Let's Talk Credit
The thing we seem to get asked about the most is credit. Young people want to establish credit, a little older people want to know how to make it better. We are talking about those things as well as what makes up your credit score.
Let’s begin with how to establishing credit. There are actually have several options.
1. Credit builder loans – First Pioneers offers a series of credit builder loans that, if the payments are made on time and the loan is in good standing, a good credit score will be established at the end of the 3-year cycle.
a. The series includes a 6-month loan for $250, a 6-month loan for $500 loan followed by two 12-months loans at $750 and $1000. Many financial institutions offer something similar, but it may be structured differently.
2. A secured loan or credit card. With most installment credit accounts, the item you are purchasing is the collateral against the loan or secures the loan. With a secured line of credit, the loan is secured with money held in a savings account at the financial institution that is issuing the credit until the loan is payed off. You aren’t able to access that money as long as it’s needed for the loan, but as you pay on the loan, those amounts become available to you.
Even though it’s not fun to talk about, the reality is, sometimes things happen and you are simply unable to pay a loan you’ve agreed to. If you stop paying your loan for some reason, this is called defaulting on the loan and the lender can repossess, the collateral.
I want to be sure it is clear that no financial institution or lender wants this to happen. In fact, it’s been my experience that, a credit union in particular, will work with you as much as they can, for as long as they can so this doesn’t happen. Unfortunately, it does still happens at times.
3. Some people also consider using a co-signer for credit to help them get started. In this instance, someone with established, hopefully good, credit signs the loan or line of credit with you. Your are basically using their credit score, so it will most likely need to be family or a good friend as this is a big responsibility. If something happens and you default on the loan, then the co-signer will be responsible for the loan, otherwise it could negatively impact their credit as well.
This can be a great option for parents and their kids as they build credit, especially as they move out on their own. Things like apartment leases, cell phone agreements or even turning on utilities need credit to do so. This is called service credit and actually not something many think about as part of their credit score, but it definitely counts. A parent or family member may consider co-signing in an instance like this to help their child get established. Make sure you take it seriously and understand the agreement before you sign.
The thing you are establishing with all this work is a credit score, which you find on a credit report.
There are three credit reporting agencies: Equifax, Experian and Trans Union. A lender will pull a credit report from these agencies to see if you are a good risk for the credit you are applying for. Your score will vary by agency, as each credit bureau places a different emphasis on different things. Your lender will most likely look at the score from each agency, and then take the one that is the middle score.
Let’s talk about what’s makes up your credit score.
1. Payment history which is 35%
2. Amounts you owe is 30%
3. Length of credit history is 15%
4. New credit is 10%
5. Credit mix is 10%
1. Payment History - As you can see, on time payments is the biggest part of that score. So, if you take nothing else away from this topic, take this… PAY YOUR BILLS ON TIME!
2. Amounts you owe - If you have 3 credit cards with a $10,000 limit on each, that gives you available credit of $30,000. The rule of thumb by most lenders is to not use more than 30% of that credit. For this example, try to keep what you are using under $9 or $10,000.
3. Length of credit history - if you have had credit for long period of time then a lender can look back and see your patterns and habits. Of course, for younger people this will take time and it should get better as time goes by.
4. New lines of credit - Opening new lines of credit, are a hit on your credit. If you are hoping to take out a loan for a car or to buy a house, try not to take out several new lines of credit at once around that time. This can hurt hurt your score for the loan you are trying to get. This is only for about 6 months, so if you have recent new lines of credit, maybe let some time pass before you do more.
5. Credit mix – This is the different types of credit you have. Revolving which is credit cards. Installment loans are ones you’ve agreed to pay back at a specific amount each month, like a car loan or mortgage. Another is the service credit. Probably the most well known service credit is a cell phone contract.
The 3 reporting agencies look at these things and a few others from your credit report and give you a credit score.
You can get your credit report for from annualcreditreport.com. They offer a free report once a year from all 3 of the reporting agencies. You can also purchase just your credit SCORE from FICO.
Scores range from 350-850. Often 720 or above is considered a good score.
