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Review your credit

What is credit? | How do you get credit? | How to establish a good credit history | How to protect your good credit standing | What's on a credit report? | How can I view or fix errors on my credit report? | How can I repair bad credit?

One of the first steps in readying yourself to buy your home is to examine and evaluate your credit standing.

What is credit?

Credit permits you to obtain something now for little or no money out of your pocket, and pay for it over a specific period of time.

There are two types of credit:
Open-end credit is extended on an ongoing basis, but usually with a limit on how much you may borrow. It is often referred to as revolving credit because as you repay the balance due, credit up to a specified limit is then available to you again to use at anytime in the future. Credit cards, such as VISA® and MasterCard®, are the most common form of open-end credit.

Closed-end credit is extended on a one-time, limited basis, such as a car loan or a personal loan. Although you may still have a positive relationship with the lender after paying off the obligation, you must still requalify each and every time you want another loan.

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How do you get credit?

Credit is most frequently extended by department stores, finance companies, oil companies, credit unions, commercial banks and credit card companies. Those who extend credit are called creditors. For credit to be extended to you, a creditor looks at two things:

  • You as a credit risk. Each creditor has different ways of evaluating applications for credit. Most creditors review various factors such as income, length of employment, how long you've lived at one residence, previous credit history, amount of outstanding debts, stability of your checking and savings accounts, number of dependents, etc., in order to determine, to a certain degree, whether you will repay the amount borrowed over a certain period of time.
  • The collateral you are purchasing. If you fail to make payments on collateral purchased with credit, it's easier for a creditor to repossess items like furniture and appliances than to foreclose on a home. Therefore, credit may be extended to even those with a questionable ability to pay when it comes to purchases like refrigerators and entertainment systems. When a home has been posted as collateral for a loan, the foreclosure process can be costly and time-consuming. The lender assumes a greater amount of risk at a lower interest rate. Therefore, the lender is going to evaluate you and your credit history more carefully when you're trying to buy a house. Unfortunately, this is where some people learn their first real credit lesson — when credit is really important — because they are stunned and surprised when denied, based on their credit history.

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How to establish a good credit history

Establishing a good credit history is actually pretty simple:

  • Open a checking and savings account. Maintain your checking account by keeping enough money in it to cover all outstanding checks. Make regular deposits in your savings account to establish a history of savings.
  • Apply for credit gradually — once your checking and savings accounts are in good working order and if you believe your budget can handle the financial load, apply for credit through retail stores or a major bank.
  • Don't apply for more credit than you can manage. A credit card establishes you with credit as soon as your application has been approved.
  • Make regular payments for the products or services you purchase with credit. Every time you make a payment as agreed to a creditor, you are building a favorable credit history.

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How to protect your good credit standing

Failure to repay credit extended as agreed is where most people get in trouble.

  • Late payments affect your credit history. It doesn't matter that the credit card balance is only $5, or that the payment is only one day late, or that you pay the late fee. Failure to pay on time will put a black mark on your credit history that can last for a year or more.
  • Minimum payments are another trouble spot. Making the minimum payment is acceptable, but it does very little to reduce your outstanding debt. Meanwhile, interest and annual fees can significantly add up over time.
  • Use credit effectively. Determine how much credit you can comfortably afford. Develop a household budget — a detailed list of your income and expenses. If you find that you cannot afford credit purchases, considering your current income and expenses, you should still concentrate on establishing good credit, but continue making most of your purchases using cash. Credit purchases should generally be limited to those that can be paid off at the end of the month. Larger purchases should be evaluated based on need, and a payment schedule must be established to assure that the debt is paid off quickly.

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What's on a credit report?

The credit report just provides information; it's up to the creditor to determine whether you are a good or bad credit risk. Each creditor will analyze the information differently when deciding whether to extend credit to you. The credit report typically includes four types of information:

  • Identifying information: your name, nicknames, current and previous addresses, Social Security number, year of birth, current and previous employers, and if applicable, your spouse's name.
  • Credit information: the credit accounts you have with banks, retailers, credit card issuers and other lenders. For each account, your credit report will list the type of loan (revolving credit, student loan, mortgage, etc.), the date you opened the account, your credit limit or loan amount, the account balance, and your payment pattern during the past two years. The report also states whether anyone else besides you (your spouse or cosigner, for example) is responsible for paying the account.
  • Public record information: state and county court records related to bankruptcies, tax liens or monetary judgments. In some states, credit reports list overdue child support payments.
  • Inquiries: the names of all credit grantors and potential employers who obtained a copy of your credit report for any reason. The inquiries section of your report contains a list of anyone who accessed your report for up to two years. These time periods protect you as a consumer or job applicant.

Almost as important as what is in your credit report is what isn't: no information about your race, religious preference, medical history, personal lifestyle, personal background, political preference or criminal record.

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How can I view or fix errors on my credit report?

To obtain a copy of your credit report, contact any of the three major credit-reporting agencies. Each agency compiles its own report, so you may want to obtain copies from all three agencies.

To correct any errors on your credit report, you may contact the credit provider and explain the error. If the creditor concurs that an error has occurred, the credit provider must report and correct the error to the credit-reporting agency.

There is also an online dispute form on each of the credit-reporting agencies' websites. After you fill out the form, the agency will investigate your claim and contact the creditor in question on your behalf. If the creditor agrees that an error has occurred, the credit-reporting agency will then fix the report.

How can I repair bad credit?

It may take some time, but bad credit can be fixed. You may want to contact a professional financial counselor or a credit- and budget-counseling agency, if you need help developing a budget/debt reduction plan.

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