Credit

In basic terms, credit scores and reports are a way for creditors (banks, credit card companies, etc.) to check your history to see how well you have and can repay debt you owe. You can build credit through credit cards, student loans, car loans, or personal loans. The history of you repaying these credit accounts will be shown on your credit report and reflected in your credit score.


What’s the difference between a credit score and a credit report?

Your credit score is a number between 300-850 that reflects your credit history, the higher your score, the better. A score between 700-800 is considered very good. While your credit score is a number, a credit report is a record of your history of borrowing and repaying debt.


For example, your credit report may say “Wells Fargo Credit Card” and show that you have made 35 on time credit card payments. Comparatively, your score would just say “750” which reflects your consistency of payments on that credit card.


Why should I care about credit?

Great credit can help you to save money in many areas. Most of us do not buy homes with cash; we will have to finance it. A good credit score will get you a lower rate on a mortgage which over 30 years and hundreds of payments can save you thousands of dollars. You may not even be able to get the home you want if your score is low. When you apply for a loan or credit card, you will get lower interest rates if you have a higher score because the creditor feels confident that you will pay them back. If you want a car loan, your score also affects whether you will be approved for that car loan and what your interest rate will be. If you want to start a business and need a loan, creditors can approve or deny you based on your credit history. So overall, the higher your score, the lower your interest rates, the lower your finance charges, and it even lowers your security deposits.


What affects my credit score?

Many people believe that as long as they make on time payments, their credit score will be fine. This is a great start but there are 5 factors that affect your credit score, not just making payments.


1. On-time payments (Affects 35% of your credit score)

  • Every month pay at least your minimum payment on time. This affects 35% of your credit score which means it has the most impact on your score.

2. Credit usage is the second most important. (30%)

  • Credit usage applies to revolving credit (credit that can be used repeatedly as you pay it down i.e. credit cards). This means if you have a credit card limit of $1,000 and you spend all $1,000 of that limit, it will negatively affect your credit score because it looks like you are overspending. This is an example of maxing out your card and would be considered 100% credit usage. Instead, you should aim to stay at or below 20% usage. This means you only spend $200 if your credit limit is $1,000. Credit usage is determined from a combination of all your credit cards. So if you own 5 cards with a total credit limit of $10,000, you can spend $2,000 amongst those 5 cards and not negatively affect your credit score.

3. Age of credit history (15%)

  • This is an average of how long you have had each credit account. The longer your credit history, the better. This is why it is important to NOT close your older credit card accounts because it will lower the average age of your accounts. Leave your old cards open and use them every once in a while to buy something so that the credit card company won’t automatically close it.

4. Diverse Credit Accounts (10%)

  • Creditors want to know that you can handle different types of credit accounts, not just one type. The more diverse credit you have, the better your score - student loans, car loans, credit cards, etc.

5. New Credit Applications (10%)

  • Every time you apply for new credit or a creditor requests to look at your credit file, it is noted and can negatively affect your score. This includes landlords and utility companies checking your score too. It only affects it by a few points though so I wouldn’t stress about this.

**FACT CHECK** You DO NOT affect your credit score by checking it! If someone else checks it like a landlord, utility company, or a banker, that will affect it but only by a few points.


Overall, if you focus on making payments on time and using up only a small amount of your credit limit, you should be fine. Those categories together affect 65% of your score and will make the most dramatic increases or decreases in your score.


How do I check my credit score and credit report?

I use Credit Karma to keep track of my credit score. It notifies me if someone tries to open up an account in my name, tracks my credit usage, and notifies me when my score goes up or down. It will ask for your social security number and other personal information when you sign up, but it is a legitimate site that you can trust. I have been using it for years.

  • The bad thing about Credit Karma is that it constantly advertises credit cards and loans to you because that’s how they keep their website/app free. Do yourself a favor and unsubscribe from all those emails, especially if you are easily tempted.

To check your credit report, go to annualcreditreport.com. You are allowed a free credit report from each of the three credit agencies once a year. If you time it correctly, you would be able to check your report once every 4 months with each agency for free. Once again, this site will ask for your social security number and other personal information, but it is a legitimate website that I have used for years.


How often should I check my score and report?

  • There’s no need to STRESS about constantly checking your credit score if you do not plan on buying a home, car, or taking out a business/personal loan anytime soon. Of course you shouldn’t destroy your credit, but these big ticket items are where you can save hundreds and thousands of dollars on interest if you have a great credit score. Other than that, you have time to improve it and build so a few points up or down isn’t too serious. I think I check mine once a month because I'll get a notification from Credit Karma.

  • I check my credit report once a year to make sure everything is accurate, but you can do it 3 times a year if you want.

How do I remove things from my credit report?

  • If there is incorrect information on your credit report, write a letter to the Credit Bureau that has the incorrect information on your report and they are required by law to investigate it. Here is an example of a letter to write and what you should include in the letter.

  • Negative items like debt that is now in collections will stay on your report for 7-10 years, but the older the unpaid bill, the less it will affect your score. There are three main options when it comes to paying off debt that has been sent to collections, which are explained here. Another option is not paying the old debt, but just remember that it will be on your report for a while and the collection agency has the right to bring you to court. Realistically, unless the amount you owe is significant, court is timely, costly, and not likely to happen.

What is the smartest way to pay down my credit card debt?

It is always wisest to pay down your HIGHEST INTEREST RATE CREDIT CARD first to save the most money. This may be discouraging if you have a large balance on your highest interest rate credit card. If it will help to pay off your lowest balance first, you can do that too. Everyone is different, but whichever route you choose, it will take discipline and commitment to denying temporary pleasures and instead choosing to paying down your debt. Once you get into a routine it will be freeing!


