Consumer Credit Basics Guide | Types | Reports | Scores | Lender Evaluation

Consumer Credit Basics Overview

This consumer credit basics guide will help you understand credit, how it is determined and its importance.  Basically credit is simply the ability for a consumer to be able to borrow money in order to purchase a product or service.  Correspondingly borrowed money takes many forms, such as credit cards. a student loan, a personal loan, car loan or home mortgage.

Consumer credit basics are pretty straightforward.  When you receive credit from a creditor (a bank), you are assuming debt.  Therefore, debt is the other side of credit. Afterwords, you will need to pay back the full amount of this debt, interest and possible late fees depending upon the terms of the credit agreement.

Consumer Credit Basics – The Power Of Credit

Consumer credit basics starts with an understanding of what it is, the types and its inherent power on your behavior.  Having access to credit means you can buy something before you pay for it.

Because of your ability to borrow, this gives you the flexibility to plan your purchases.  Also this makes it possible to pay for a large purchase (e.g., car, house) over time.  However, you will pay interest on the purchase amount, so use credit wisely, and should only borrow money to make necessary purchases.

This consumer credit basics guide will help you learn about the different consumer credit types and how a lender views you as a potential borrower.

Types Of Consumer Credit Overview

Today there are many different types of consumer credit that are available from a wide variety of sources.  For example, some loan agreements specify equal monthly or annual payments.  While others require a large single payment of both principal and interest.

Alternatively some loans require nothing more than a borrower’s promise to pay. Conversely others require that the borrower pledge certain assets as collateral to guarantee repayment of the loan.

Consumer credit basics is divided into two broad categories: installment credit and non-installment credit.

Installment Credit

Installment Credit or closed-end credit, are loans that require you to repay the principal amount in equal periodic payments, usually monthly.   For example, an automobile loan is an example of installment credit.
Installment credit is also a popular method of financing expensive items like appliances and electronics.  Generally the lender will ordinarily retain the title to the property until the loan is paid completely. So if you don’t pay it off, the lender will repossess the property.

Non-Installment Credit

Non-installment Credit, is comprised of single-payment loans and loans that permit the borrower to make irregular payments.  Also this type of loan allows you to borrow additional funds without submitting a new credit application.  Another name for this type of loan is called revolving or open-end credit.

Single-payment loans (or term loans) require the repayment on a specified date of the entire amount that was borrowed plus interest charges.

Open-end credit allows the borrower to draw out additional funds as they’re needed. So as long the total outstanding loan balance doesn’t exceed a predetermined limit.  Another name for this your credit limit or line of credit.  For example, charge accounts (Sears and J.C. Penny) and credit card accounts (MasterCard and Visa) are the most common examples of open-end credit.

These types of accounts permit a continuous source of credit.  Basically, the borrower reduces the debt by making payments and can also add to it by borrowing.  Obviously this means “charging” addition amounts without having to reapply for credit. Generally, open-end credit accounts allow irregular or partial payments to be made subject to a predetermined periodic minimum amount established by the lender.

Consumer Credit Basics – How The Lender Views You

All lenders have a responsibility to determine the amount of financial risk associated with extending credit to a borrower. The lender, of course, expects and needs to be paid back the credit extended (the loan) in the time-frame agreed to by the borrower.

The lender takes into consideration the type of loan, secured with property (a car loan) or unsecured (a credit card) as part of determining the financial risk of the loan. If the loan is secured with property, there is less risk to the lender. When it is an unsecured loan, the lender will place more emphasis in evaluating you, the borrower.

The lender evaluates you based on the Three C’s of Credit – Character, Capital and Capacity in making a decision about whether to take you on as a borrower.

Character – From your credit history, the lender attempts to determine if you possess the honesty and reliability to repay the debt.

  • Have you used credit before?
  • Do you pay your bills on time?
  • Do you have a good credit report?
  • Can you provide character references?
  • How long at your current address?
  • What type and how long at your present job?

Capital – The lender will want to know if you have any valuable assets such as real estate, personal property like an automobile, or savings and investments that could be used to repay unsecured credit debts if income is unavailable.

  • What property do you own to secure the loan?
  • Do you have a savings account?
  • Have you investments to use as collateral?

Capacity – This refers to your ability to repay the debt. The lender will look to see if you have been working regularly in an occupation that is likely to provide enough income to support your credit use.

  • Do you have a steady job? If so, what is your salary?
  • How many other loan payments do you have?
  • What are your current living expenses?

Consumer Credit Basics – How Credit Worthiness Determined

Your financial life is defined by the contents in your credit reports that are generated by the national credit bureaus.  Whenever you have requested credit from a lender, for whatever reason, that is noted in your credit reports.

Each payment or non-payment that you have made to a creditor is recorded in your credit reports.  Also, all of these credit activities are retained in your credit reports for a period of seven to ten years before rolling off.  Basically, in the eyes of a potential lender, the contents in your credit report defines you.

