What is a Credit Score?

 

I was sitting in a bar one night with an accountant friend "talking shop". We discussed everything from student loans to credit scores to the poor spending habits of our fellow millennials. She described a credit score in such an understandable way. Your credit score is your word to a lender to pay the money back.

If you lend a friend $20 once and they don’t pay it back, how likely are you to lend that same friend more money? Depending on the circumstances, probably not likely. This is the same with lenders. If they see that you haven’t done a good job of paying back other lenders, they are more wary of letting you borrow money from them.

So when you apply for any type of loan, the lender will pull your credit report to see your credit score. This essentially is your grade. Personal finance is a class and you're being graded as a borrower. 

This number can range from 300 to 850, or 0. It's sort of like the SAT where if you've made a solid attempt, you get some pity points. A score of 300 is still not great, but it’s a million times better than 0. If you’re a recent post-grad and your credit score is above 750, you should probably be writing these articles instead of me.

So let’s say you have never applied for a credit card, don’t have any student loans (lucky bitch), and your car didn’t require payments. You have no credit. You’ve never borrowed money, so you don’t have a score on how you’ve paid it back. Stay tuned, this is easily fixable.

Most students have some sort of credit. Maybe the electric bill is in your name and you’ve paid it religiously on time. Or you could have a store credit card that you pull out and put your 7 for $27 panties on every time you get the VS text alert. As long as you pay these off in full, you are on the right track towards building a credit score.

Back to the lender. They pull your credit report and see your score. Now what? They use this score to determine the interest rate for the money you just decided to borrow. The higher your credit score, the lower your interest rate. And visa versa.

Let’s use a car loan for an example. You need a $10,000 loan and the rates range between 3% and 15%. If your credit score is closer to 300, your interest rate will be in the 15% range. Whereas if your credit score is around 700, your credit score is more likely to be in the 3% range.

Why does this matter?

Say your loan is 36 months. Your $10k loan at 4% will be $295 per month. However, that same loan at 12% will be $332. This is only a $37 per month difference. That’s maybe a meal out and one coffee, no big deal. But over 36 months? You pay $1,332 more just for having a lower credit score.

So just because you have been loyal to paying back all the other money you have owed, you don’t waste as much money on interest each time you need to borrow money. It doesn’t cost you any extra to pay all of your bills on time each month, it’s just part of adulthood. You will need to borrow money eventually whether it be for a car, house, or maybe even refinancing your student loans. Save yourself the money and stress and start caring about your credit score now.

Moral of the story? Pay your credit cards off. In full. Every month. This will help you build and maintain credit so your interest rates will be lower in the future. 

Jager Bombs & Compounding Interest

Life lessons often come when you least expect them.  And they can carry such a wallop that your invincible post-grad ass hits the ground faster than you can regret not taking a victory lap. I don't know about you, but the life lessons I value most didn’t come from a classroom or a textbook.

See, my former boss was an avid drinker. I'm convinced he only hired me so he wouldn't be the only one hungover in our 9am Thursday staff meetings (RIP Corner Bar $5 bucket Wednesdays). Fast forward through a few company-funded lunches, even more expensed happy hours, and a small period of time where everyone who I reported to left the company. I had a questionable internship under my belt and was ready to graduate. What better way to send me off into the adult world than a liquid dinner?

Like most red-blooded Americans, I’m a sucker for free alcohol. And so, when your boss orders a round of literally anything, you smile and drink up. The limit does not exist.

Zombie Dust? Sure, it’s an acquired taste (so why not work on acquiring it?).
Jager bombs? Smells like my freshman year and regret, but sure, I’m game.
That final “wait, wait… OK, one more round”?  It’s fine.  The hangover is tomorrow’s problem.

Several hours - and a tab I’d rather not know the total of later – I found myself and the other intern blacked out in a Target, but cheap champagne.  Because graduation was tomorrow and you need mimosas before your ceremony or it’s not a proper graduation.  Trust me.

I don’t blame the cashier, I really don’t. She asked if I wanted to save 15% off my first purchase and open up a Target REDCard, and my frugal self said yes. Why would I not want 15% off my $4 bottle of champagne? I’m awesome at credit cards. I’ve never made a late payment, never have paid a cent of interest, never over utilized.

