Updated: Mar 14
Every time you borrow money, you're robbing your future self. --Nathan W. Morris
Hello Wine Tribe!!!!
Let’s talk about credit. No, I’m not talking about giving credit when credit is due. I’m talking about obtaining goods or services with the promise of paying for the goods or services at a specified later time. Buckle up folks, this will possibly be a bumpy ride of education.
Credit 101 ~ Credit is defined as the ability of a customer to obtain goods or services before paying for them, based on the trust that payment will be made in the future. There is a lot to unfold just in this definition alone. According to the 2014 Consumer Financial Literacy Survey of Adults, about a quarter of adults in the U.S. or nearly 56 million Americans do not pay their bills on time ( here is the link to view the full story https://www.thestreet.com/personal-finance/credit-cards/quarter-americans-dont-pay-their-bills-time-12785626). I chose an older article because I believe newer information will be skewed by the impact of COVID-19. This is a lot of people and it’s a very alarming statistic.
Credit Awareness ~ One in eight Americans are unaware of their credit score, according to new research (article link https://nypost.com/2019/12/17/shocking-percentage-of-americans-dont-know-their-credit-score/). The operative word in the first sentence is “new”. I say that because, for so many of us who are a little bit older and more than likely in the minority community, credit was not something discussed in our households until much later in life. There was this time frame seemingly in the 90’s when adults were obtaining things in their kids names without them knowing of course. What then happened is that the child would apply for credit only to discover their credit was already “bad”. Just sad! Sure we were told to get a job to make money or find a career to generate wealth but no one really said to establish and maintain good credit. Being aware of what credit is, what your credit score is, how it works, and how credit impacts you is monumental. An individual with a social security number can start establishing credit as early as age 13. We’ll discuss later how this works. For now, let’s talk about who can obtain or establish credit.
Credit Is Given to Who ~ In the U.S., you absolutely have to be 18 years old in order to legally sign a loan contract. Until you turn 18 years old, you're considered a minor by law and can't enter into a contractual agreement with a lender. However, anyone as young as 13 can legally have a credit score. Earlier, I mentioned this and now I’ll share how this can be. There are some credit card companies who will allow a credit card holder to add someone as young as 13 years old to their account as an authorized user. In most cases, if the creditor asks for the authorized user’s social security number, the payment history of the credit card will be reported to the authorized user’s credit report (more on that later). While the authorized user can use the credit card, make payments on the credit card, and receive limited information about the credit card, they are NOT legally responsible for the debt of the card. The debt of any credit card is only the responsibility of the credit card holder(s). This means the person or people who have the contractual agreement has the legal obligation to pay any money owed to include fees accrued. Follow this link for more detailed information. https://www.creditkarma.com/credit-cards/i/authorized-user-credit-card Let’s move on.
Credit Reporting ~ Once you have obtained credit, most creditors report information regarding your credit performance to what are known as Credit Bureaus. There are three main credit bureaus and they are Experian, Equifax, and Transunion. Creditors sometimes report to all three but they may also choose to report to one or two of them or even none. Your performance not being reported at all is rare though. So, just when you have finished high school or college and you are all done with grades…..annhhhh….your grades as an adult is your credit score. The information reported to the credit bureaus translates into a credit score. What is this? How is it determined? How does it impact me and you? Well, let’s jump into the answers to these questions.
What is a Credit Score ~ A credit score predicts how likely you are to pay back a loan on time. A scoring model uses information from your credit report to create a credit score. Some of the information reported is:
● Credit card and loan balances
● On-time and delinquent payments
● Any items sent to a collection agency
● Discharged Bankruptcy
It’s very important to understand the laws and regulations regarding credit reporting. Knowing these laws can prove very helpful in maintaining a good score. If you ever find that there is incorrect information reported you should move quickly to get it corrected or in some cases moved. Often, when individuals have bad credit they choose not to look at it as if it makes it go away. However, this is the time in which it’s best to monitor it with the motivation of improving your score. You will also want to know how long information should be reported, especially as it relates to negative items. Additionally, be sure to understand when each of your creditors report your information. This can be KEY and leveraging the usage of your credit. Here is another link to expound upon this section. https://www.consumerfinance.gov/ask-cfpb/what-is-a-credit-score-en-315/ Time to go to Math class.