It’s important to state that when you go into a loan or line of credit agreement you do it with good faith that you will repay it. And generally, that’s what happens. The lender goes into this agreement with a certain amount of risk. This is why a credit score is important. They measure the risk of what they are willing to lend based on that score. If you are considered a higher risk, you will most likely pay a higher interest rate. Because let’s face it, sometimes things happen and a loan can’t be repaid. The lower the score, the higher your interest rate will likely be. The higher the score, the lower the interest rate.
So, what does that mean? Once you’ve established a good score, you want to at least maintain it and if you can, make it better.
Let’s talk about the other things showing up on your report that can effect it.
1. Missing payments can drop your score as much as 60 points and that remains on your credit report for 2 years.
2. Maxed out credit cards can reduce your score 100 points.
3. Closing credit cards can actually reduce your score as well. This reduces the amount of available credit, so leave those accounts open especially if you are applying for a new loan like a car or mortgage.
4. Multiple inquiries on your credit can lower your score as well. Soft hits come from things like a credit card offer in the mail and it doesn’t effect your credit. A hard hit is when you are applying for lines of credit. If you are car shopping, it will probably be evident that’s what you’re doing so a lender will take that into account, but you don’t want to apply any more places than you have to. Only apply places where you really think you want to use their loan.
5. Opening multiple new credit cards or loans can have an impact, I think we said that before, especially loans less than 6 months old.
6. Having a higher balance in credit cards than in installment loans can actually make your score lower. Credit cards are revolving credit with no collateral so they are higher risk to the lender.
7. Bankruptcies remain part of your credit history for 10 years.
8. Judgments remain on your credit report until they expire, unless the creditor reaffirms the debt. Then it stays until its paid.
9. Liens or collections, show up and can make a difference in whether you get approved for a loan and your interest rate. Collections are commonly things like medical bills.
Bonus…. We’ve been hearing about people taking student loans and basically using them as income. Student loans never leave your credit. Even if you default on the loan. Where other liens may eventually leave your report, a student loan, however, is with you forever. It’s probably better to look for another source of income versus a student loan.
Did you know 50% of credit reports contain errors?
It’s a good idea to review your credit report about once a year. If you have any collections or judgements, you can set up payments to take care of those. You can also dispute anything that’s not accurate.
Very common errors are things like previous employers or addresses, as well as judgements or collections that have been paid, but they’re still showing up.
If there is an error on your report, you can send a letter to the credit bureaus and the lender disputing the information. You will want to include copies of any documents to support your claim. But keep the originals for yourself in case you need them again.
The credit bureau is required to investigate within 30 days and to give you the results in writing.
How can you raise your score?
1. Pay your bills on time - Payment history is on your report for 2 years which means you can work to make a better history and the old habits will basically start to go away and not be reported. Start making your payments on time. Signing up for bill pay with your bank or credit union can help you be on time. Your financial institution should offer something like that and they should be able to help you set it up.
2. Pay what you owe - If you have liens, judgements or collections, make arrangements to pay them and get them taken care of so they can be removed from your report.
3. Credit builder, secure lines of credit - You can also consider a credit builder loan or secured line of credit to give you time to build your score back up. Using a co-signer on a loan could help as well.
Also keep in mind that a score is not all a lender will look at.
1. Stable employment.
2. Money in savings or investment accounts.
This is often when a credit union can be an advantage. A credit union can often give you a loan where a bank can’t just simply due to their rules. Build a relationship with your financial institution! It really can help you!
One more thing…
Look at your debt to income ratio. Your debt-to-income ratio compares how much you owe each month to how much you earn. It’s the percentage of your gross monthly income, which means before taxes, that goes towards payments for rent, mortgage, credit cards, or other debt. Lenders generally prefer a debt-to-income ratio of 36% or lower.
If it’s higher, consider looking at what your debts are and trying to reduce those, especially if an increase in income is not an option. Less debt is always better, not just for a loan but for your life and your budget!
People often find themselves paying really high interest rates because they either have no credit or have bad credit and felt like they had no other choice. Look at your situation and see what you can make improvements. It is possible!
Don’t give up! Ask for help!