Module 3: Understanding credit


Understanding Credit

Narrator: Understanding Credit. Using credit when needed can be a helpful tool if you don't let it get out of control. It's important to pay your bills in full and on time to build a good credit history.

Twitter conversation (on screen):

Sarah: It's my lucky day! Just got pre-approved for a new credit card!

Vince: @Sarah Do you really need another credit card?

Sarah: @Vince Aren't credit cards like shoes? You can never have enough?? ;-) Ellen Roseman: Personal finance journalist, instructor, and author

Narrator: The option to buy on credit or borrow money can be helpful, but it can also lead to financial problems. Today we will talk about how to practice good credit management.

First, we will review different types of credit products available to most Canadians. Then we will talk about credit reports and credit scores, as well as credit reporting agencies.

We'll take a short quiz to test your credit card knowledge, then discuss some tips to avoid problems with credit cards.

Finally, we will present some interactive tools to help you select a credit card and better understand your credit card payment options.

Types of CREDIT

Narrator: There are several types of credit products.

The best known is probably the credit card. But there are also student loans, car loans, personal loans, lines of credit, and mortgages.

When you use credit products, credit reporting agencies track how you use them and create a credit report. Credit reporting agencies are private companies that sell credit reports to their members, which include banks, credit card companies, and other financial institutions. Most Canadians have a credit report on file with a credit reporting agency.

Twitter conversation (on screen):

Vince: @Sarah I wonder if having a lot of credit cards affects your credit score?

Sarah: @Vince Um, what's a credit score?

Vince: @Sarah If you're using credit you should know about credit reports and credit scores!

Vince: @FCACan Can you help us understand credit reports and credit scores?

Credit report and CREDIT SCORE*

Narrator: A credit report is a summary of your credit history. Building a good credit history is important to your financial health. Your credit report is created when you borrow money or apply for credit for the first time.

The credit report includes personal information as well as dates of account openings and loan applications, Credit balance, Payment history how much money you owe, your payment history, and any debts sent to collection agencies. When you apply for credit, the lender reviews your credit report as part of the process before approving your application.

The lender wants to minimize risk and make sure you have a record of being a good borrower. That means you make regular payments and pay debts back in full.

Did you know that late payments and other information such as personal bankruptcy will stay on your credit report for several years? The length of time this information remains on your credit report varies by credit reporting agency and sometimes by province. See the Financial Consumer Agency of Canada's publication titled "Understanding your Credit Report and Credit Score" for more information.

A credit score is a three-digit number based on information in your credit report along with other factors. Each credit reporting agency uses its own formula to calculate credit scores. Lenders can also calculate your credit score based on their own formulas.

In Canada, credit scores range from 300 to 900 points. The best score is 900 points. How is your credit score calculated? In general, you get points for actions that show lenders you can use credit responsibly.

You lose points for things that show you have difficulty managing credit. The actual formulas used are not available to the public. However, the main factors that are used to calculate someone's credit score include payment history, use of available credit, length of credit history, number of inquiries for your credit report, and having a mix of credit products. In Canada, there are two major credit reporting agencies: TransUnion and Equifax.

Both companies provide you with a free copy of your credit report whenever you ask for one. This report does not include your credit score, which is a paid service. It is important to review your credit report regularly to check for errors or fraud. A simple mistake on your credit report can cause you problems when you apply for credit.

To get your credit report free of charge, you may order it by mail, fax, telephone, or in person, and you must receive it by mail or in person. There is usually a fee for accessing your credit report online.

Knowing what is in your credit report is important. If you have a poor credit history, it could be harder for you to get a credit card or a loan.

You could have to pay more to borrow money. It could even affect your ability to rent housing or get hired for a job. So review your credit history annually and work out ways to improve your credit score.

Twitter conversation (on screen):

Sarah: @Vince Wow, I just reviewed my credit report and they catch everything!

Vince: @Sarah Borrowing money is not a game... or you would definitely be the winner!!

Sarah: @Vince So the free credit card is not so free after all?? Vince: @Sarah Is anything in life really free???

How well do you understand CREDIT?*

Narrator: Now, let's do a small quiz to test your knowledge about credit cards.

True or false: Paying your credit card balance two or three days after the due date has no effect on your credit score.

That's false. Regardless of how soon after the due date you pay, a late payment could be recorded on your credit file and stay on your record for several years. Not to mention what you'll pay in interest fees!

