The Credit Score

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The truth of the matter is that everyone should strive to use as little credit as possible because credit equals debt. Having said that, most people find that they need to use credit on high ticket items such as vehicles, buying a house, home air conditioning systems, furniture, home repairs etc.

 

The three main credit bureaus in the U.S.A.  are Equifax, Experian, and TransUnion and the  Creditors and lenders will normally use one of these bureaus to check your credit rating when you apply for credit. The credit bureaus operate by collecting and continuously updating a consumer’s credit rating and then selling that information to businesses in a credit report. Each credit bureau operates independently and issues it’s own rating. Consumers normally know this as their credit score, one number that represents your reliability as a borrower.

 

Credit scores generally range from a low of 300 (poor)  to a high of 850 ( excellent) and the score has a major impact on your credit options. Each individual business has their own model of credit score generation but the final ratings usually fall within a few points of each other. A lower credit score will put you at a disadvantage. You will find that you have less credit options, and the options that are available to you will come with a high interest rate and normally give you less time to pay the loan off. I think that it is always a good idea to get as high a credit score as you can, because you never know when you may need it.

FICO

The Fair Isaac Corporation formulated FICO credit scores. They are an amalgamation of the information found in the major credit bureau files on you. These scores are used by more than 90% of lenders when it comes to granting loans. They are also used when setting the interest rates, monthly payments, terms of each loan and loan approval. The FICO score is something that is normally supplied to many credit card holders on their monthly statements.

 

How To Get And Maintain A Good Credit Score

The first thing you will need is a credit history. If you have never used credit, you will have no credit rating and you will probably find it hard to get a loan.

The easiest way to begin your credit history is by getting a credit card. My suggestion is to use the card and either make sure that you pay it off every  month or keep a low balance on it. The credit history uses data from you “on time” payments, use of the card and length of credit history. You normally find that if you pay off the whole card balance in full every month, you will not be charged interest, but that depends on the individual lender and you should read the small print on your agreement.

After you create a credit history, make sure that you make all of your loan payments by the payment “due date” and keep your debt to 30% or less of the total credit available to you.

The categories generally used to determine your credit score is:-

Payment History – 35%

Credit Utilization – 30%

Length of Credit History – 15%

Mix of Accounts – 10%

New Credit Inquiries – 10%

 

The two most important factors, according to the above figures are the payment history and the credit utilization. Payment history is self explanatory – pay on time, every time. Credit utilization is a calculation of the total available credit you have versus your total debt. If you can keep the ratio of debt to credit below 30% then you should be in good shape.

Example –   Total Available Credit = $30,000

                     Total Debt = $9000

                     Credit Utilization = 30%

 

You never know when you may need credit and it doesn’t hurt to build yourself a good credit score for potential use.

If you can build and maintain a good score you will be able to take advantage of the best offers, such as:-

0% interest  finance loans for several years with no prepayment penalties

18 month + 0% interest credit card offers

9% or less APR credit cards

4% or less mortgage loans

And more

 

People with bad credit can still obtain credit but the interest rates are normally extortionate. Unfortunately,  the people who pay the most interest on loans are the people who can least afford it, or the people who have neglected to cultivate their credit score.

I once saw a 70 point drop in my credit score due to one minor monthly payment that I forgot about. The minimum payment was so small that I could have easily paid the amount many times over. The payment was to a store type credit card, and I paid the forgotten payment the following month. I had been an account holder for several years, and I had used it, and got to a zero dollar balance several times over that time. This was the first time that I had missed a payment. This didn’t matter to the company. It took about a year to rebuild the credit score to a very good level. The company involved, was so fast to react to this one missed payment in my history of being a reliable customer that I payed off the whole thing the month after that and shredded the card, never to be used again. These things happen and it is inconvenient, try not to let it happen to you.

 

Yes, the system has the advantage. I am not advocating the system and I am not advocating borrowing money, but if we are diligent, we can use the special offers that are available to a person with an excellent credit score as a useful financial tool.

