgage:
- Determine the timeframe in which you want to buy a home.
- Review your credit reports to see if you have the score needed for the mortgage you want.
- If necessary, improve your credit score before applying for the mortgage.
- Pay off your debts, as mortgage lenders often assess how much debt people have compared to their income.
- Make sure you have enough money saved for your down payment.
- Before choosing a mortgage, ask the lender the following questions:
- What is the total amount of the mortgage loan?
- What is the interest rate? Is it fixed or variable?
- What is the annual percentage rate (APR)?
- What is the term of the loan?
- What are the loan closing fees and additional costs?
- Does the mortgage have other risk characteristics (such as prepayment penalties or a lump sum payment clause)?
Keep in mind: After answering these questions, make sure that the mortgage you select actually fits your needs. To find out how much you can afford, consider your household income, expenses, and saving priorities. Before you sign your mortgage contract, consider seeking counseling through official government channels.
In addition to mortgages, there are also other types of loans that you may have access to. The most common types of loans are:
- Student loans. Student loans are used to cover a student's educational expenses during college or university. There are two types:
- Federal loans: Federal loans are granted by the U.S. Government. They are the most convenient type of student loans, as the payment terms are often more lenient.
- Private loans: Private loans are provided by private financial institutions and they typically charge higher interest rates and fees than federal loans. In addition, they do not offer much flexibility in their payment terms, so it is important to review all of your options carefully.
- Car loans. As their name implies, car loans are used to finance the purchase of a vehicle. There are two options:
- Direct lending. A direct auto loan is obtained directly from a bank or credit union. This type of car loan must be paid within a specified period of time and typically includes the financed amount in addition to the financing charges agreed upon in the terms of the contract.
- Dealership financing. Dealership financing is a type of car loan provided by the car dealership. Payments on this loan are made directly to the car dealership who issued the loan.
- Loans to open a new business. The U.S. Small Business Administration (SBA) offers a small business loan program supported by private financial institutions. SBA loans help new businesses meet their financial needs, such as covering the costs of buying or renting business space(s) or payroll expenses. Although these types of loans are derived from private banks, we recommend that you contact the SBA directly if you need to extend the payment terms of your loan as they can offer support.
Keep in mind: Similarly to mortgages, it’s possible to acquire these types of loans without a SSN, as long as you have an ITIN. If you qualify for a Social Security Number in the future, you will be able to transfer your credit from your ITIN to your SSN.
Beware of fraudulent loans!
- Don’t sign documents without carefully reviewing all the fine print. If possible, we suggest having a lawyer’s review and approve it before moving forward.
- Don’t make payments to any other institution other than the one who provided you the loan.
- Remember that government aid is free, so don't pay anyone who says they belong to a government agency.
- Don’t provide anyone with your personal information (SSN or bank account details) without confirming that the person belongs to the institution that granted you the loan.
Report any suspicious activity. File an online complaint with the Federal Trade Commission (FTC) or call toll-free 1-877-382-4357 or 1-866-653-4261.
What is a credit score?
A credit score is a system used by lenders to decide if a person is eligible for a loan. If the lender or financial institution decides to extend credit, the terms of the contract will also be determined by the borrower’s credit score. This is why it's important for you to be aware of your credit score and improve it if necessary. A favorable credit score will allow you to access better terms when seeking out financing.
A good credit score:
- Gives you more financial security.
- Helps you make important life purchases (such as homes or cars) without having to pay everything at once.
- Provides you with loan options to start or grow your business.
- Gives you access to funds for emergency expenses.
- Helps you access rewards programs (such as airline miles).
A bad credit score:
- Creates more financial hurdles when seeking financing.
- May lead some creditors to deny you a loan.
- Can result in unfavorable credit terms, such as higher interest rates.
- May require you to pay a larger deposit when purchasing a house or a car.
- Can prevent you from getting emergency funds when needed.
- In some cases, it can impact your career prospects.
How to check your credit score
Your credit report contains all the relevant information of your credit history, such as your name, address, social security number (SSN), credit card information, current loans, current money owed, and payment history.
Fortunately, you can get your credit report completely free of charge! Follow the steps below to learn how to get your free credit report and monitor it for accuracy.
1. Request your free credit report. Under the Fair Credit Reporting Act (FCRA), you have the right to request a copy of your credit report from each of the credit reporting companies previously mentioned. You can request it in two ways:
- Online at: www.annualcreditreport.com.
- Over the phone at: 1-877-322-8228.
2. Correct any errors. Read your credit report carefully. If you find any errors or possible fraud, report it immediately to the credit reporting agency that you requested it from. The Federal Trade Commission (FTC) provides asample letter to dispute credit report errors. If the errors on your credit report continue even after you have notified the corresponding agency, you can file a complaint with the Consumer Financial Protection Bureau (CFPB).
3. Understand your credit score. There are several credit score models, however one of the most widely used is the FICO score. FICO scores range from 300 to 850 points and are affected by various factors:
- Payment history: 35%
- Amount owed: 30%
- Length of credit history: 15%
- New credit: 10%
- Credit mix: 10%
FICO credit score ranges are ranked as follows:
- Exceptional: 800 or more
- Very good: 740 to 799
- Good: 670 to 739
- Fair: 580 to 669
- Poor: 579 or less
4. Improve your credit score. If your score isn't high enough to achieve your financial goals, work on raising your credit score!
Your financial goals are within reach!
We hope that after reading this definitive guide you’ve gotten a better understanding of the world of credit and that you feel more prepared. If you’ve still got questions, don’t hesitate to reach out to us.