- Mar 23, 2011
After providing some tips and tricks, some people on another forum asked me to do a primer about credit and credit cards. I figured I'd spread the info over here as well as I really like this community and there is so much misinformation about credit.
What is this thread: This thread is meant to be a collection of information and discussion about credit. Your credit is one of your greatest assets; unless you plan to live the rest of your life paying cash for everything. There's a good chance you will need to leverage your credit rating to buy a car or a house at some point. How you handle your credit will determine if you qualify for a loan, what your interest rate will be, and ultimately how much you actually end up paying for that house or car.
I am not an expert, and this is not meant to be an "Ask me about..." thread.
Why is there this thread: There is a great deal of misinformation and misunderstanding about credit, how to establish it, how the scoring works, etc. I have seen people on 2p2 talk about building credit in nonsensical ways. I have talked to my friends who are deathly afraid to open a credit card because of how it will affect their credit score. Invariably, my friends don't actually know the value of their credit score when they say this.
Who am I: I'm just a guy on the internet. I don't work in finance, in fact I make cosmetics for a living. In the last year, I have taken on credit cards as one of my new hobbies, with the goal of reaping rewards in the form of cashback, frequent flier miles, hotel points, etc. Since April (2012) I've opened 12-15 new credit cards. I've monitored my credit score. My only qualifications are that I've read a lot about credit and how it works, and I've seen the impact leveraging my credit has had on my FICO score.
Where I am lacking: I was fortunate to have a credit history established for me when I was younger, and to have good credit by the time I got interested in credit card rewards. I have helped friends write "good will" letters to have late payments removed, but I have very little experience with removing negative tradelines from credit reports. If your credit is in shambles and you're looking to repair it, go to www.creditboards.com and spend several days reading.
What is your credit report: Your credit report is a listing of all open tradelines and associated accounts. It contains your name, address, employer, and SSN. It is usually broken down into sections which include Info about you, open tradelines, closed tradelines, active collections, settled collections, personal statement.
How to check your credit report: You are entitled, by law, to a free credit report from each of the major bureaus (TransUnion, Equifax, Experian) once a year. Go to https://www.annualcreditreport.com/cra/index.jsp and follow the prompts to do so. Do not give your credit card information to any site that says they will give you your credit report unless you know what you're buying. When you view each report print out a copy and/or save it to PDF for future reference. Also, some credit cards give you access to services that allow you to check or monitor your report whenever you'd like. One example is Citi's Identity Monitor http://identitymonitor.citi.com. Refer to this wiki page as well: http://en.wikipedia.org/wiki/Comparison_of_free_credit_report_websites
What are you looking for: Accuracy mostly. You want to make sure that your name is spelled correctly and consistently across the three reports. You want to make sure you know about all of the accounts listed. If someone has stolen your SSN the accounts they open will show up here.
What can you do if something is wrong: All of the bureaus allow you to dispute information that shows up on your credit report. It is important to make sure that the information is accurate. Once an item disputed the bureau will check into it and adjust if necessary, and they are required to do this within a specific time frame. Some credit repair tactics tell you to dispute negative items on your report even if they are accurate in hope that the bureau will not be able to validate it in time and remove it from your report. But again, I know little about credit repair, so if this is your interest go to www.creditboards.com.
What is your credit score: Your credit score, commonly known as your FICO score, is a numerical representation of your creditworthiness. Looked at from another viewpoint, it is an assessment of how risky it is to extend you credit. The FICO score ranges from 300-850. There are several different interpretations of the zones, but roughly (imo) 750+ is Excellent, 700-750 is very good (and typically considered "excellent" for credit cards), 650-700 is OK, and lower than 650 is bad news. Of course, 500 is worse than 610, but you don't want to really be in the low 600s or worse.
Here are a few pictures I found on google:
What does your credit score affect: Your credit score affects whether or not you will be approved for new credit. Mortgages, auto loans, and credit cards are all directly affected. If you get approved with a mediocre credit score, your interest rate may be higher than someone else who has a higher score. Lenders do this to compensate for the risk they are taking by lending to you. Also, it is not uncommon for "non-lenders" to use your credit score/history. It is known that credit scores are used to determine rates for homeowners and automobile insurance. And in some states, credit checks are used in the hiring process.
How is the credit score calculated: Per the FICO website, the five main factors of your credit score are:
35% payment history, 30% amounts owed, 15% length of credit history, 10% new credit, 10% types of credit
This is the most important component of your credit score. PAY YOUR BILL ON TIME. Even if you are just making the minimum payment. Pay it on time, always. IF you miss your CC due date by accident, call IMMEDIATELY and apologize, pay it, and ask for them not to assess a late fee. In reality, you shouldn't care about the late fee but you do not want it posting to your credit report as a late or missed payment.
