Credit. What is Credit?

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1 Credit What is Credit? For some, Credit can seem like this mysterious invisible force that pushes against us when we try to figure out how to buy a car, or a house. For others it is a wonderful ninja waiting to strike at interest rates when purchasing or getting credit cards. So I guess this begs the question...what exactly is credit and how do we keep track of it? Believe it or not, the idea of Credit isn t that old. In the early 1950 s the first appearance of Credit showed up as a Diners Club card. Even then, the method behind this card was more in line of a charge card. A charge card allows you to use the card to buy items, with the intention of paying off your balance at the end of each month. It wasn t until 1958 that Banks got involved with the term we all know now of, revolving credit. Revolving Credit allows a balance owed to keep moving from month to month. In today s society, Credit is seen as a means to an end, but what some have forgotten is that the decisions you make with Credit related products (Cards, Mortgages etc), stay with you forever. There are key factors that affect your credit, and the higher the number, the better shape you will be in. The lowest score you can possibly have is 300, and the best is

2 This mystical number, whatever it might be, is called your FICO score. FICO is an easy way of saying the largest and best known of several companies that provide software for calculating your credit score. If you were to look on the NY Stock Exchange, it would translate to Fair Isaac & Company. Knowing that just helps you sound smart, but knowing your actual FICO Score is where the true genius plays in. Where do I get my FICO Score? Your FICO score can be found through a number of sources. It wasn t that long ago that figuring out your score would have been difficult and also condemning to the score itself. But now, we have what is called a soft pull, and a hard pull to help differentiate. (I know, I know...more terms). A soft pull is the term for checking your credit score without actually impacting your score. This would be used to just keep an eye on your credit report to see new things get added or drop off as time goes on. A hard pull however, is considered the real deal. If you apply for a credit card, or go to a dealership to buy a car, new or used, the dealership will pull your credit score to see if they find you to be trustworthy and to figure out how much to charge you. The higher the FICO score, the better deal you will get because you considered trustworthy with your finances and reliable when paying your debts. One tool that is widely used it Credit Karma. This app can be used on the go and is 100% free to install and sign up for. The app offers an indepth look at your Credit history showing you payments, what offers might best suit you and also what your score is. However, I will advise you that the score they show you will not reflect a true, up to date score. Credit Karma is perfect for keeping an eye out for fraudulent uses of your good name being used in a fraudulent way, but 2

3 not for the actual number. I still recommend it because of the excellent information you will receive from the app. One thing you can check, if you have a credit card now, they might offer your actual FICO score as part of their app. That trend is becoming very popular - use it! Your bank may even offer it as a perk of their mobile banking. If you don t see it immediately, call or stop in and ask them about it. Where do I start? There are so many options for Credit Cards and other types of Credit lines that it can be difficult to know what to do first, last and all the stuff in-between. Some factors to take into account are your age, how much you earn annually and what you want to achieve with the credit you obtain. If you are young, and never had any kind of credit before, the first thing to apply for should not be a mortgage or even trying to buy a car (even a used one). I would recommend a simple Bank Credit card, or a personal loan. These are easy ways of starting to build your credit without hurting yourself to much in the process. Most dealerships won t even consider you without having one of those two things in place first, and a mortgage is off the table completely. But as I said, depending on what your specific goals are, will dictate how you start. If you go for a personal loan at a bank, your interest rate will be lower than a Credit Card, but the amount of money you will need to borrow will be higher. The opposite applies for a Credit Card. You won t be given a high limit (the amount of money you can spend), but your interest rate will be a lot higher than a personal loan. So how do you decide which fits you better? If you have the income to support a higher debt amount, such as $ from a personal loan, this might be the choice for you. And just because the monthly payment might be $90, doesn t mean you can only pay that amount. To help ensure you don t pay to much in interest, paying more would help expedite how long the loan lasts, and therefore how much interest gets paid. 3

