Credit Education: Credit 101

A credit score is a mathematical model that evaluates many types of information in a credit file. A credit score is used by a lender to help determine whether a person qualifies for a particular credit card, loan, or service. Most credit scores estimate the risk a company incurs by lending a person money or providing them with a service - specifically, the likelihood that the person will make payments on time. Generally, the higher the score, the less risk the person represents.

The federal FACT Act mandates that consumers are entitled to a free copy of their credit report annually from each of the three credit bureaus. To access your report: Go to www.annualcreditreport.com or call 1-877-322-8228. Or contact one the of the nationwide consumer credit reporting bureaus directly: Equifax - www.equifax.com or 1-800-685-1111 Experian - www.experian.com or 1-888-397-3742 TransUnion - www.transunion.com or 1-800-888-4213

Please visit the Federal Trade Commission Identity Theft Center at www.ftc.gov/bcp/edu/microsites/idtheft.

A debt-to-income ratio is a widely used measure of financial stability and is calculated by dividing monthly minimum debt payments (excluding mortgage or rent payments) by monthly gross income. For example, someone with a gross monthly income of $2,000 who is making minimum payments of $725 on loans and credit cards has a debt-to-income ratio of 36 percent ($725 / $2000 = .36). Other authorities may offer slightly different definitions of debt-to-income ratio. While variations will result in different percentage outcomes, the overall concept is the same: a debt-to-income ratio compares debt load to income.

Generally, the lower your debt-to-income ratio, the better your financial condition. A recommended debt-to-income ratio is less than 36 percent. A ratio of more than 36 percent signals a need to control credit and to begin a plan for regaining financial stability. The ideal situation would be to carry little or no debt so your income can be saved, invested, or spent as desired, rather than used on interest.

By staying aware of your debt-to-income ratio you can avoid "creeping indebtedness." Knowing this ratio will help you make sound decisions about purchasing with credit or taking out loans. Keeping your debt-to-income ratio less than 36 percent will help you avoid major credit problems. It is a powerful indicator lenders look at whenever they consider extending credit. Letting your debt-to-income ratio increase jeopardizes your chance of making major purchases, such as a car or a home. Also, if your ratio is high, you will find it difficult to get additional credit in emergencies. On the other hand, if you keep your debt-to-income ratio low, you will more likely qualify for lower interest rates and better terms when applying for credit.