The information in your credit reports are numerically analyzed by the credit scoring companies.  Consequently, based on their financial models they assign you a credit score.  In short this is used by a lender as a predictor of consistent, on time repayment of credit debt.

Consumer credit basics indicate that you are defined by this magic number that reflects the sum of your life’s story.  Basically, your credit score determines whether you are considered a good or bad credit risk.

The financial models that the credit scoring companies use do not take into consider any personal information of the debtor.  So, in a sense your credit score is completely impersonal.

Right or wrong, good or bad, your credit score determines your credit worthiness. 

Your Credit Reports And Credit Scores

There are three major US credit bureaus: Experian, TransUnion and Equifax. The credit bureaus maintain records of your credit data and other identifying information. These are your consumer credit reports.

There are two major US credit score providers: FICOScore and VantageScore. FICOScore is the market leader and are used in over 90% of US lending decisions. These are your consumer credit scores.

When you get a new loan or credit card, make or miss a payment, apply for a car loan, etc., your lenders will report this information to the credit bureaus. Since it is up to your lenders what information they report to the credit bureaus, and which credit bureaus they report to, it is not uncommon for your credit reports to be slightly different at each bureau.

All consumer credit reports contain the same four categories of information.

Personal Information – Your name, address, Social Security number, date of birth and employment information. This information is NOT used in calculating your credit score.

Accounts – Your credit accounts, organized by type (bankcard, auto loan, mortgage, etc.), date opened, credit limit or loan amount, account balance and payment history.

Inquiries – Requests for your credit report within the last two years. There are two types of inquiries: hard inquiries and soft inquiries. A hard inquiry occurs when a lender or other third party checks your credit report or score when you apply for credit with them. A soft inquiry typically occurs when your credit reports and scores are pulled without you applying for credit (like when a credit card issuer sends you a pre-approved offer), or when you pull your own credit reports. Your credit scores only consider hard inquiries.

Negative Items – Delinquency information from missed payments that have been reported by lenders. This also includes information on overdue debt from collections agencies, and public record information (bankruptcies and foreclosures).

And since your credit scores are calculated from the credit data on your credit reports, it is also common for your credit scores at each credit bureau to be slightly different. Yes, you have multiple credit scores. And, different lenders use industry specific credit scores when evaluating your credit. For example, there are credit score versions for auto, home mortgage and credit cards.

 What Affects Your Credit Score

Credit scores are based on the information in our major credit reports.  Simply put, they represent a numerical weighting of different categories found in a credit report.  Furthermore, there are two major providers of credit score reports in the US: FICO Score and VantageScore. While the credit scores may be calculated a bit differently, they will likely produce very similar results for you.

Your credit score is calculated only from the information in your credit report. However, lenders may look at many things when making a credit decision, such as your income, how long you have worked at your present job, and the kind of credit you are requesting.

If you have good marks in each of the following credit categories (using FICO Score as reference), your credit should be good no matter which credit score report is used. These percentages are based on the importance of the five categories for the general population. The importance of these categories may vary from one person to another.

Payment history is the most important part of any credit score. The first thing any lender wants to know is whether you have paid past credit accounts on time. This helps a lender figure out the amount of risk it will take on when extending credit.

Having credit accounts and owing money on them is the second most important category of a credit score. It is an indicator of whether your spending habits are sustainable and if you are likely to face serious financial problems in the future. If you are using a lot of your available credit, this may indicate that you are overextended-and banks can interpret this to mean that you are at a higher risk of defaulting.

In general, a longer credit history will increase your credit report. The length of time using loans, credit cards and lines of credit is important in accurately forecasting a borrower’s future risk behavior. However, even people who haven’t been using credit long may have credit scores depending on how the rest of their credit report looks.

This category measures your mix of different types of credit accounts (credit cards, retail accounts, installment accounts, auto and mortgage loans) and how recently you have used them. The types of credit you have used shows how experienced a borrower you are. It is not necessary to have one of each.

On a credit score, this category emphasizes your recent financial performance. This is one of the best predictors of your future financial activities. Research shows that opening several credit accounts in a short period of time represents a greater risk, particularly for people who do not have a long credit history. If you can avoid it, try not to open too many accounts too rapidly.



Consumer Credit Basics Guide Review

Americans are living beyond their means. Overall the average American household carries $137,063 in debt, according to the Federal Reserve’s latest numbers.

Yet the U.S. Census Bureau reports that the median household income was just $59,039 last year.  Consequently that means many Americans are living beyond their means.

There are good and bad uses of credit.  Particularly consumers have a problem managing their credit card debt.  While good use of your credit cards should be for their convenience, ease of use, and relative safety.  Conversely, bad use of your credit cards is if you are using them to make everyday purchases that you cannot afford to pay in cash.  Undoubtedly you are on the verge of debt trouble.

One of the principal consumer credit basics is that you need to live within your means.   So use credit responsibly and don’t be a debt statistic.

Fix My Credit