For example, I know a girl who has a 5 year car loan. She has made 49 payments as of this month, and was late on one payment in 2009. Her car loan, which is nearly paid off, is listed on her credit report as 'potentially negative' and 'will chance to positive status in July 2016'. To use 'payment history' to increase your credit score: pay on time, always.
This is commonly referred to as the 'debt to credit ratio' or 'credit utilization'. Simply this is your carrying balance divided by your overall credit lines combined. So if you have 4 cards, each with a $25k limit, your total credit line is $100k. If you are carrying a 10k balance on one card you are at 10% credit utilization. The lower this % is the better.
The second part of this is assessed by each lender. For example, if on one of those $25k limit cards, you charged something for $20k, that could be bad as you are at 80% utilization on that card, and you may be (temporarily) viewed as a risk to lenders.
To use 'amounts owed' to help your credit score: get your utilization low. beware that this is not always 'at the end of a statement' when your utilization should be 0% (if you pay off in full every month). It is whenever your credit is checked, which can be any time.
Length of credit history:
This one is kinda self explanatory. Lenders love to see that you pay on time, but it means little to them (and your score) if you have only had credit for 6 months. No one is going to give you a 30-year mortgage based on a 6 month credit history.
To use 'length of credit history' to help your credit score: keep your oldest accounts open if you can. Do not close cards if you do not have to, especially your no annual fee cards since they do not cost you anything. Your credit score does not really care if you have a 10 year old card that you don't use (although the particular lender might not be impressed). In a similar vein, if you are a parent, add your child as an authorized user to one of your accounts when they are eligible so you can start their credit history early for them. My mom added me as an authorized user when I was 16, and my credit is fantastic as a result of that. Of course, don't do this if you are not able to pay the card in full and on time, as you risk ruining your kid's credit.
This should really be "requests for new credit", and is typically referred to as 'number of inquiries', or 'number of hard pulls'. Every time you apply for a credit card, or auto loan, or mortgage the company will run your credit. If it is a 'hard pull' it shows up on your report for anyone to see. If it is a 'soft pull' (like the free credit reports you get yearly), it shows up ONLY for you to see. Banks get nervous when they see you are shopping around trying to get credit. Inquires fall off your credit report after 2 years.
How to use 'new credit' to help your score: This is hard. Basically, if you know you are going to be applying for a big loan (house, car), try not to open any new credit cards for the two years preceding, or keep it to a minimum. Also, if you apply for a new credit card, expect your score to fall 2-5 points per hard pull. However, this is usually countered by an increase in your available credit when you get approved for the card as mentioned in 'amounts owed'
Types of credit:
Banks like to see that you are not only responsible, but responsible with multiple types of credit. Credit cards are only one type. Car loans, mortgages, and other loans are other types.
How to use 'types of credit' to help your score: Don't worry about it. If you happen to have a school loan, or a auto loan in addition to a credit card, good for you. But typically this section does not have a big effect on your score and it's not worth taking on a new credit type unless you need to.
How do you check your credit score:
www.creditkarma.com - gives an approximation of your score based on TransUnion data
www.creditsesame.com - gives an approximation of your score based on Experian data
Both sites are free to use, and require no credit card or payment plan. They rely on the mint.com business model where they suggest cards and accounts for you and if you open them they get referral commisions.
Both of these sites will give you an idea of your scores range, and will let you track data month to month. There is really no reason not to sign up with both. They will also allow you to see some other score type approximations like your VantageScore and your auto insurance risk score.
While these sites will give you an approximation, you can get your actual calculated score any time you apply for credit. Typically an approval/denial letter from a credit card company will include a note about your score and which bureau the pulled.
Checking your own credit score/report hurts your score: Checking your score/report yourself on the websites listed above shows up on your report as a "soft pull", meaning it only shows to you. Other lending institutions will not see these inquiries and they do not affect your score. When an institution checks your credit for a formal credit request (applying for a new car, applying for a car loan, etc.) they do a "hard pull" which does get recorded and will lower your score based on the 10% category "New Credit".
Carrying a balance helps your score: Carrying a balance will never make your credit score improve. In fact, carrying a balance can only hurt your score based on the 30% category of "Amounts owed" or "credit utilization". Carrying a balance and actually using the card may help your relationship with the lender (Chase, BOA, etc) as it can show them you are a profitable customer, but the effect is not typically worth what you pay in interest. Almost always, the best strategy is paying your bills in full every month.
