How to Establish Credit

Most major financial landmarks in life, such as buying a car or a house, will require the use of credit, but when you have little or no credit, there are often more “no’s” than there are “yeses” from lenders. Starting to build your credit is not the easiest thing to do when there are more rejections than approvals, it is difficult to know where to start.

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When starting out, it is important to ensure that you are starting out clean. There have been several cases over the years that I have seen when someone who thought that they had no credit actually had some credit from a joint account they held with a parent or from years of student loans they have been paying. There have been those that have very bad credit riddled with collections from utilities or rent that went unpaid. The first thing you need to do is check your credit. There are several ways to do this but the easiest is to head over to www.annualcreditreport.com, which provides a free credit report from each of the three major credit reporting agencies once per year. You should verify that the information you find on your credit report is correct and accurate. If it is not, for instance, if you have fraudulent charges on your report, you will need to dispute the charges, most likely with both the creditor and the credit reporting agency.

Once you have an idea of what your credit looks like there are several ways to go about building credit.

Retail Cards

Retail cards, such as credit cards for department stores and gas companies, are often the easiest credit cards to obtain as they are limited to the retailer that you choose and usually come with lower spending limits, hence less risk for the issuer. However, these cards often come with high interest rates if you are not paying them off every month and carrying balances month over month, and they can have you paying much more for a product or service than it is actually worth.

Secured Credit Cards

One of the best ways to build or rebuild your credit is to start with a secured credit card. Secured credit cards are safeguarded by money you provide to the lender, usually in amounts of $300 or greater. This money is placed in a savings account and locked until the card is closed. The lender issues you a credit card with limits equal to the amount of money you provided. When charges are made to the card, monthly payments are still required and interest accruing. The initial secured payment that you provided the company is to be used only in the event that you default on making your payments, which would show negatively on your credit report, as well.

Many of the companies that issue secured credit cards have programs where they will evaluate your payment history on a regular basis and consider graduating you to an unsecured card when you meet their specific guidelines. The great thing here is that you are building credit and should not have to pay fees or undue interest provided you make the payments in full each month.

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Secured Loans

A secured loan can have several advantages, including helping you build your credit faster than you could with credit cards alone. The process is very similar to that of a secured credit card, where you provide the lender with cash in advance. For a secured loan, the security amount is usually $3,000 or greater. This amount is placed in a savings account that you cannot access until the loan is paid in full. In the meantime, the lender gives you a percentage of the held amount, usually around 90%, and you establish a set payment plan of a few years to pay the loan back in regular monthly intervals. One of the greatest advantages of this type of loan is that it will show as an installment loan, a loan for a fixed amount of money repaid over a set time period, when reported to the credit agencies. This will add to your overall credit mix and help you increase your credit score.

Going the way of a secured loan is in essence paying for the privilege to establish your credit. These loans also often come with a hefty interest rate or loan origination fees.

Become an authorized user

Another option and often one of the simplest ways to build credit, is to be added as an authorized user to a friend or family member’s credit card account. This allows you to associate your name and information with that of the credit your friend or family member is using. However, not all lenders report authorized users to the credit reporting agencies, so there is a chance that being an authorized user may not be helping you build your credit.  Before taking this approach, make sure the credit card company reports all authorized users to the credit reporting agencies.

This option may be risky, so use extreme caution if you choose to become an authorized user. In becoming an authorized user, ensure that you friend or family member uses their credit responsibly and always makes their payments on time. Should their account become delinquent or go to collection, that negative action will also reflect on your credit.  On the other hand, you need to practice responsible credit behaviors as well. Having a clear plan in place to inform the card holder of the purchases made and how you will reimburse your friend or family member for purchases is also important so that you don’t hurt someone else’s credit.

Have a Co-signer

If you’re having a hard time accessing credit for a purchase, you can ask a friend or family member to co-sign a loan. Similar to the authorized user option, you are using your friend or family member’s good credit standing to help you get approval for a loan; however, in this case, their credit now counters the risk to a lender on your behalf. In essence you are requesting this person to put their credit reputation on the line for you. Should you default on the loan, this person is now responsible for the full repayment of any outstanding balances and fees that may accrue. Any missteps on the repayment of this loan by you can negatively affect your co-signer’s ability to obtain financing in the future and can cause irreparable damage to their credit history and your relationship.

