Credit 101

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Credit…a word that makes some shake in the boots. Credit…this non-descript word that seemingly controls your financial journey. Bad credit…good credit..no credit…extra credit. What is it all about?!?

Per our good pals over at Merriam-Webster credit is defined as “the provision of money, goods, or services with the expectation of future payment”. Simply put credit is money given to a person in belief they will run it back when due. Credit terms are the parameters surrounding how/when you will run it back.

Why do I need credit? Way back in the olden days, one could stroll into a bank and convince a banker that they were a good guy and walk out with a loan. Have a couple pals to vouch for you and a call from your boss, and away you went with a stack of cash. Now typically lending back then also required some form of collateral. Your daddy’s pocket watch, prized cow, a gold tooth, etc. was needed alongside your perceived good character.

Over time, banks realized that holding cows in vaults was kind of cruel and the used gold tooth market was slim, so a better system was created. Better is very subjective here, but work with me. Credit bureaus evolved or devolved (depending on your feelings) into the Big 3, Equifax, Experian, and Transunion. Credit bureaus store your social security number along with any loans, inquiries, and payment data to create a credit report. Potential creditors plug your credit report data into their handy dandy algorithm and poof, approved or denied!

So what’s in my credit report? Good news that invoice from Columbia House that you skipped out on won’t be on there. Here is what you will typically find:

  1. Personal information – Your name, addresses, SSN, and employment.
  2. Inquiries – Requests to check your credit. Hard inquiries – lender is checking your credit because you’ve submitted an application. Soft inquiries – requests that will not end in credit being issued. Checking your own credit falls under this category. Hard inquiries impact your credit score; soft inquiries do not.
  3. Open loans – Think mortgages, cars, boats, student loans, personal loans.
  4. Open revolving accounts – All things credit card related: balance, date the account was opened, payment history.
  5. Closed accounts – Paid or charged off, they remain for up to seven years.
  6. Collections – Now if Columbia House sold your “I’m not paying for these cds if they ain’t a penny” invoice to Gonna Git You Sucka Collections, it will appear on your report.
  7. Public records – Bankruptcies, tax liens, and court judgments.
  8. Comments – I’ve never seen a comment, but creditors can do so.

Is my credit score the same as my credit report? No! Your credit score is a number derived from all the info in your credit report. This number is supposed to tell creditors how likely you are to repay a loan on time. How is this magical number calculated? Glad you asked. Let’s start with as I like to call them, “Gladys Knight”

  1. Payment history – 35% of your score is how you pay your creditors. According to Fair Issac Corporation aka FICO, your past payment history is a good indicator of your future payment history. Right, wrong, or indifferent, this is a major factor in your score.
  2. Credit utilization – Expressed in a percentage, outstanding balances to your credit limits. Here is a super simple example. You have a $1000 limit on your Titanium VisMasMexCover card. You charge $100 on it. Your utilization is 10% and that is lovely. Now let’s say you end up charging another $400, your utilization shoots up to 50% and not that is not lovely. A good rule of thumb is to keep utilization low because it accounts for 30% of your credit score.

Be super mindful of these factors. They account for almost 2/3 of your score. Pay on time and keep balances as low as possible. On to “The Pips”

  1. Length of credit history – How long each account has been open and how long it’s been since it’s seen any action. 15% of your score is basically time. This is why I implore people to not close credit cards. Once you pay a card off, place it in a sock drawer and every 6 months dust it off and buy a tank of gas.
  2. New accounts – Same way you’d look sideways at a person sliding into multiple folks DMs, creditors aren’t very fond of lots of inquiries. They may believe that you’re desperate and in financial trouble. Let your accounts age like fine wine and reap the benefits of this 10%.
  3. Credit mix – The remaining 10% of your score comes from having a variety of credit. Allegedly, if you can juggle all kinds of credit balls without dropping them, you’re a great potential borrower. So to all you “I don’t want no dang credit card folks”, you may want to rethink.

 

Now that you know what makes up a FICO score, let's see the score ranges:

Let's call a thing a thing with these score ranges. Red and orange score holders should expect any credit approvals to be tethered to awful terms. Think: higher double digit interest rates. Yellow score holders should expect much better approval odds. Terms will be favorable but could still have high(ish) interest rates. Green score holders should expect approvals on almost all credit applications. These score holders will usually be offered the best terms the lender offers.

Typically speaking, a person with an 820 credit score will be offered the same rates as a person with a 750 score. While it's super dope to have an 800 credit score, don't obsess over it.

Long story short: credit is important. I know some sites tell you to avoid it like the plague. If you cannot handle credit, take a step away from it. However, you shouldn't avoid it. Cash may be king but the majority of us won't be able to go plunk down $200k in cash for a house. Learn to not fear credit. It's a tool. A tool that DIAR will teach you how to master.

How do you feel about credit? Is it a scam? Do you think it's a necessary evil? Hit the comment box and drop your thoughts.

Bonus: I’m far from a credit historian, so here’s a dope link that gives you more background on the history of credit bureaus. https://www.philadelphiafed.org/-/media/consumer-finance-institute/payment-cards-center/publications/discussion-papers/2002/CreditReportingHistory_062002.pdf

 

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