Long story short, I had a few mimosas, graduated, and left for a month long European adventure. I’ll assume Target sent me the card in the mail and I shredded the envelope because I had no memory of ever opening the card. I’ll also take responsibility for screening all my calls and straight up avoiding those unknown 800-numbers (pro-tip: they aren’t always spam calls).

As a result of this, it took Target about six months to find me.  And once they got ahold of my irresponsible ass, they made me pay my bill and then some. 

Remember when I told you to ignore your interest rate because it forces you to pay your bill on time and in full? Well lol. My interest rate was around 20%, not unlike most store credit cards. How much do you think a $4 bottle of champagne costs after six months of late fees and compound interest? Roughly $300.

You read that right: I wound up paying $300 for a cheap bottle of champagne because I was an idiot. That’s not even mentioning the damage it did to my credit score, but that’s a different story for a different day.

Why?  Compound interest.

Much like the Jager bombs, it can sneak up on you like a bitch.  Sometimes, a little compound interest can work very much in your favor, or knock you flat on your ass. Say you put $1,000 in a savings account. At the end of each month, you earn interest on that money. At 20%, your $1,000 would be $1,219.39 at the end of a 12 month span. You’re making money the money you just made.

So, reverse that and let’s talk about how I fucked up.

I put $4 on a credit card. That’s dumb enough but that’s not the point. I was charged a late fee and my first month of interest (at around 20% APR). Let’s assume the late fee is $21 for easier math. At the end of month 2, my total was my purchase plus the late fee PLUS the interest charged on that – something like $26.  At the end of month 3, another late fee plus even more interest.  Boom $50. You can see how this spirals downward and could end up in hella credit card debt?

Please, learn from my mistakes. Don't black out and open up credit cards. And even if you do, please pay them off.

5 Ways to Kick Ass at Credit Cards

Now you know the importance of a credit card and how much it can benefit both yourself and your credit score. Ready to learn how to maximize your benefits?

1. Do your research.

I highly recommend doing quite a bit of research before opening up any type of credit card. Each time you open a new line of credit, your credit score takes a hit. I know this seems counterintuitive, but it keeps you from opening up multiple accounts too quickly. So take your time, research a few cards, and make sure you apply for one that caters to your needs the most. Most importantly, make sure your card offers you some sort of reward. This is what makes a credit card more beneficial to you than a debit card.

For example, I absolutely love to travel. I spend almost every free second and spare dollar I have exploring new placing and experiencing new cultures. When I applied for my fist credit card, it was important to me that my rewards benefit my travel addiction. This is when the love at first sight with Capital One comes in. I got a 30,000 mile bonus when I spent $1,000 in my first three months. I also earn 1.25 miles for every dollar I spent. Slowly but surely, the points added up and I got my happy ass on a plane for free.

2. Never max out your card.

Your credit utilization factors into your credit score. Remember, its a score that judges your ability to pay back money. A credit card company will give you a limit, or an allowance, based on your annual income. However, FICO knows that if you make $20,000 annually, you will not be able to pay off a monthly balance of  $1,500. Often, they will give you a higher limit than you need hoping that you spend too much and fall into their debt trap. Ideally, you should use 20% of your credit limit. This is a safe number that illustrates your ability to control your spending and highlight your success in paying off your bill in full each month.

3. Review your transactions.

I review my credit card statement each month before I pay it off. It's important to make sure it is accurate and each purchase was made by you. Unfortunately, credit card fraud is common and could easily happen to you. Reviewing your statement will make you feel at ease before paying off your bill.

This was another benefit that heavily weighed my credit card decision. Capital One provides excellent customer service when dealing with fraudulent activity or repeated transactions. Read review and ask around when researching to see which companies provide great customer service as well as competitive rewards.

4. Pay off your bill.

I can't tell you how many people think that in order to build credit, you need to carry a balance on your card. This is absolutely not true. Carrying a balance from month-to-month will only resort in you paying unnecessary interest charges. I promise, pay your bill off completely each month. You won't accrue any extra fees or interest and your credit score will rise.

5. Don't choose a card based on the interest rate.

I know this sounds silly. You should absolutely care about what interest rate you're paying. But hear me out, the point is not to ever pay any interest.