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Once you have a few types of credit under your belt, it’s important to carefully monitor your credit reports for changes, understand what is on your credit report, and know how your credit score comes together. This is a good way to monitor your credit-building efforts and see how these efforts are paying off in terms of building your credit while actively protecting yourself from fraudulent activity.

When starting out, it is imperative to begin making your payments on time as agreed from the beginning. Reports of late payments and other missteps will stay on your credit reports for up to seven years. A few late payments or an account that becomes a collection account when building your credit can cause you years of work and frustration trying to clean it up.

As you make payments you’ll progressively build your credit and it is possible to make significant progress on establishing your credit quickly. As building your credit is not quick project, incremental improvements month by month will provide you better financial options in the future.

Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.

Understanding Your Credit Score

Your credit score can affect many aspects of your financial life.

The three main credit reporting agencies, Equifax®, TransUnion®, and Experian™, create and generate your credit reports. You credit score is a number, typically ranging between 300 and 850, that indicates how likely you are to repay your debts. The three major credit reporting agencies calculate your scores based on their own models, but these are not the scores that most lenders are looking for. There are several independent scoring companies, each with its own model for how they convert your credit report information into a score that indicates the level of risk that you may default to a creditor. Today, a vast majority of major lenders use the FICO® Score, a credit score created by the Fair Isaac Corporation, when making decisions on whether to lend to you. The score holds so much weight that it can affect the interest rates that you may pay on loans, your insurance rates, and even your ability to rent a home.

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Understanding your credit report and how your credit score is compiled is a good place to start. Let’s break down your FICO® Score, as it is currently the most widely used credit score format that the top lenders are using.

The Fair Isaac Company considers five categories when calculating your FICO® Score: your payment history, how much you owe, your length of credit history, the credit mix that you keep, and your new accounts.

Your payment history (35%) — Thirty five percent of your FICO® Score comes from how you have managed your past payments to your creditors. This section of the reporting will take into consideration the payments you have made to creditors. Creditors, including credit cards, retail accounts, installment loans, auto and mortgage loans and many others, report to the major credit reporting agencies and that information is used to tabulate your score. To maintain, improve and build your credit score, it is important to make your payments on time every time. This keeps your accounts in good standing and helps create more depth in your payment history.

Missing payments or making payments late will have a negative effect on your score. The more frequent the missed or late payments are, the greater the impact they will have to your overall score. Public records and collection accounts, such as bankruptcies, tax liens and civic judgements, can lower your rating in this category dramatically and can have serious long-term repercussions on your overall score.

Your payment history is the section given the most consideration in determining your score, and it is the most important factor a lender assesses when determining the level of risk it will undertake when issuing you credit.  

Amounts Owed (30%) — Thirty percent of your score is based on how much you owe your creditors. There are several factors that come into play in the amounts-owed part of the scoring. Simply owing money does not always negatively affect you score, though when your credit utilization ratio (the total dollar amount of revolving credit, usually credit cards and personal lines of credit, you currently owe divided by the total available credit limits of the accounts) is high, it can indicate that you are overextended and are more likely to default if you come into a financial hardship. 

For example if you have on credit card with a limit of $10,000 and owe $6,500 on that card you would have a credit utilization ration of sixty five percent. The higher your credit utilization ratio the great the impact it will have on your overall score. A good rule of thumb is to have a credit utilization ratio of thirty percent or lower.

Length of credit history (15%) — You can still have a high credit score if you haven’t had a long history of credit, but you’re doing well on all the other categories. Your length of credit history makes up fifteen percent of your total score. Typically, the longer you have had credit accounts the more positively this will impact your overall score. The average time that each of your accounts has been open will help to determine  your overall length of credit history.  Having a longer credit history provides more information to base lending decisions on for potential lenders.

