Credit 101

Credit 101

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Managing and Improving your Credit

If you don’t make sure your credit worthiness and credit scores are as high as they can be, you’ll qualify for fewer credit products, such as credit cards, auto loans, mortgages and small business loans.

Many potential employers also ask for access to your credit reports during the application process or after an interview.

If you’re not looking for a new credit card or shopping for a mortgage or thinking about buying a new car, why do you need to manage your credit on a regular basis?

The short answer is, if you need a new card or loan, it’s probably too late to fix or improve your credit before you apply. It can take weeks or months to optimize your credit reports and keep your scores as high as possible.

That’s why now is the time to make sure your credit and scores are in good shape. Some of the benefits of good credit include:

  • Lower interest rates
  • Higher credit lines
  • More access to credit
  • Fewer fees

Pulling Your Three Credit Reports

Your credit reports include the number of credit cards and loans you have, the balances, your payment history and other information about your credit history, going back many years, such as previous employers and addresses where you’ve lived.

Therefore, the first step to improving and managing your credit is to pull your three credit reports, which are created, maintained and distributed by Equifax, Experian and TransUnion. These three companies also generate one or more credit scores for you.

Each time you use credit, the credit card company, auto lender, mortgage company or other lender reports your information to these three agencies. In exchange for helping these agencies keep tabs on your credit, lenders get access to your reports so they can evaluate your credit worthiness.

You legally have access to these credit reports free, once each year. If you’d like to monitor them throughout the year, you can purchase credit report updates from them, or use a credit-monitoring service.

To get free copies of your credit reports, you can visit www.AnnualCreditReport.com, which is the official government site for doing so. You can also get your reports one at a time by contacting Equifax, Experian and TransUnion individually.

You’ll need to answer a few questions about yourself at these websites (or send in a letter), such as your name, address, date of birth and Social Security Number.

If you request your credit reports from AnnualCreditReport.com, you will be able to download and start reading them within minutes.

Understanding Your Credit Reports

When you get copies of your three credit reports, it’s important to make sure that every piece of information about you on them is correct. This includes even small details, such as your previous addresses, middle initial, previous employers and birth date.

Make sure there are no accounts on your report that don’t or have never belonged to you (e.g., credit cards, auto loans, mortgages).

Derogatory marks on your credit reports hurt you. These include:

  • Late payments
  • Missed payments
  • Bankruptcy
  • Debt consolidation
  • Wage garnishment
  • Foreclosure
  • Short sale
  • Default
  • Civil judgement
  • Tax lien
  • Recently opened accounts
  • Recent inquiries

Derogatory items can stay on your credit reports for up to 10 years.

Even if you have good credit, each time you receive a new credit card, that will ding your score slightly. Each time a creditor pulls your credit report (with your permission), that dings your score, but is not a major hit. That means you need to be careful shopping for credit cards and giving multiple card companies permission to pull your credit reports.

If you can’t pay your taxes and set up an installment plan with the IRS, that will NOT be reported to the credit reporting agencies. Some lenders do NOT report late payments if you are less than 30 to 90 days late, even if they charge you a late fee. Check with your lender to find out what their policies are.

Fixing Your Credit Reports

If you find any incorrect information on your credit reports, get it corrected. If it’s incorrect information such as your address or date of birth, contact the reporting agency or agencies with this mistake and ask them to change it.

If a lender has incorrectly reported information, such as a missed payment, contact them first and have them correct the information. If they will not, then you can challenge the information by contacting the reporting agency.

Follow the steps at the reporting agency’s website to request a correction. You’ll need to provide as much support as possible and wait up to 30 days for a ruling. If the reporting agency sides with the lender making the derogatory statement, you can then take legal action.

You can also leave a comment for lenders who pull your reports explaining the situation. For the most part, however, lenders won’t consider sob stories.

Reviewing Your Current Credit Products

Once you’ve cleaned up your credit reports, it’s time to start improving your scores. You do this by reviewing your current loans and credit cards to determine whether or not you can improve or replace them.

Rank your credit cards by the annual percentage rate they charge to see which ones cost you the most in interest each year. Look at which ones come with an annual fee. Look at which cards offer a balance transfer and what the terms are.

Look at your mortgage to see if a refinance might be in your best interest. This can save you tens of thousands of dollars over the life of your loan. A refinance might also significantly lower your monthly payments.

Any time you’re shopping for a credit product, contact credit unions for the best deals. They are nonprofit lenders and usually offer the best credit products, in terms of low rates and zero fees.

What are Credit Scores?

There are a variety of ways to improve your credit scores, but you’ll first need to know what factors affect your score. According to FICO, these factors impact your score, in order of importance.

  • Payment history (35%)
  • Amounts owed (30%)
  • Length of credit history (15%)
  • New credit (10%)
  • Credit mix (10%)

If you log into your credit card accounts and check your credit score, you will see reasons that are affecting your score. These include:

Proportion of balances to credit limit is too high

This means you are using too much of your available credit, such as more than 25% of your credit card lines.

This is why it’s important NOT to close credit cards after you pay them off. First, you lose the credit history for that card, which might be 10 years old or more.