I purposely do not know the interest rate on any of my credit cards. I've never paid a cent of interest, so it's irrelevant information. If I know my interest rate, I can easily calculate what my fees would be from month-to-month if I only made the minimum payment. I force myself to be in the dark whether it be $2 or $200. This encourages me to pay off my card every single month, no matter the balance. If it's $2, you may be persuaded into paying the minimum and paying the bulk of the bill next month. On the other hand, no one wants to pay $200 extra. Be in the dark, always assume it's a huge fee, and pay off your bill.

Each dollar you spend will add up, I promise. Keep at it and start planning your vacation, you deserve it. Most importantly, enjoy your rewards! It's not very often that a company will pay you to use their product.

Credit Cards for Beginners

I've been in a committed relationship since January of 2013.

It was love at first sight, we travel together, and he calls every time I have fraudulent charges on my account.

Wait, what?

Let's back up. You know how important a credit score is, right? It determines your interest rate for loans and whether or not you are able to borrow money. It will come into play when you try to buy a car, apply for a credit card, and eventually make the decision to purchase a house.

The higher your credit score, the better. This informs someone that you are reliable and have paid back money that you have previously borrowed. Having a decent credit score will save you thousands. It's important, I promise.

So how do you build credit?

You have to borrow money and then pay it back. It might seem a little silly, but I'll teach you how. It doesn't have to be as extreme as buying a car or a house, that's much farther down the road.

Keep an open mind. How often do you use your debit card? At least 5 times a week, unless you are still in the stone age and pay with cash everywhere you go. What if I told you there are companies out there that will pay you to do that exact same thing, but with a different card?

When using your debit card, you are pulling money directly from your checking account and essentially giving it to the company you are purchasing from. You receive no rewards. But, this is a great way to start out learning the basics of plastic money and how not to overspend, or in some cases… spend what you don’t have. However, if you can show self-control and continue to limit yourself on spending, you'll benefit more from a credit card.

A credit card is a very simple way to build credit when done correctly. Switching your debit card out for a credit card is a manageable change, with little to no hassle.

With that said, a lot of people do not handle credit cards well. Most companies will give you a large limit that they know you would never be able to pay back. This is how they make money.

Every month, your bill will give you the option to pay off your balance in full, or make a minimum payment of $25 or so. When you pay it off in full, you are not charged interest, you are only charged for the purchases you made on the card. This is similar to a debit card, you are not paying anything additional for the credit card vs. the debit card.

Buuutttt....when you choose to make the minimum payment, your remaining balance then starts accruing interest at a compounding rate, and this is where people run into problems. Allow me to give you an example; my credit card balance is currently around $1,500 for the month. If I paid only the minimum payment of $25 until it was paid off, it would take me 11 years. Yes, years. Do the math; I would end up paying $3,300 for my $1,500 balance. So where does the extra $1,800 go? To the credit card company.

This may seem like a small amount for the company to care about. But imagine you have 2 or 3 credit cards each with a $10,000 limit. Without being careful, it would be easy to max each one out while continuing to apply for new cards. This is how people enter the downward spiral of debt.

With that being said, there's absolutely no reason why you can't be one of the people who DOES handle credit cards well. Here are a few helpful guidelines that I have practiced to remain debt free while using a credit card.

1. You wouldn't swipe you debit card if you didn't have the money in your checking account, right? So don't swipe your credit card unless you have the money readily available to you. This will help limit your purchases so when the bill comes at the end of each month, you'll easily be able to pay it off.

2. If you are unable to limit yourself, lower your limit. Most companies will start you off much higher than you need to be, because that's how they make money. You are allowed to lower your limit to an amount that you know you'll be able to pay off. There's nothing wrong with lowering your limit to $100 a month and proudly paying it off. You're doing this to improve your credit, not to impress your friends.

3. Get a credit card with rewards. This will give you an incentive to use it rather than your debit card. My credit card gives me 2 airline miles for every dollar I spend, I haven't touched my debit card in years. I essentially get free flights because I don't pay any fees or interest on the card. They pay me for using their services.

You can do this, I promise. Your credit score with thank you when it comes time to buy a house, take out a loan, or buy a car. You'll have years of experience building a credit score to get you the lowest possible interest rate. I know it sounds scary, but it's just adulthood, we'll take it one day at a time.