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Organizing Your Finances

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Everyone needs to have some type of system for their finances. Everyone (almost everyone) has monthly bills to pay, and missing a payment is a bad thing as it can affect your credit rating. The credit rating is very important as it affects the interest rates that you are eligible for when applying for a loan, mortgage or a credit card.

 

Bill Payment Systems.

One system that can be used is to set up automatic payments from your bank to your creditors. You don’t have to keep up with due dates and everything is automated. The problem is that if you have an unexpected payment that you have to make then you may end up with an overdrawn account or the bank may not honor the payment due to insufficient funds. This could also be an issue for a business person, contractor or freelancer who does not get a regular set amount deposited into their bank every month. The system is not good for a person who does not have regular scheduled payments into their bank account.

Another system, preferred by myself, is to receive paper bills/invoices. I organize the paper bills by stacking them on top of each other after sorting them by date, with the closest date to the present on top. Keep the stack in a place that catches the eye regularly and get into the habit of checking the top bill frequently, not a very high tech system, but it is a system, and it works. This system allows a person to either wait for the “due date” to pay the bill or pay it early if sufficient funds are in the bank at the time that the person checks the stack. It may not work for everyone and I suppose that the system relies on habit and a good memory, but it is useful when you have income that is not received on a regular date, the system also aids the cash flow. Cash Flow is not the same as a general lack of cash.

I have noticed that some banks and credit card companies are attempting to charge for paper bills. When that becomes common, I will probably go to a paper stack of printed email reminders.

 

Another option is to have no system and hope for the best. This doesn’t work and usually results in missed payments, late fees and a less than impressive credit score. Many people think that they will not have to borrow money and that the credit score is of no interest to them, but it is always wise to be prepared for the unexpected and ensure that your credit score will allow you to get a good interest rate, just in case you need it.

People qualify for interest rates on loans based on their credit score. It is very unfair, but the bottom line on this is that the people who need credit the most and who have the least amount of wealth, end up being offered loans with the highest interest rates as their only option.  I have seen credit cards offered with a great 6% APR (only with an excellent credit score), but I have also seen credit cards with a crazy 25% APR, these are generally the store charge card types of deals. I would not take that deal, I would rather walk around in worn out clothing (or whatever else they are offering at the store).

 

Should You Use Savings or Credit on an Unexpected Expense.

It would be nice for a person to have enough cash reserves to be confident that they could cover any eventuality, but for most people, this is not reality. The use of cash or credit depends upon the credit deal that is being offered and the cost of the unexpected expense. I have used credit when there has been a 0% deal on offer for the amount that I require, but before I accept the offer, I always check the APR on the loan, in case I don’t finish the payments in time. I always calculate the minimum monthly payments that are required to pay the loan off before the 0% APR expires.  I have sometimes ignored the 0% deals in favor of a low interest rate when the expense is so large that I know that I will not pay it in time. Most of the time I will take a 0% loan offer on an expense even if I have the reserves to pay cash, as long as I can be sure of paying the loan off before the interest takes effect.. Taking a loan helps with cash flow, and I suppose that some of it is psychological, because I still have all my reserves in place for emergencies.

Sometimes the offer is very good, such as an 18 month 0% APR for purchases. The thing is, you must be aware of the “ 0% for 18 months, then 22% (example) APR” statement in the offer.  The interest usually encompasses the whole loan amount after the special rate expires, not just the outstanding balance, which means that you will have to pay all of the interest if you don’t pay off the loan in time. If you are considering a credit card offer, make sure that you start with a zero balance, because your monthly payments are usually applied to your original balance first, until it is paid in full. The original balance will still be subject to your normal APR, so you could end up making purchases under the 0% offer but never actually enjoy that offer because your monthly payments will go to something else. As long as you can be sure of paying off the loan in time, the 0% APR deals are worth taking advantage of and they will also help to build an excellent credit score.