Credit Mix (10%) — When it comes to credit mix, think about diversity. Having a variety of types of credit accounts can have a positive effect on your credit score. It is not necessary to have every type of credit account available, but a few different types of credit will show that you can manage a mix of account types. It will be okay if you are just starting out or do not have a variety of forms of credit. Your credit mix is ten percent of your combined FICO® Score.

New Credit (10%) – Last but not least, the final ten percent of your FICO® Score is made up by evaluating your new accounts and account inquiries. It has been shown that opening numerous new accounts in a short period of time can indicate a financial problem and may indicate a greater likelihood of future default. It is not just a new credit account that will impact you but also the credit inquiries. When you are shopping for new credit, the lender will report an inquiry regardless of whether they issue credit. These inquires will remain on your credit report for the next two years and can negatively affect your credit score for the next year. Consider this whenever seeking to obtain new credit.

 Knowing more about how your credit score is calculated can help you maintain or build a better score. Think of your credit score as a way of explaining your combined history of credit to a lender who knows nothing about you. Your credit score is simply a risk score, a risk of how likely you are to repay a lender. The higher the score the more likely you are to repay them. A lower score may indicate the opposite, and this can make it more costly for you to borrow money (riskier loans charge higher interest rates). Having a higher credit score can help you save thousands of dollars over the course of your lifetime.

In the case of credit scores, knowledge can be power. Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.

Understanding Your Credit Reports

You credit can have a major impact on so many aspects of your life, and it is important that you know what is on your credit report and how to manage it. Understanding your credit can appear complicated and challenging; however, it can also be a powerful tool. In this three piece series we will go over understanding your credit report, understanding your credit score, and establishing your credit.

Our credit plays a big part of our daily lives. Sometimes we do not realize this until someone starts asking us about it. Our credit determines our cost of lending. Essentially, credit effects interest rates, the price and ability to obtain insurance, housing opportunities, and our ability to obtain certain jobs. While credit can and should be used to improve our financial well being, many people struggle with excessive debt obligations because of the mismanagement of their credit. Using credit wisely is the key to assisting you to a world of possibilities.

You should be checking your credit at least once a year from each of the three major credit reporting agencies: Equifax®, TransUnion® and Experian™. You should also check your credit report anytime you think that your information may have been compromised.  Each of your three different credit reports most likely will have slight deviations, but on the whole each should be relatively similar as most major lenders report to all three agencies while some of the smaller agencies and collection companies may only report to one of the three.

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To get started, you will need to pull your credit report from each of the three credit bureau reporting agencies listed above. You can access all three agencies at one time through sites such as www.annualcreditreport.com, which provide a free credit report from each of the three major credit reporting agencies. You can also get your credit report through many credit card providers, which provide monthly credit report tracking tools for free as long as you have an account with them. These programs vary by company and usually only provide access to one of the major credit reporting agencies, but they are useful tools for tracking and learning about your credit.

Once you have access to your credit reports it’s important to understand the information on them. Your credit report is typically divided into categories consisting of your Identifying information, credit inquiries, public records, and account information.

Identifying Information

                The identifying information on your credit reports is essentially all your personal information, including:

  • Name, known aliases, and previous names (these may include maiden names, other married names or nicknames; for example, if your legal name is Stephen but you go by Steve, then Steve will also be listed)
  • Social security number
  • Date of birth
  • Current and former addresses
  • Current and former phone numbers

The purpose of the identifying information section of your credit reports is to verify the information you have provided and to look for any warning signs or red flags regarding incorrect information. The information should be reviewed carefully to ensure that your identity has not been confused with someone with a similar name or a relative with the same name. You may be able to tell whether you have been a victim of identity theft.  Should you find a discrepancy in any of the information on your credit report you can file a dispute or an update to change it.

Inquiries

                In the inquiries section of your credit report you will find a listing of creditors and other companies that have requested your credit report over the past two years. There are two types of credit inquiries, soft and hard inquiries.

  • Soft inquiries are a result of companies purchasing or obtaining your information for promotional purposes or a current creditor checking your account on a regular basis.
  • Hard Inquiries are made when you have applied for credit through a financial institution. Close attention should be paid to any unauthorized hard inquiry as it could be a sign of identity theft. These inquiries can also negatively affect your credit score.

