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Federal Reserve Bank of Philadelphia


redit is a valuable commodity. Having the ability to borrow funds enables us to obtain
things we would otherwise have to
save years to afford: homes, cars, a college education. Credit is an important
financial tool, but it can also lead people into debt far beyond their ability to
repay. That is why learning how to use
credit wisely is one of the most valuable financial skills anyone can learn.
Before creditors lend money, they need
to be assured that the funds will be
repaid — in other words, is the prospective borrower creditworthy? To
find out, they ask for various types of
Income & Expenses
Lenders will look at what you earn and
your regular expenses, such as rent,
utilities, food, and other ongoing items.
The amount left tells them whether you
can afford to take on additional debt.
Do you have assets that can serve as
collateral? Lenders will look for things
like bank accounts and valuable items
such as a house, if you own one.
Credit History
How do you manage debt? If you have
credit cards or have borrowed money
before, you have a history that indicates
to prospective lenders whether you are

creditworthy by revealing details about
the amount of debt you already have,
how many credit cards you have, and
whether you make payments on time.
It’s easy to qualify for credit if you have
a good history, but what if you have
never used credit before? This is a common problem for people who have just
started working, people who always
pay in cash, or people who have not had
assets or accounts in their own names.
For people in these categories, the first
step is to establish a credit history.
*Creditors obtain much of this information
from your credit report, a computerized
profile of your borrowing, charging, and repayment activities. For further information
on credit reports, see Understanding &
Improving Your Credit Score, a brochure
published by the Federal Reserve Bank of
You can apply for a bank loan secured
by the funds you have on deposit or by
items you own, such as a car. You can
ask a friend or relative who has good
credit to cosign a loan, which means
that he or she shares the liability for the
loan with you. You can also apply for
department store and gasoline credit
cards, which generally are easier to
obtain than regular credit cards.
Before you apply for any credit, however, make sure you understand the

terms. For example, how long is the
grace period — the time you have to
pay the current balance in full before
finance charges are incurred? Is there
an annual fee, or other fees, associated
with the credit? If you believe that you
will carry a balance, you need to know
how finance charges are calculated.
Patience is important. It takes time to
establish credit, to build a record of
consistency in making payments that
demonstrates your creditworthiness.
And it is much better to go slowly and
assemble a strong credit record than
to apply for too many credit cards or a
loan that is larger than you can handle.
Start slow, be cautious, keep track of
your overall debt, and pay on time.
Most important, remember that credit
represents real money and has to be
repaid with interest. These are the keys
to establishing good credit.
Once you have obtained credit, it is essential to protect it. This means safeguarding your credit, debit, and ATM
cards, as well as your account and
personal identification numbers (PIN).
Carry only the cards you expect to use
and keep the others in a safe place.
Maintain a list of account and telephone
numbers of the companies that issued
your cards. Then, if your cards are lost
or stolen, you can notify the companies

quickly. If your notification is received
before the cards are used by someone
fraudulently, you have no liability. If it
is received after a credit card has been
used, your liability cannot exceed $50
for each card. Your liability for ATM
or debit cards depends on how quickly
you report the loss.
If you dispute an item on a bill, you are
responsible for notifying the creditor
in writing within 60 days of receiving
the bill. You should include your name,
account number, the item you believe is
in error, and the reasons why.
Among the most common reasons
people are turned down when they apply for credit are:

too little time in current job or at
current residence
too much outstanding debt
unreasonable purpose for requesting credit
limited credit experience
foreclosure or repossession
delinquent past or present credit