Using loans in this way takes a lot of discipline and a constant awareness of what you are doing. If you lose track of things, you will be worse off in the end. Sometimes people have no reserves and have absolutely no option but to take a loan for an emergency, to buy a car (to get to work), new HVAC system to stay warm or cool , medical bills, help a family member etc.

APR is Annual Percentage Rate of Charge.

Credit is a bankers game, either avoid it or learn to use it to give you as much benefit as you can squeeze out of it. Have you ever wondered why you are offered 1% interest on your savings account, with banks advertising this as a great rate,  but their best offer to you is a loan with 15% interest on the total value of the loan? I sure have, but most of us have to play this game at some time.

 

Achieving a Good Credit Score

Achieving a good credit score is not that hard, and a payment system helps greatly.  Try to keep your outstanding balances on credit cards low. You must pay the monthly bills on time, even if you can only afford the minimum payment, make sure that you pay it somehow. The same goes for all bills. Beware of small medical bills and store charge cards that can easily be overlooked, they will report a person to the credit agencies in the blink of an eye for one missed payment, even if you have been making regular payments for months. Once reported, a late payment could result in a loss of 60 points or more on your credit score. I don’t advocate this credit score system, but play the game, to give you more options and a good interest rate just in case you do need a loan at some stage.

 

Live Within Your Means

The best option for having enough money and avoiding credit is to live within your means. I have read that many wealthy people do this, maybe this approach helped them to become wealthy. Don’t spend money that you don’t have on a flashy new car, be happy with a reliable one (for now). Don’t feel the need to keep up with other people. I have never understood people who feel forced to buy things just to keep up with neighbors, friends etc. If someone thinks less of you because you don’t spend a crazy $200 on a pair of already ripped jeans, so what. The tennis shoe fad is really puzzling. I refuse to pay more than $60 for a pair of tennis shoes, and when I do buy a pair, they need to be well designed running shoes. I also know that a $60 pair of running shoes is overpriced but I have found that this is about the cheapest quality shoe available for running at this time in the U.S.A.

Don’t be influenced by advertisements. This is hard because ads are specifically designed by some very clever people to have a psychological effect, that effect being to get you to buy what you don’t need or sometimes don’t even want.

 

Save Money

This is a good habit to acquire. The act of saving will help you to feel better and it is the starting point for building a cash reserve. Set a figure or percentage for yourself to save every week, pay period or month and don’t break into it except for extreme emergencies. Buying stocks or shares with savings is ok, but one needs to be aware that they can lose value as well as gain value and it is really a long term strategy, unless you have a significant amount of money to invest.

 

Insurance and Pensions

I would suggest that it is wise to get life insurance of some type while you are still young. The younger a person is, the cheaper the rate and the more coverage you can get. Ideally, life insurance should cover 2 people such as a husband and wife  in a mutual agreement. The actual product does not have to be the same one, but the benefit amount should be equal for both parties (to be fair). If the worst happens, the person left here will not have so many financial problems. There are plenty of different products available with various rates and terms.

Pensions are not usually a high priority for young people but this is the best time to begin planning. You don’t know what you will be doing in the future and the work that you do may not offer anything other than a 401k. The longer you invest in your own scheme, the more you will have when it comes time to claim the pension. If you are young and you are reading this, take a few hours over the next few days to investigate this. Normally, the employer contributes a certain amount of cash into a 401k, which makes it more valuable and a 401k is portable from one job to another, but you will have to work for an employer for a certain amount of time to be able to keep the employer’s contribution. This is called vesting and each employer has their own time period for the employee to be fully vested. Once you are fully vested, you can get another job and take 100% of the employer’s contributions with you in the form of the 401k. From the employer’s point of view, the vesting period encourages employee longevity, from the employees point of view, if they want to keep that employer contribution to their 401k, they will have to stay with the company for a set period of time. You could have to spend between 3 to 8 years or more with a company before you are fully vested.

Planning for  pensions too late could result in a person relying on social security alone in retirement. Pensions are seen as an old person’s issue, but early consideration of this topic is advisable.