Public Records

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                The public record section of your credit reports will display financial activity such as foreclosures, bankruptcy, tax liens, and civil judgments against you. Ideally, you want this section to be blank as anything displayed in this section can penalize your overall credit score.

Account Information

                Your account information is where you will find the specific details of your account history. This will likely be the most significant portion of your credit profile. It is here that you will find the specific details of your credit history from current and past creditors. Each creditor will have their own section containing information regarding:

  • Payment history
  • Credit limit
  • Dates accounts were opened and closed
  • Most recent payment amount
  • Current balance

If the account has not been managed properly the account will reflect this in the history, including current or previous late payments, and cases where accounts have been closed by the grantor or even transferred to collection.

Understanding how to read your credit report is a start, but you need to know your rights and resources, as well.  The Federal Trade Commission, which protects consumers by preventing unfair, deceptive or fraudulent practices in the marketplace, enforces the Fair Credit Reporting Act and Accurate Credit Transactions Act, with which the credit reporting agencies must comply. Accordingly, you have the rights to:

  • Be told if information on your credit report has been used against you, such as being declined for credit or employment due to information obtained from your credit report.
  • Know what is on your report and having free access to your credit report annually. You also have the right to view your credit reports should you believe that you are a victim of identity theft or fraud, and if you are on public assistance or unemployment.
  • Request to see your credit score, though you will have to pay for it.
  • Dispute incomplete or inaccurate information, though the credit reporting agency must investigate should your dispute be frivolous.
  • Have inaccurate, incomplete or unverifiable information corrected or deleted by the credit reporting agency within 30 days of being notified, though they can and will continue to report should they confirm that it is accurate.
  • Remove most negative information from your report after seven years and remove bankruptcies that occurred more than 10 years ago.
  • Limit access to your report to those with a legitimate business interest .
  • Privacy regarding credit reports, wherein a credit reporting agency may not provide information to employers without written consent.
  • Opt out of “pre-screened” offers of credit and insurance by calling the nationwide credit bureaus at 1-888-5-OPTOUT (1-888-567-8688).
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Another great resource for understanding you rights is the Consumer Financial Protection Bureau. They regulate the offerings and provisions of consumer financial products and services under the federal consumer financial laws. This is a great site to visit for additional information that will help you to become a better informed consumer of financial products and services, such as lending and how it relates to your credit.

Your credit reports are a record of your borrowing history and how you have managed your financial obligations. Knowing how to read your credit reports is an important step in helping yourself understand how to better utilize your credit to help you succeed financially and ensure that you are protecting yourself from identity theft and fraud.

Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.

Your Interest Rate Doesn’t Matter. It’s All About That APR

Interest rates have seen a steady decline of the past year and with the recent cut by the Federal Reserve they are now hovering around the lowest rates in history. With rates being at an unprecedented low in the United States and around the world, borrowing is at an all-time high as individuals rush to purchase and refinance large items at today’s record low rates. If you are considering purchasing or refinancing a large item that you must finance it is important to know the difference between interest rate and annual percentage rate (APR) to get the best loan available to you.

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Interest Rate is the annual cost of borrowing the principal amount of the loan. Most often this will be the advertised rate that you will see lenders providing to the public in large bold numbers. However, when reviewing you loan documents you will often find a different rate, that of the APR.

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The APR is calculated separately of the interest rate and is the combined cost of interest on the principal plus the cost of other fees that you might be paying as well. For example: most mortgage companies have an array of fees that often are reflected in your APR but not your interest rate such as a loan origination fee, documentation fees, discount points, closing cost, and borrower paid mortgage insurance. These fees must be displayed in the APR according to The Truth in Lending Act. The APR is a more true reflection of the total loan cost and will allow you to shop loans in a more apples to apples comparison being a more precise means of determining the accurate cost of a loan.

You must be diligent when shopping for a loan, many times you will hear a lender quote the interest rate or even quote a discounted interest rate only to fine large fees or “points” hidden to get you that super low interest rate that they quoted you. When comparing loans pay close attention and compare the APR to decide the least expensive loan.

Please leave a comment below, I would love to hear your stories, answer your questions, and have better money conversations.