If you pay your balance off in full every month your "utilization" will show as 0%: Credit utilization is a snapshot of your balances as any given time, not only when your statement closes. If you make a $4000 charge on a card that has a $5000 limit, even if you pay it off in full when your statement closes, your score may temporarily suffer due to high credit utilization if it is checked in the middle of the statement. This is the main reason why the myth of "you have to carry a small balance to show that you're using a card" is absolutely false.
It's a good idea to close accounts you don't use or use often: Unless the account has a negative association or charges you a fee to keep it open, it's usually not a good idea to close accounts. Closing an account will reduce your overall credit available, which will artificially increase your utilization (30% of your score). It will also affect the average age of your accounts (15%). If you close a new account your avg. age may increase, which is a good thing. But if you close an old account your avg. age my decrease, which is bad.
Opening a new credit card (or multiple cards) hurts your score: This is the one I hear the most often. Each new credit application will drop your score by a few points due to the hard inquiry (10% category - New Credit) and may decrease the average age of your accounts (15% category - Length of History). But it will also increase your total credit available, which will artificially decrease your utilization (30% category - Amounts Owed). Typically after applying for several new credit cards, my score dips 10-15 points, and then recovers over the next month or two.
Here is a snapshot of my credit score approximation from CreditKarma, with black lines drawn where I applied for multiple cards at once. Remember, over this period I've applied for ~12 new cards. Notice how the score drops initially, but always rebounds:
Paying off a debt in collections removes the negative item from your credit report: FALSE!! This is why it's so crucial to pay your bills on time, always. As I mention above, even a single late payment on an account that's been open for 5 years can be potentially damaging. If you have an account in active collections, always negotiate "pay for delete", meaning when you pay, they delete the item from your credit report. Otherwise it will show up on your report as settled, but still shows that it was in collections, so it is still damaging.
Credit Tips & Tricks:
First, treat your credit carefully. Understand what you're agreeing to whenever you take out a loan or get a new card. Your credit is one of your greatest assets. You need to guard it and make good decisions. A friend of mine is a responsible guy, always pays his debts, means well, etc., but when he tried to better himself by going to school, he didn't realize that student loans would become active once he stopped schooling. He missed a couple of payments and all of the sudden his credit is in shambles. He's since settled everything and did so pretty honorably imo, but his credit is still a wreck and will likely be that way for several years.
Amex backdate trick: I have heard that American Express reports any new account as opened on the date of your first open account date. So if you opened an Amex in 2002, and you open one today, it will show as 2 amex cards, both opened in 2002. I do not have experience with this as I only started this hobby in the past year, but if true, you could really boost your length credit history with this trick.
Young Authorized User: If you have good credit as a parent, you can start your children's credit history when they turn 16 by adding them as an authorized user on one of your accounts. You can give them the card for emergencies only, or not even give it to them at all. This will show up on their credit report as an Authorized account, but it still starts their history early. Beware that if you are irresponsible with this account it may affect their future credit as well.
This trick has been around for a while and has been partially negated by the rating agencies. Amex Centurion card holders (black card) would offer to add a stranger as an authorized user to their account for a fee. They would never give them the AU card of course, but having your credit report associated with such a prestigious account used to do wonders for your credit.
Business card spending: This is another one I haven't verified yet. Business accounts are not shown on your personal credit report, and they are tracked separately. So maxing out a business credit card (temporarily of course) will not have the same effect on your credit score as doing the same spending on a personal card.
What you should do right now:
1) Start monitoring your credit. Get all your reports and print them out, verify their accuracy, and submit claims to the bureaus if info is incorrect.
2) Sign up for creditkarma and creditsesame and start tracking your scores.
3) Read more on credit repair @ creditboards.com
4) Add to the discussion or ask questions in this thread.
5) Do not be afraid of your credit score and take an active role in finding out what will harm it and what won't.
If you are paying for everything on a debit card, why not open a simple cashback card like the Chase Freedom or Discover More and earn some cashback or rewards for your spending? Just remember to pay on time and in full!
Or if you'd like to start smaller, or maybe can't get approved for a rewards card, look into a store card or a secured credit card to start building your history. Typically if your credit history is blank you can still get approved for a rewards card if you have decent income. If your income is low and you have no history, you'll have to start with the non-rewards cards.
I would certainly be happy to help you choose what card best suits your needs or spending habits. Hopefully this has been a good primer and I look forward to the future discussion.