Debt Free

Credit affects so many aspects of your daily life. Many people use it for a myriad of purchases, while others confine credit to cars and mortgages. In any case, even for those who only use credit for major purchases such as vehicles and real estate, knowledge of credit will be vital to get the best interest rate and fee structure. Given the level of debt of the average American, you can never know too much about credit. Here are 3 things that you should be aware of when shopping for credit.

Credit Knowledge Point #1 – APR does NOT indicate the true cost of your credit.

Many consumers are under the mistaken assumption that APR reflects the true cost of the credit they are applying. Well, you know what happens when you assume…….. In any case, APR does give a better picture of how much your credit is costing than the interest rate alone, but to give the most accurate reflection of how much a particular debt will cost for a year, you should use the Effective Annual Rate (EAR). EAR takes into account the interest, fees and compounding effect of the interest. To calculate EAR (you’re forgiven if you hate this part), use the formula EAR = ((1+APR/n)^n)-1. You’ll not that you need the APR to arrive at the EAR. This will give a better indication of your total cost of credit per annum. The difference between EAR and APR is more pronounced on longer term loans, such as mortgages and vehicle loans.

Credit Knowledge Point #2 – Your FICO score will not determine weather or not you get a loan.

It can influence weather or not you get a particular credit account, however it’s only one piece of the credit puzzle. Lenders will use it to give a general picture of your credit worthiness, distilled to a single, 3 digit number. All other things being equal (and you know they never are) a higher FICO score will get you a better rate on a particular loan, but typically it will not determine, in and of itself, if you get the loan or not.

Credit Knowledge Point #3 – Your credit score is not reduced every time you apply for credit.

There are two types of credit inquires, also known as “pulls”, hard and soft. Soft credit inquires will not affect your credit score in any way, no matter how many of them are requested. These are common when someone is getting your information for a pre-approved credit offer (junk mail), when you are opening a bank account, or when current creditors are evaluating your ongoing credit worthiness. Checking your own credit, which you should do a few times a year, also counts as a soft pull.

Hard credit inquires, on the other hand, will come into play when your credit score is being calculated. Every had pull will ding your credit score by approximately 5 points, and will stay with you for about 6 months. You have to approve any hard inquiry on your credit, but you may approve it without even being aware of it. Make sure you check in the bowels of any contract you sign to verify weather or not you’ve given permission for your credit to be checked. You’ll have a hard pull the next time you apply for a credit card, make a major purchase on credit or get a mortgage. 

These are three things you should be aware of regarding your credit. A little knowledge here will help you save money and ultimately get debt free.