This week is different

We are going to switch things up a bit this week. Specifically, we are curating some important lessons from our Knowledge Base to help you learn more about credit and how to build it.

What are credit scores?

Full article “The 3 Most Important Numbers in Your Life” available on our KB

A credit score is supposed to predict how likely you are to pay a loan back on time. It gives a metric to banks to determine who might be a good person to lend to, and who may not be a good candidate for a loan. Here’s how credit scores are typically used:

• Landlords use credit scores when deciding whether to rent to a potential tenant.

• Insurers can use your credit score to set your insurance rates.

• Employers can use your credit score to determine whether to hire you.

• Lenders use your credit score to determine your ability to pay back a loan like a mortgage.

The Consumer Financial Protection Bureau (CFPB) and the Federal Trade Commission (FTC) are arms of the federal government, tasked with protecting consumers. Both of these government agencies provide oversight to credit reporting companies. The three largest companies that create and maintain credit scores are Equifax, Transunion, and Experian. These three, along with a multitude of other companies creating credit scores, use their own mathematical models to determine what your score is.

There isn’t a hard and fast rule on how your credit score is calculated and maintained - you may get one number from Equifax that looks noticeably different from Transunion on the same day. It’s normal to see different numbers because scores are calculated at different times, in different ways.

Generally, your credit score is calculated by looking at your credit history. Your credit history describes how you use money. The formulas try to answer questions like…

1. How many credit cards do you have?

2. How many loans do you have?

3. Do you pay your bills on time?

There are lots of different scoring systems, but most factors that are used in most calculations are:

• How much money you owe

• Whether you’ve paid on time or late

• How long you’ve had credit

• How much new credit you have

• Whether you applied for new credit recently

Then, using a statistical program, companies compare this information to the credit behavior of people with similar profiles. Based on this comparison, the statistical program assigns you a score. Usually, credit scores fall between 300 and 850. A higher score means that you have “good” credit, and a low score means you have what businesses see as “bad” credit, which means it will be harder for you to get a loan or credit card.

As discussed earlier in this article, how you handle your money in your credit history will help lenders decide if they want to do business with you.

Like many things related to the economy and money, trust and confidence are key. If the potential lender looks at your credit history and can see that you pay your bills promptly, it boosts the lender’s confidence that you’ll be able to pay back your loan. This is considered a “good risk” for lenders - your past actions with money suggest you can be trusted to take care of it.

Methods to Build Credit

For those new to credit, it can be an upward battle to reach a respectable score. However, there are some actions you can take now to build your newly created credit profile, or improve your current score.

Full article “Building Credit” available on our KB

Become an Authorized User

An authorized user on a credit card is an individual other than the cardholder who is able to make purchases using that credit card. The authorized user receives their own card from the issuer, but is not responsible for making payments. Card companies may charge an additional annual fee per authorized user, typically around $75 or more. The benefit of being an authorized user is that as long as the cardholder pays off the statement balance each month, both the cardholder and authorized user(s) will receive a positive boost toward their credit. Establishing your child as an authorized user at a young age then paying off the balance over the duration of their childhood will build a robust credit history for that child by the time they grow up. Authorized users can also be friends or other family members and authorized users can receive a positive boost to their credit even if the individual never uses the card themselves.

Credit Builder Loan

A credit builder loan is perfect for those with a thin credit history, no history at all, or those attempting to rebuild their credit. This loan is usually for an amount ranging from $300 to $1,000, placed into a secure account. You make fixed payments on this loan every month until it is paid off in full, at which point you will receive the loan proceeds (minus fees) at the end of the loan term. These loans usually have APRs ranging from 6-16%, though it is recommended that you always pay off the statement balance in full each month so the APR becomes negligible; in addition, you will be charged late fees if you miss payments.

This type of loan is offered by community banks, local credit unions, online lenders, and financial technology companies. Some examples of online lenders include: Republic Bank, Alltru Credit Union, Sunrise Banks, Self, MoneyLion, and Digital Federal Credit Union.

Secured Credit Card

A secured credit card is backed by a cash deposit from the cardholder. The amount that you put down as a deposit for the credit card becomes the credit limit for your card. This deposit amount acts as collateral–and is not available for the cardholder to retrieve–in case the cardholder cannot pay back the amount charged to the card. Each month, the cardholder will receive a statement listing the charges on the card. The credit card holder must pay the minimum due (but ideally the full statement balance) each month by the payment due date.

These cards are a good option for those with poor, little, or no credit history. The card issuer will send your usage to credit reporting agencies which will improve your credit score. Therefore, it is important to actually use this card when making purchases. However, the card is only a good option if the cardholder pays off the statement balance each month, because these cards have a high APR (20% or more), which comes into effect if the statement balance is not paid in full by the payment due date. Here are some highly ranked secured credit cards.

Experian Boost

Experian Boost is good for people with little to no credit history. This is because Experian Boost factors in your bank and credit card records to find on-time payments for bills including utility, streaming, and rent payments. These payments are reported to credit agencies and help build your credit. The best part is, Experian Boost is completely free.

Now that you know the foundation of credit and how to build it, you can start slow and gradually improve your credit score. Good credit is defined as 740 or better. By no means should you feel obligated to add large amounts of debt to your credit profile. Instead, simple options like a secured credit card or simply making sure all your payments are recorded with Experian Boost can provide a quick bump up in credit, before you move on to bigger responsibilities like a credit card, car loan, or mortgage.