September 12, 2016 – By Dawn Papandrea
Did you know that FICO is a credit score, but a credit score isn’t necessarily FICO? Or that there is a difference between a charge card and a credit card, and debt settlement is not the same as debt consolidation?
“When it comes to the world of credit, there are a number of terms that can be confusing or misleading to consumers,” says Katie Ross, education and development manager for American Consumer Credit Counseling, a nonprofit credit counseling agency.
Find out the answers to some of the most common credit conundrums below.
1. A charge card and a credit card are not the same.
Some consumers do use these terms loosely as if these products are the same, but they definitely are not, says Michael Rose, vice president of payment solutions and technology with Affinity Federal Credit Union.
A charge card requires full payment of the principal amount (i.e., the total charges put on the card) each month. “And a charge card typically does not have a limit,” explains Rose.
A credit card, on the other hand, allows the cardholder to choose to pay either the balance in full each month, the minimum payment required or any amount in between, says Steve Min, executive vice president and chief credit officer of Synchrony Financial. Generally, depending on the terms of the credit card agreement, if you don’t pay the balance in full each month, your account will be assessed interest.
In the early days of plastic, charge cards such as Diners Club card were king, but eventually, the concept of tacking on finance charges to revolving balances caught on in the late 1950s, and the industry evolved.
Today, American Express is one of the few players left offering charge cards.
What you need to know: No matter what type of plastic you have, be sure to understand the billing cycle so you know when to make your payment, if there’s a grace period (before you are charged interest), and the consequences of being late. If you are someone who tends to rack up card debt, a charge card can force you to keep those balances in check, as you are typically not allowed to roll over any balance.
2. A credit report is not your credit score.
While your credit report and your credit score both assess how you use credit, credit reports and credit scores are often confused. Credit reports are compilations of data collected by the three major consumer credit bureaus: Experian, Equifax and TransUnion. Credit reports include your payment history and the amount of credit you have available and are utilizing for all your accounts. They also show whether you are in default or have been delinquent on any other reported debt obligations.
From this bureau data, various credit scores are generated, which calculate your creditworthiness, as well as the likelihood that you’ll be able to repay your debt at a given point in time. The most popular credit scores in the United States are the FICO and the VantageScore.
What you need to know: You can get all three of your credit reports each year for free via annualcreditreport.com. You should also take the next step and purchase your credit score at myFICO.com (or you can get one for free – a VantageScore through my.creditcards.com – and some credit card issuers now offer free credit scores to their cardholders or even the public). Both credit reports and scores will give you a sense of how your credit profile will look to a prospective lender.
3. FICO is a credit score, but a credit score isn’t necessarily FICO.
Now that you have an idea of how credit reports and credit scores differ, you might be wondering where FICO fits in to all of this. “FICO is the brand name of the most commonly used credit score, similar to how some people may use the brand name Kleenex when referring to tissues,” says Min. But there are also other credit scores out there, VantageScore being the other major one. Both the FICO, which stands for Fair Isaac Corp., and the VantageScore scales range from 300 to 850. The higher the score, the more creditworthy you are to future lenders.
To complicate matters, there is more than just one FICO and one VantageScore, says Ross. “There are hundreds of credit scoring methods that each provide a different score and change constantly,” she says. Each lender/creditor chooses its own preferred scoring model to evaluate potential borrowers. In fact, credit scoring companies offer a variety of industry-specific scores, such as those used by auto lenders.
What you need to know: When you request or purchase your own credit score, chances are it’s not the same one a prospective financial institution, auto loan provider or credit issuer will look at, but that’s OK. It will still help you see where you stand, and reveal ways in which you can make improvements.
4. How “available credit” differs from your card’s “credit limit.”
A credit limit is the maximum amount a borrower can spend on an individual credit card. Available credit is the amount of credit a cardholder has left on a card at any given point in time, says Min. For example, if you subtract your purchases and unpaid balance from your credit limit, you should have your available credit amount. Or at least in theory.
Where some people get tripped up is when transactions that have been authorized, but not yet posted against the account, are withheld from the customer’s available credit, says Min.
“Subtracting only unpaid balances and posted transactions may not be a completely accurate depiction of how much a customer has available to spend on her card account,” he says. For example, when you check out of a hotel, even though you have an itemized bill, sometimes the hotel will place an additional hold on your account to cover any unexpected charges. That hold usually disappears within a day or two, but if you’re close to maxing out your card, or if you have a low credit limit to begin with, a hold can make an impact.
What you need to know: Consumers can check their statements and balances online in real time by logging into their banking institution or credit card company’s website or app, says Ross. “Most banks will include pending charges and holds in the outstanding balance and will also list them separately from the completed charges,” she says. “This is the best way to know your current balance and how much available credit you have.”
5. Debt consolidation, credit counseling and debt settlement.
For people with serious debt problems, it’s important to know the difference between these terms, says Ross. Credit counseling agencies are typically nonprofit organizations that provide budgeting and financial education to consumers as well as discussing various options for getting out of debt. Debt consolidation and debt settlement are two options for getting out of debt.
“Debt consolidation is using home equity or another loan product to pay off multiple debts,” explains Ross. “This does not eliminate debt. Instead, it combines multiple debt amounts into one product that is easier to track and pay with a potentially lower interest rate.” Even transferring a high-interest card balance to a new, lower-rate balance transfer credit card is a form of debt consolidation.
Debt settlement companies attempt to negotiate with creditors to pay less than what is owed on your behalf. While that might seem ideal, be aware that going this route does long-lasting damage to your credit, says Ross. That’s because debt settlement agencies will often collect payments from the consumer for many months as they wait for the debt to become severely delinquent.
“They will then contact the creditor and attempt to negotiate. Credit companies are under no obligation to accept the settlement, which makes this an extremely risky approach to debt resolution,” she says.
Taking the time to learn the credit industry lingo will help demystify some of these confusing terms, so you can make educated decisions.