I don't have any credit, what should I do?

An easy way to start building credit is by applying for a credit card at your bank. If you are in college your bank may offer a college credit card. If not, you can try applying for an unsecured credit card, but if you do not get approved you will have to get a secured credit card. An unsecured credit card means you did not put down a deposit to get your credit card/credit limit. With a secured credit card, you give a deposit to the bank, and your credit limit is for that amount. If you do not pay your credit card bill, they keep the deposit.

  • Secured Card Example: I give a deposit of $1000 to my bank... I will receive a credit limit for $1000. If I do not pay my credit card bill, the bank can keep that $1000.

  • Unsecured Card Example: The bank approves me for a credit card balance of $1000, if I do not pay my credit card bill, the card can be frozen and the bill with all its interest and fees will be sent to a debt collection agency.

Another option is to become an authorized user on a family member or friend's card that always makes payments on time. An authorized user is just a secondary account holder on a credit card. You can make purchases too, or not, but ultimately the primary account holder is responsible for paying the bill each month. The secondary account holder would just reap the benefits or repercussions on your credit report and with your credit score. I don't usually recommend this option because you are not 100% in control, so if the primary account holder decides to stop making payments, it will negatively affect your score.


A third option is opening a store credit card. Just like any of the other options, you have to be wise about your spending habits. If you know doing this will tempt you to shop more often, don't fall into the trap. Store credit cards do not exist to help customers save, they exist to hopefully get you to spend more money.


**Having no credit can be just as unhelpful as having bad credit, so take the step towards building good credit today so that your future self will thank you.


What are your thoughts on credit cards/debt?

  • I believe credit cards and debt can be a useful tool to buy things that can help you create more income. If I decide to use debt to buy a house I cannot afford on my own and then rent it out to pay the mortgage and create income for myself, the debt was worth it. Many people don't use debt in this way though. People use debt to afford things they don't need and that don't help them generate income. Personally, I love credit cards, but using them wisely requires self control. Credit cards ≠ free money. If you are disciplined, they are the best thing ever! I earn cash back buying things that I would already be buying. Comparatively, if you just swipe and build a balance buying things you don't need then it may be detrimental to your current and future finances. Credit card debt is EXPENSIVE and companies make millions off of people who do not understand how much more they are paying for things when they decide to pay for it later. If you cannot afford to buy it today and you do not NEED it today, you cannot afford it at all. That item will cost so much of your future money, it is not worth it.

  • I also love credit cards because they are great when handling fraud issues. If someone steals your credit card, you report it to the bank, they investigate the claim, and resolve the issue and you don’t have to pay for the fraudulent transaction. If someone steals your debit card, your actual money is withdrawn from your account which may affect future bills you had planned to pay with that money. Most importantly, if you report the debit card fraud after 48 hours you could be liable for up to $500 of the charges. With credit cards, you are only liable for up to $50 of the charges.

  • My #1 tip to all credit card users is to ignore the minimum monthly payment… that is a trap to keep you paying the credit card company as long as possible. If you have the money, PAY YOUR BALANCE IN FULL! Do not ever, ever, ever hold a balance and let interest be charged, it adds up. There is no reason for you to have extra money in your savings yet hold a credit card balance. You’re losing money, pay off your balance. Yes it feels better to keep your money in savings and pay off the credit card debt later, but your pockets will not feel better later.

  • Credit card debt is not only dangerous because of the high interest rates, the interest is also compounded DAILY, not monthly or annually. This means interest is charged today, then interest is charged on that new balance tomorrow, and then interest is charged on that newer balance the following day, and so on each day.

  • I wouldn’t recommend this tip if you know you cannot control your spending, but as for me… always use your credit card. Rewards are a great reason to get a credit card and to always use your credit card. Also, you don’t need 10 different reward cards. Choose a card that offers a specific % back on every purchase and stick to that. I have the WF Cash Wise Visa Card that earns 1.5% cash back on all my purchases. I use this card for everything and I don’t ever use my debit card.

  • My only advice when choosing a credit card is to be careful of annual fees. A card may seem like it has many perks but it will also come with a high annual fee; make sure the benefits are worth that fee. There are plenty of credit cards that have a $0 annual fee, so don’t pay for something that could be free.

  • All in all, I think credit and debt can be extremely helpful if you are using it to produce income and build wealth. On the other hand, if you are just accumulating debt to pay for material things that you don’t need, then it’s not worth it.


Action Steps

  • Focus on making on-time payments and keeping your credit usage at 20% of your total credit limit.

  • Create a plan to pay down your credit card debt each month

  • Make an account with Credit Karma to check your score and monitor your credit accounts

  • Check your credit report on www.annualcreditreport.com to ensure your credit report is accurate and doesn’t have incorrect information.

  • Pay your credit card balance in full always if you have the money.

  • If and ONLY if you are responsible, use your credit card for ALL your purchases. If you are not going to be paying off your entire balance every cycle, do not do this.

  • If your credit usage is consistently above 20%, call your credit card company and request a credit limit increase to boost your score. (They will ask your income and rent/mortgage, but it takes 5 minutes and the worst that happens is they approve you for less than the amount you request.) Again, know yourself. If a higher balance will just lead to more spending, don't do this.


This is a lot of information all at once, but come back and read this blog multiple times if you need to. Comment any questions you have or something new you learned & share this with your friends trying to reach their financial literacy goals :)


#KOtheCOMP #TakeLeaps #NoLimits


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