4 If your income doesn t allow for extra payments, the Credit Card might suit you better. Only being able to get a maximum of $500, but having a higher interest rate might be better suited for your spending habits. These are not the only ways to start yourself in the world of Credit, and I will recommend you speak to your local financial institution to feel out all the opportunities, but that doesn t mean you need to sign up for that one immediately either. Take your time. Understand your limits. The more knowledge you have, the better prepared you will be to make the decision that fits you best. What happens Next? Now that you have your Credit, (regardless of it being a loan or Credit Card), there are 3 important things to remember and rules to follow so that you build your credit instead of damage it. 1. Never miss a payment a. If you can t afford the payment, you shouldn t get the credit. With a personal loan you will have the knowledge upfront of what your payment will be each month. WIth a Credit Card, it all depends on how much you spend on that card. The more you spend, the higher the monthly payment will be. Stay within your limits. 2. Don t overreach or overspend a. If it s a personal loan, don t ask for more than you can pay for. Sure, you could ask for $10,000 and then one month later, just give them the money back (plus some interest), but that won t build your credit. b. And for Credit Cards, staying within your means is very important. If you get behind on your payments, or skip a payment because you need extra cash, it will haunt your credit score for 7-years. 3. The longer the better a. I will admit, the game is rigged. The longer you have a balance on your credit card that you are consistently paying on the better it is for your credit score. Sadly, it s also better for whomever the money goes to. As I said earlier, the more you owe, 4

5 the more interest you pay. But the length of time your credit is open affects your overall credit score too, so try not to close anything out. What Can Impact My Score? There are set standards in which your credit score lives by. And let s be thankful there are, otherwise it would be impossible to know if we are doing things right or not. Thankfully, understanding what those are is easier to figure out than it used to be (even just a few years ago). And I will lay them all out for you here. Payments (late or on time) Length of Credit History New Accounts Hard Pulls (also called Inquiries) 5

6 Accounts in Use Credit Utilisation These are all ways in which you can help improve your credit, or unfortunately, hurt your credit. Payments The worst and best of these is also the most simple - Making Payments. If you re looking at the Pie Chart, this category can take up to 35% of the pie. Although 35% doesn t seem like a lot, in the world of credit, it is huge! Length of Credit History The length of your credit history is determined on an average of all your credit lines put together. If you have a Credit Card on file for 10 years, and then decide to open one now, that will hurt your 10-year time frame because it takes the average time of both cards. New Accounts At the same time though, new accounts add to your resume. The more accounts you have on file, the more likeable you are to lenders reviewing you. It shows that you are eager to borrow, but also that you are invested in your own credit. Hard Pulls When it comes to hard pulls/inquiries, the rule of thumb is 3-months. If you are planning on applying for a mortgage in the future, don t open a credit card at the same time because it will hurt your credit score (temporarily). Every time you endure a hard pull, it dings your credit for a short time, but it will bounce back. In a nutshell, don t open too many lines of credit at the same time. Accounts in Use 6

7 Also, try to avoid closing them. A pro tip on the Credit Card would be to try to only go for ones that don t have an annual fee. You can leave a card open for a long time without it defaulting to closed due to lack of use. But there s no need to pay that $99 annual fee just to have it in your possession if you can avoid it. Credit Utilisation (How much have you spent?) And last but certainly not least, is utilisation. Lenders will look at how much debt you owe over all your accounts. If you have 10 credit cards that have a max balance of $1,000 each, then you have $10,000 overall. Between those cards you have accumulated $500 in debt, then your utilisation is only 5%. Lenders want to see you under 30%, but if you want to be a pro user, try to stay under 10% if you can. Staying under 10% will will boost your credit score. Another pro tip to keep in mind is that Banks were recently regulated to cap how much interest they can throw on your card. But department stores have free range. If you decide you want to get a department store credit card, make sure you have the funds available to pay that sucker off fairly quickly. You will feel it on your wallet if you let interest build up on that card. Now, go forth, live wisely and use credit in a healthy way so that you can benefit from an excellent score. It will save you thousands and thousands later in life! 7

8 Copyright of A Life of Heart, Jason Atkinson owner and CEO. Not all outcomes and experiences will be the same. The views and ideas expressed here within are the sole responsibility to act out by the participant. Each person following these steps will have different desires and therefore different examples of right & wrong financial decisions. The views expressed here within are made to provide a guideline of which to live by. These statements have not been evaluated by the SEC. 8