In general, creditworthiness must be
determined on the basis of criteria that
relate to your ability and willingness to
repay debt. You cannot be denied credit
based on your sex, marital status, race,
color, religion, national origin, age, reli5

ance on income from a public assistance
program, or exercise of rights under the
Consumer Credit Protection Act.
If you are denied credit, the creditor
must provide to you in writing a statement of the action and your rights, as
well as the reason for denial, or how to
request the reason. For information on
the laws applying to credit, see Do You
Know Your Credit Rights?, a brochure
published by the Federal Reserve Bank
of Philadelphia.
For information on rectifying credit report errors, see What Your Credit Report
Says About You, a brochure published
by the Federal Reserve Bank of Philadelphia.
If you have fallen behind in your payments, the only alternative is to begin
immediately to repair your credit
record. Here’s how:



Face up to the problem. Recognize
that you are overextended and contact your creditors to see if they will
set up a new payment schedule that
you can maintain. Contact creditors
to try to work out a payment plan
that you can live with. In any case,
never ignore bills.
Immediately stop purchasing with
credit. Take your credit cards out of
your wallet. Store them in a place
that is inconvenient to reach, or




even cut them up.
Consider consolidating debts. You
may find it easier to make a single
payment rather than several, and
you might obtain a lower interest
rate that will make it easier to keep
up with the payments. Remember that debt consolidation is not
a cure-all: You also have to learn
to control your spending to avoid
future debt.
Contact a credit counseling organization. You can obtain referrals for
organizations in your area through
the National Foundation for Credit
Counseling’s member agency locator, 800-388-2227.
Don’t expect miracles. Don’t believe
companies that promise to fix a
poor credit rating quickly and
painlessly for a fee. As long as it is
accurate and timely, negative information cannot be removed from
your credit record. The only way
to improve a credit record is to let
time pass and establish a record of
on-time payment.

The dissolution of a marriage does not
erase the debts you and your former
spouse took on as a couple. Even if
your former spouse is ordered by the
court to pay debts from the marriage,
you can become liable if the payments
are not made. Here are a few suggestions to protect your financial standing:





Decide how to divide or dispose
of property. If necessary, you can
retain a mediator to work through
this with your former spouse.
Close or separate joint accounts.
Decide with your former spouse
who will be responsible for paying
bills and notify your creditors of
your divorce.
Establish independent credit, if you
do not already have it.
Make sure bills are paid.

If you are applying for a loan and you
think you may want to pay it off before
it has run its full term, you should be
aware that lenders have several methods of calculating interest. The method
they use affects the amount you may
owe if you decide to pay it off early,
and since lenders are not required to
disclose which method they use, you
may have to ask. Here is a brief description of the most common interestcalculation methods.


Rule of 78s
This formula, which originated
when most loans were made for 12
months, is derived from the sum
of the numbers from one to 12. Its
use may be mandated by state law.
The rule of 78s may not be used to
calculate interest rebates for loan
transactions made after September
30, 1993, and with a term exceeding
61 months.



Actuarial Method
This method is most often used for
mortgages and other loans in which
a periodic rate is applied to a declining balance. It does not take into
consideration whether a payment is
made before or after the due date.
Daily Simple Interest
In this method, a daily periodic rate
is applied to an outstanding balance. Therefore, borrowers benefit
by reducing the outstanding balance through early payments or
lump-sum payments, both of which
reduce the balance and the interest
due. Under a simple interest system, late payers will end up owing


The Federal Reserve Bank of
Philadelphia has other brochures on
credit topics.
To obtain copies of these brochures, or
for additional copies of this one, please
Federal Reserve Bank of Philadelphia
Public Affairs – Publications
P.O. Box 66
Philadelphia, PA 19105-0066
Questions and concerns about credit
bureaus can be directed to:
Federal Trade Commission
Consumer Response Center
600 Pennsylvania Avenue, NW
Washington, DC 20580
877-FTC-HELP (382-4357)


For information on credit counseling in
the Philadelphia area, please contact:
1608 Walnut Street, 10th Floor
Philadelphia, PA 19103
215-563-5665 or 800-989-2227
For credit counseling in other areas,
please contact:
National Foundation for Credit
2000 M Street, NW, #505
Washington, DC 20036
Member Agency Locator


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Reserve Bank of Philadelphia,
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