All About Credit

I’m sure you have heard quite a bit about credit. Good credit, bad credit. But what exactly is credit?

Quick answer: “Credit” generally refers to your credit score, which is a number that grades you on how risky it may be to give you a loan.

Having good credit means that you are expected to be a responsible money borrower- you will probably pay your loans back in full and on time. Good credit is often rewarded with the ability to borrow more money and lower interest rates on loans (you REALLY want this, because of compound interest!)

Bad credit means you are considered a higher risk loan customer. It might be harder for you to get a loan, and your interest rates will probably be higher than someone with good credit.

So what is a credit score? A credit score is a number between 300 and 850. Seems crappy that all of your brains and beauty and talent should be simplified into one measly number, but that’s how life works sometimes. Try to get the best number you can!

  • Below 600 is generally considered not so hot. You might have trouble getting a loan and your interest rates will not be great.
  • 600-674 is below average.
  • 675-710 is good.
  • 710 and above is excellent. You should have no trouble getting a loan and you should be able to get highly competitive interest rates.

How do you find your credit report? 

Under law, you can get a free summary of your credit report once a year. There is only one website that is authorized to give you the official credit report that you are legally entitled to. This is https://www.annualcreditreport.com/. They get their data from one of three sources and you can pick one to give you your free report: Equifax, Experian or TransUnion. Any other website has not been Federally approved and are considered scam websites (and you are putting your social security number in there, so be careful!).

Equifax, Experian and Transunion get their data from different sources, so theoretically your credit reports could be different from each company. You can only order from one of these companies each year for free, but you can always pay for reports from the other two companies.

It’s important to get your credit report periodically because it helps you make sure the information is accurate. It also protects you against identity theft.

What is in a credit report?

Information such as: your address, social security number, date of birth (to make sure it is you!).

How much credit you have access to (loans, credit cards, mortgages etc.) and the dates of opening these accounts.

How many loans you have requested (signing up for lots of credit cards can impact you negatively!)

Any outstanding debt or collections you have against you.

If information is not correct on the report, you can follow these instructions for getting it fixed. If this happens to you, I am sorry about the additional paperwork.

Is my credit score on the report?

Drat! No! You usually have to pay more (between $10 and $15) to get your credit score. If you are thinking about taking out a big loan in the future, it is probably worth your money to pay for the credit score so you can factor interest rates into your budget. I get mine every few years just to check in, because there are ways you can improve your credit score if you need to.

What impacts your credit?

Credit Pie
Credit Pie

Payment History

I hope by now you have already automated your bill payments so you know that 35% of your credit score is PERFECT!

If you had some errors in the past, those problems may stay on your report for up to 7 years. Sorry. If you are currently in a dispute over a bill or if you just missed one payment, make sure you call to ask that the late payment isn’t reported. Usually there is a grace period and you won’t get reported if it has only happened once, so don’t freak out. Also sometimes (for whatever reason this happens with medical bills frequently) the first time I get the bill in the mail it is already overdue. Just pay it as soon as you get it and save the envelope with the postage date stamp- they will send you second and third notices before they actually report you for nonpayment.

A benefit to being young: if you make a lot of credit errors when you are 21 (we all made a lot of mistakes when we were 21, don’t worry. Tequila was high on my list…), by the time you are ready to buy a house, you will probably have moved past the seven year mark and your errors will be off of your credit report. It is not as easy for a 35 year old to recover from credit mistakes because a 35 year old generally needs access to more credit than someone in their early 20s.

Amount Owed

The amount owed does not necessarily mean that if you are in debt, you have bad credit. It really refers to a how much you owe compared with how much people would loan you. If you have a credit card with a $15,000 limit and you owe $2,000, you still have $13,000 of credit available. That is good. If you have a credit card with a limit of $5,000 and you owe $2,000, you only have $3,000 left of credit. That isn’t so great.

One way to improve your credit score (immediately! One phone call!) is to ask for a credit increase. This is only appropriate for you to do if you don’t have a ton of credit cards and/or loans out, because asking for too much new credit at once can harm your credit report. (GAH! Can we never win!?!) But occasionally- maybe once a year, or if you get a raise- call up your credit card and ask for a credit increase.

Length of Credit History

This one is pretty obvious- the longer you have been using credit and paying bills on time, the safer a candidate you are. If you are a freshly minted adult, now is a good time to slowly start using credit to build up a good credit history. Additionally, if you have a credit card that you never use but you have had for a long time- don’t close that account. Keep it open (maybe put your Netflix subscription on there and automatically pay it off each month, so you don’t have to think about it).

Also- closing an account does not delete it from your credit history. Sorry, kids.

New Credit

If you have suddenly signed up for four credit cards all in the same day (did you get suckered into those 20% off offers at the mall?!?!! NOOOOOOOOOOO!!!!!) then your credit score will suffer (especially if you don’t have a long credit history). Any sudden request for multiple forms of credit may drop your score.

This is why I NEVER recommend that people sign up for those store credit cards at the mall. Saving 20% on a pair of sweet shoes may save you $20  today, but a lower credit score can impact your mortgage rates when you buy a house, which will cost you THOUSANDS OF DOLLARS. You should have two or three credit cards, but you should not have a different credit card for every store you have ever shopped in. It is better to have a few credit cards with high credit limits and rewards you like.

Types of Credit

Your score also considers the different types of credit you have. Credit cards, installment loans, retail accounts, mortgages, car loans are all different types of loans. It’s normal for young people to only have a credit card and not a mortgage, so don’t go buying a car to try to diversify your loan types. It is more important that you are responsible for the types of credit that you do have, so that when you get older and buy a house you will already have a solid credit score to negotiate with.