The Math of a Credit Score ~ Okay, let’s talk about how a credit score is calculated. There are five components that are the sum total of your credit score.
Payment history - Payment history is the most important ingredient in credit scoring, and even one missed payment can have a negative impact on your score. Payment history accounts for 35% of your FICO® Score☉ , the credit score used by 90% of top lenders.
Credit Usage - Your credit usage particularly as represented by your credit utilization ratio, is the next most important factor in your credit scores. Your credit utilization ratio is calculated by dividing the total revolving credit you are currently using by the total of all your revolving credit limits. A good rule of thumb is to not use more than 30% of your credit. For example, if you have a credit card with a credit limit of $1000, IF you carry a balance it should be no more than $300 to maintain a healthy reporting of this card. Credit utilization accounts for 30% of your FICO® Score.
Length of Credit History - How long you've held credit accounts makes up 15% of your FICO® Score. This includes the age of your oldest credit account, the age of your newest credit account and the average age of all your accounts. Generally, the longer your credit history, the higher your credit scores.
Credit Mix - People with top credit scores often carry a diverse portfolio of credit accounts, which might include a car loan, credit card, student loan, mortgage or other credit products. Credit mix accounts for 10% of your FICO® Score.
New Credit - The number of credit accounts you've recently opened, as well as the number of hard inquiries lenders make when you apply for credit, accounts for 10% of your FICO® Score. Too many accounts or inquiries can indicate increased risk, and as such can hurt your credit score.
For more detailed information, please use this link. https://www.experian.com/blogs/ask-experian/credit-education/score-basics/what-affects-your-credit-scores/ There are other sources that can be used for this information. This was just my preferred source of information. Let’s dive into the two types of credit.
Credit Mix ~ There are two types of credit that make up your credit score. The two types are Installment credit and Revolving credit. Here is the breakdown of each of them.
1. Installment Credit ~ This type of credit is typically when you borrow money and pay it back at a fixed amount over an established amount of time. These loans can be either secured or unsecured. Examples of secured installment loans are car, mortgage loans or home equity loans. Examples of unsecured loans are student loans and personal loans.
2. Revolving Credit ~ This type of credit is typically when you have an established credit limit and as you pay your balance down or off, the funds become available for usage. The other difference is revolving credit has a minimum monthly payment which can fluctuate depending upon your current balance. Examples of this type of credit are credit cards and home equity lines of credit.
Credit Score Ranges ~ Your credit score can range between 300-850. Here is the breakdown of the range:
300 - 579
580 - 669
670 - 739
740 - 799
Now, what does all of this mean? A LOT! It is how the creditor views your ability to pay back borrowed money. It is the deciding factor for whether or not creditors will approve or deny you for credit. It is also the difference between creditors giving you a high interest rate versus a low interest rate. Having a higher interest rate means you will pay much more money than the original amount borrowed.
Okay, Wine Tribe, I think it’s time to end this course on credit basics for now. It’s clearly not a fun or sexy topic; however, it may be very sexy to a potential significant other knowing that you have your finances in order and they won’t be possibly taking on a financial burden not created by them. Money problems continue to be one of the number one issues within a relationship. Not to mention if you are credit conscious it can eliminate stress by having a good credit score and knowing that creditors aren’t constantly calling you.
Stay tuned for more information regarding credit. It’s a topic near and dear to my heart. It’s also the giver in me that enjoys sharing information. I will continue to share more information on this topic in building block form. I’ve enjoyed writing this piece (maybe not the writing aspect…LOL). I hope you have enjoyed reading it and have found something helpful in your journey to a 750+ credit score. Peace and Blessings until we chit chat later!