True or false: All credit cards have the same grace period, or interest-free period, in which you can pay your balance in full without penalty.

That's false. Each financial institution sets its own grace period. Federally regulated financial institutions require a grace period of at least 21 days. However, a lender could choose to have a longer grace period.

True or false: For a cash advance, you pay interest from the day you take the advance until the date on which you repay it in full.

That's true. Interest starts adding up on cash advances right away, unlike a credit card purchase, where you are charged interest only after the grace period has passed, unless you are carrying a balance from month to month. I hope you guessed all the answers right! Before you accept any form of credit, make sure you read the terms of the agreement and understand your rights and responsibilities.

You can learn more by visiting the Financial Consumer Agency of Canada's website.

Twitter conversation (on screen):

Sarah: @Vince Don't be a downer!! This could be my ticket to financial freedom!

Vince: @Sarah Ya, if you call 18% interest financial freedom!!!! Read the fine print...

How to avoid problems with CREDIT CARDS*

Narrator: Credit cards can be a convenient way to pay, but remember, when you pay for something with a credit card, it is the same as taking out a loan, and you have to pay it back. To avoid problems with credit cards, here are some tips:

Pay the balance in full every month to minimize interest charges. If you cannot pay the balance in full, don't make just the minimum payment; pay as much as you can to minimize the interest charges.

It is your responsibility to pay your balance a few days before the due date to ensure your payment is credited on time. If you typically carry a balance, look for a credit card with a low interest rate. Every financial institution offers one, sometimes with a small annual fee.

Finally, if you can arrange to do so, transfer your credit card balance to a line of credit with a lower interest rate. This option only works if you have the discipline to pay off the line of credit and not take on new credit card debt. Avoid temptation –  leave your credit cards at home until your debt is paid off.

Twitter conversation (on screen):

Sarah: @Vince Yikes!! You're right – hate to say it ;) It's expensive to own a credit card...

Vince: @Sarah Well, not if you use it right. How do you think I paid for dinner last week? ;)

Sarah: @Vince Let me guess... you've already paid your balance off?

Vince: @Sarah On time, and in full! Lenders love me. I'm low risk. And yet, still a fun guy!!

Interactive TOOLS*

Narrator: You can find a lot of information about credit reports and types of credit products, as well as interactive tools, at the Financial Consumer Agency of Canada's website. The Credit Card Selector lets you compare different credit cards according to your buying habits and needs. The Credit Card Payment Calculator lets you see what happens if you make a minimum payment on your credit card balance, compared to paying more.

Narrator: Let's try out the Credit Card Payment Calculator.

Step 1: Enter your information into the Credit Card Payment Calculator.

For this example, we will use the default information that's already in the calculator. The credit card balance is $1,000, annual interest rate is 18%.

Option A: What if you only make the minimum payment each month? The minimum monthly payment is usually $10 or 3% of your balance, whichever is higher. In this case it is 3% of $1,000, or $30.

Option B: What if you make the minimum monthly payment plus an extra amount? Let's say you can pay an extra $5 a month, for a total monthly payment of $35.

And finally, Option C: What if you pay a fixed monthly payment of $100?

Step 2: Click on the Calculate button.

Step 3: Review your results

As you can see under Option A, if you only make the minimum monthly payment, it would take you 10 years to pay off $1,000, and you would pay almost $800 in interest.

Option B shows that by increasing your monthly payment by $5, you will pay off your credit card balance 3 years and 10 months sooner and save $286 in interest.

And finally, if you could pay $100 per month, as in Option C, you would pay off your debt in less than a year, and you would pay less than $100 in interest!

Now try it with your own credit card information. Your balance, annual interest rate, and required minimum monthly payment are all on your monthly statement.

What did we LEARN?

Narrator: To conclude, let us summarize what we have learned today. We began by looking at different types of credit products. Then we talked about credit reports and credit scores and the importance of having a good credit history.

We discussed credit reporting agencies and how to get a free copy of your credit report and review it regularly.

Through a short quiz, we tested our knowledge about credit card rights and responsibilities.

Then we reviewed some tips on how to avoid problems when using credit cards.

Finally, we looked at some interactive tools to help us choose a credit card and manage our payment options. All this knowledge can help us use credit responsibly.

I wish you financial success.

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