Next, let’s say you have two credit cards, each with a $5,000 credit line and you have used $2,000 of your available credit. Your debt-to-credit-available is 20%

If you close one card, you now have $5,000 worth of credit, not $10,000, so that $2,000 in debt now changes your debt-to-credit ratio to 40%.

Too few installment loans

This means you don’t have a car loan or mortgage or student loan. Installment loans help your credit score.

What About My Scores from my Credit Card Company?

The two main credit scoring companies are FICO and VantageScore.

Your free credit reports provide you with your credit history reports, but not your current scores. You can purchase those, if you wish, and check your scores regularly using a credit-reporting company, but those are often not the scores lenders see when they pull your reports and scores.

Why not? Because there are dozens of different scores on you, which are given to different lenders. For example, credit card companies get one type of score, auto lenders get another score (based on different aspects of your credit history), while mortgage lenders get a different score.

If you have several credit cards and get a free credit score, updated each month, you’ve probably noticed that your scores are different at each different credit card website.

What Affects Your Scores?

You can raise or lower your credit score in a variety of ways. Things that affect your credit scores include:

  • Late payments
  • Missed payments
  • Hard pull of your credit report
  • Closing accounts
  • Bankruptcy
  • Debt Consolidation
  • Garnishment
  • Collection
  • Percentage of credit used
  • Too few installment accounts (vs. revolving)

Late or missed payments can also change your interest rates with credit products you already have. For example, if you have a balance transfer at 0% interest for 12 months, if you miss one of your payments during that 12-month promotional period, you might lose your 0% interest rate and have to start paying the regular rate immediately.

Lowering Your Debt

One of the quickest ways to increase your credit score is to lower your debt, or the amount of money you owe; however, not everyone can do that.

If you do have some extra cash that exceeds your emergency fund, you might want to look at your credit cards and their APRs.

If you can pay down $1,000 on a card that has a 20% APR, you’ll not only raise your credit score, you’ll save $200 in interest payments this year (assuming you were going to carry that $1,000 for one year).

You might want to ask a family member to lend you money in a win/win situation for both of you. If you have a credit card with 20% or higher APR, you might borrow money from a family member and offer to pay them 10% interest and pay them back in one year. If 10% is more than they make in the market and you are a better risk than the market, you both win.

On a $5,000 loan, you’ll save $500 in interest payments and raise your credit score because you reduced your debt-to-available-credit ratio.

Your family member earns 10% interest, or $500. Your family member might have to pay income tax on that interest.

Balance Transfers

Balance transfers allow you to move balances you have on other credit products to a different card, often at 0% or low interest. Some lenders let you use a balance transfer to send money to your checking account to use as cash. Even with a 0% balance transfer, you might have a fee for the transfer, usually 3% to 5%, but the overall savings is still better than paying your current high interest rate on the other credit card.

Cash Advances

Cash advances are just what they sound like – your credit card company give you cash and lowers your available credit by that amount, but usually charges you a higher APR than for charges and balance transfers.

Look toward the bottom of your monthly credit card statements. They will tell you much of your balance is for purchases, balance transfers and cash advances, and what the interest rates are for each.

It will also tell you how long it will take to pay off a card paying the minimum balance each month and how much interest you’ll eventually pay, which can be a shocking figure.

Credit Card Rewards/Points

Many credit card companies offer you rewards, such points you can redeem for discounts on airfares, rental vehicles, hotels or shopping purchases.

The problem with points is that if you rack up high balances chasing points and pay interest on those balances, you end up paying more interest than you get in value of the points.

Read the fine print on any point programs you enter. Some travel points might be subject to multiple blackout dates. Some programs let you use your points to pay off some of your balance, or transfer them to a shopper program. Some will even let you synch up your card with your Amazon account and redeem your points on Amazon. However, when you do this, you only get a lower percentage of your point value, so it’s probably better to use your points to reduce your card balance (and reduce your interest payments).

Cash-Back Cards

Cash back is another reward some cards offer. You get a small percentage of cash back for each dollar you spend. Cash-back cards often have a higher APR. Check all of your cards to see if this is true for you. If you carry a balance and pay interest, don’t think your cash-back cads is the best deal for you—you might find out that your cash-back card has such a high interest rate, you’re losing more money using that card.

Cash-back cards are excellent credit products for those who pay off their balance each month, especially if you can load them up with all your business expenses and pay them off each month.

Small-business credit cards are tied to your personal credit, but they offer different features for small-business owners, such as different rewards, spending reports and the ability to add authorized users. In addition to helping you keep your business expenses separate from your personal charges, small-business credit cards help you look more professional when you’re paying clients and suppliers.

You will qualify for a small-business credit card pretty much the same way you qualify for a personal credit card. That means the credit card issuer will want to pull your personal credit report and look at your personal credit score. You are personally on the hook for all charges with a small-business credit card, even if you close your business.

Paying Down Mortgages

Be careful about following one well-known personal finance guru’s advice of paying down your mortgage as fast as you can. If your mortgage is only 3%, why would you pay off that loan when you can take that money and earn 8% or more in the stock market, or get a 50% match from your employer if you put that money into your 401(k)?

He also recommends the “snowball” method of paying off credit cards. He recommends paying down the card with the smallest balance first, rather than the one with the highest interest rate, so you get a “psychological win” when you pay off the card.

That’s pretty patronizing. Pay off the high-interest cards first.

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