Chapter 2: Getting Started
What You Should Look For
Before you apply for credit, make sure you know what the terms of borrowing are, especially the following:
- Annual percentage rate (APR) – The APR is the annual rate of interest charged on the outstanding balance. The lower it is, the lower the cost of borrowing. The APR can either be fixed, meaning it never changes, or variable, meaning it fluctuates according to an index. For credit cards, a variable rate is common, as is charging a different rate for different types of transactions. (For example, the APR for cash advances is usually higher than the APR for purchases.) For mortgages and other large loans, a fixed rate is usually preferable because the payment is set. You may be able to get a lower rate initially with an adjustable-rate loan, but if the interest rate rises, the payment does too.
Keep in mind that the rate advertised in the application or marketing materials is the rate that is given to borrowers with the strongest credit history. After the creditor processes your application and checks your credit score, you may be given a higher rate. If you are not satisfied, you do not have to take the credit.
- Grace period – For credit cards, a grace period is the number of days, usually 21 to 30, before interest is assessed on new purchases. (It is only given if you paid off your balance in full the previous month. Also, there is usually no grace period for cash advances.) If your credit is good, you should have no problem finding a card with a grace period.
- Annual fee – Unless you want special features, if you have good credit, you should be able to find a credit card that does not charge an annual fee. If you have no or a poor credit history, you may be out of luck. However, once you build a positive credit history, request that the fee be reduced or eliminated, or shop for a card that doesn’t charge one.
- Late fee – Virtually every credit issuer charges a late fee. You should always make your payments on time, but it does not hurt to look for an account with a low late fee just in case.
- Application or activation fee – For secured loans, you may have to pay an application fee (which should be refunded if you are denied). However, if you have good credit, you should not have to pay one when applying for a credit card. Neither should you have to pay a fee to activate the card.
- Miscellaneous fees – Some credit card issuers charge for a variety of other activities, such as for not carrying a balance or carrying a balance under a certain sum. The better your credit history is, the less you have to accept such expensive terms.
What Creditors Look For
To get a credit card or other type of credit, you must fill out and submit an application. You may receive a “pre-approved” offer in the mail, but it is just a marketing device – you still have to apply.
While specific approval guidelines vary from lender to lender, many base them on the “Five C’s of credit”:
- Character – Character refers to how responsible you are with repaying your debts. Most creditors judge this by looking at your credit report and/or score. Your credit report tracks your credit activity: what accounts you have, how much you owe, your payment history, etc. Your credit score is a numeric summary of the information in your credit report and is formulated to predict the likelihood you will not repay what you borrowed. The two most important factors in your credit score are your payment history and level of debt (the higher the balance, the lower your score, especially if the balance is close to your credit limit).
- Capacity – Capacity refers to the ability to repay what you borrow. Few lenders would approve you for a loan with a $1,700 monthly payment when you are bringing in $1,800 a month. Creditors also usually consider what your current debt obligations are. If a creditor feels you do not have the capacity to pay back the amount you want to borrow, they may deny you or approve you for a lesser amount.
- Capital – Capital refers to the assets that you have. Basically, the creditor wants to know if you have savings or other assets that you can use to make your payments if you lose your job or experience something else unexpected.
- Collateral – When you are applying for secured credit and the collateral is an item, not cash, the lender will likely be concerned with what the condition of the collateral is. For example, most lenders require an appraisal when you apply for a mortgage. A crumbling house near a toxic dump that appraises for $25,000 is not very good collateral for a $200,000 loan.
- Conditions – Conditions are situations that could affect your ability to make payments. Often these situations are beyond your control. For example, a creditor may be less likely to lend to people if the economy is weak and many companies are shutting down.
New to Credit
If you are new to credit (or trying to reestablish a positive credit history), you may find it difficult to get approved for a regular credit card or loan. However, you still have options. A secured credit card is usually the easiest type of credit to get. As mentioned previously, it requires you to make a cash deposit that the creditor can keep if you do not make your payments. (You will get the deposit back otherwise.) The credit limit is often low, and the fees can be high, but you may be able to convert it to a regular credit card after a year or two of on-time payments. Make sure that the creditor reports your account to the credit bureaus – if they don’t, you won’t be establishing a credit history. The approval standards are often not that strict on retail cards either. Another option is to have someone with a good credit score cosign an account for you. This requires a great deal of trust on the part of the cosigner – if you fail to pay, he or she can be held responsible for the full balance.