There you go: credit demystified. Not as scary as it seems, huh?

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[James Earl Jones voice] Do You Need Help Paying off Credit Card Debt?

“You want 21% risk free? Pay off your credit cards.”- Andrew Tobias

Did you know, I hate paying for other people to use and manage my money? I hate bank fees, I hate late fees, I hate paying compound interest on my debt.

The all time worst deal on taking out a loan (that is what a credit card is, kids) is the interest rate you pay on credit cards. One of my cards is 17% interest! That means if I have $1000 worth of debt and I only pay off the minimum ($25 a month, on that card) it will take me FIVE YEARS to pay that debt off and it will cost me $1486! I end up paying almost 50% more for everything I bought with my credit card- not savvy at all. You’re paying for designer and you’re wearing TJ Maxx (that you bought five years ago). Don’t do that!

Not only is not paying off your credit cards immediately bad for your closet and your wallet, but you should think about where you want your money to go, as a consumer. You have to buy clothes and food, and you have the option to spend your money on other things. You can buy yourself more shoes, donate to charity, buy organic food, buy video games, save for Lasik, give your money to your sister, pay your college loans off, buy some new wallpaper. That’s awesome- you get to choose where your money goes, and you can invest in yourself, others, or in something you believe in.

If you are spending your money on credit card debt, you are spending your money on supporting credit card companies. Companies that exploit the part of human nature that loves immediate gratification. Yuck. That is not where I would choose to put my money. I’d rather have a new pair of shoes.

Stop a minute. How are you feeling? If you have any credit card debt, you probably feel guilty and annoyed that I am telling you how horrible something that you already hate is. Completely valid feelings. The real way that the economy works is that it takes advantage of  a few flaws in human nature, and it rewards people who can thwart those instincts with their massive brainpower (I’m talking to you, my brilliant reader!)

The reason why credit card debt is so common is because of something called future discounting (sounds fancy, and it sure is! You’re going to learn something new today). Future discounting is human nature. It means that you place less value on $110 that you will get in the future than $100 in your pocket today. You can spend that $100 today, but what is that $110 in the future gonna get you?  You will probably have way more money in the future, and maybe that $110 will not buy as much because of inflation, so you would rather have $100 right now. This is how credit cards work. Foiled by our own future discounting!

How do you overcome this teeny flaw in human nature to become the master of your own destiny?  Here is the strategy:

1. Stop charging more than you can afford. Look at your budget. Is what you are charging in the budget? Will you have enough in your checking account to cover this purchase? No? Then don’t buy it. Check out my tips to slenderize your spending.
2. Pay off more than the minimum amount due and set up automatic bill pay so you don’t tempt yourself to just pay the minimum when you pay your bills. If I made $50 payments instead of $25 payments on my TJ Maxx debt, I would pay off my debt in two years and it would only cost me $1184 total- you can save $302 just by paying a little more off each month! Stopping compound debt in its tracks feels just as good as earning compound interest.
3. Think about interest rates. If you are investing $50 a month and earning 6% and you are paying off debt that is costing you 17%, you should be putting that $50 investment money towards your debt. You will save more money on paying off debt interest than you would make investing. If you have any wiggle room in  your budget and if you are putting money into long term savings, I recommend that you shift that money over to debt reduction (provided the interest rate on your debt is higher than the interest rate on your savings).

If you have more than one credit card, pay off the card with the highest interest rate first. Some schools of thought say that you should pay off the smallest amount first so you have a victory under your belt and you stay motivated- that is fine too, but it will cost you more (but spending money to stay motivated is a legitimate expense so if it works for you, go for it!)
4. If you haven’t maxed out your credit cards and you still have access to some funds in a pinch, it is better to wait before building an emergency fund. If an emergency does happen before you have an emergency fund, you will probably put the expense on your credit card where you will be charged interest- but only if an emergency happens. If you build an emergency fund while paying off your debt, you will definitely pay that interest on your debt. Go with the option where you MIGHT pay interest rather than the option where you WILL pay interest.
5. Call your credit card companies. See if they can lower your interest rates, and while you’re at it, see if they can stop charging you any stinkin’ fees you might be paying. They work for you, and if they won’t help you can always tell them you are thinking about closing their credit card- they hate losing customers.
6. If you are still drowning, think about consolidating your credit card debt. To do this, you can transfer your debt over to a card with zero interest for a certain amount of time. There are a few pitfalls, because opening more credit cards is not necessarily good for your credit. If you choose to do this look for the lowest interest rate. That being said, don’t charge more just because you have an amazing (or no!) interest rate for a certain period of time. It will bite you in the butt and then you will have to start over at step 1.
7. Make a plan and stick to it! If you have promised yourself to pay off your newly consolidated debts, that should be your main financial goal. If you are having a hard time laying off the plastic, switch to a cash-only budget. I just read a study that found that spending is reduced by 20% on average when you use cash instead of credit cards.

You might be finding this completely intimidating. You might feel like it is hopeless and you will be mired in debt forever. YOU WILL BE FINE. Just like saving up for Lasik, eliminating your debt is a slow process. Cut back on your spending, automate your bill payments, and relax about it for now. You have a plan, you are following the plan- and you are right on track. So pay attention to your debt, but stop worrying about it. Check back in in 3-4 months. See how your progress is. Readjust if you need to. When you make a plan for yourself and you follow that plan, you are making the best financial decision that you can make. Instead of worrying about unknown debt you can now say with confidence that you are in control of your finances and there is no need to worry about the unknown. Do you feel better? Me too.

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