Credit is also known as “debt” in this country. Unless you have been living under a rock, then you have noticed that this country is run on credit.
Almost all the small and large purchases you make in your lifetime will come into contact with a credit application, and yet has anyone told you what credit is, how it works, why it matters, and how it can work for you? Probably not as in depth as you wish so sit back and listen…
What is Credit?
– Credit is a loan; as simple as that. It can come with many different terms and rates or in different shapes too. You may have heard of credit in the following forms: Mortgage, Car Loan, Credit card, Store card, Overdraft protection, etc. Credit is all around you and is used every day, even more so than cash. It is a way of life for some, a nightmare for others and can really help you create wealth if you understand it.
What is a Credit Report?
– A credit report is a detailed report highlighting your entire credit history. Every time you apply for credit or choose to take on credit obligations, you provide the person, entity or bank some basic information along with your Social Security Number and they make a determination of your ability to repay that obligation. Regardless of their answer, the information they enter and submit in their magical computer gets recorded on your credit report. Most common items on your credit report are open/closed accounts, balances carried on those opened accounts, late or defaulted payments, charged off accounts, history of who accessed your report in the past 60 days. Based on who provides you a copy of your report, the information might be limited.
The Beacon Score:
– What is your credit Score? A question commonly asked and answered in the credit business. Your credit report is a full report that shows the history of your credit, the great, the bad and the ugly but what it really does is create you a score, a beacon score that is. It is a score that is a summary of your credit history and that allows creditors to understand how trustworthy you are, but also how smart you have been with using your credit. The score ranges between 850 and 300. 850 being the best score you can possibly have. The beacon score also known as a FICO score takes in effect the following:
– Length of Credit
– How much Credit you have and the types
– How much of that credit you have used and for how long
– Your delinquencies on any loans or cards
– Any previous accounts you have had charged off
Every decision you make regarding your credit can impact your score and it is often an indicator of your ability to repay a creditor when you are seeking credit products. It is important to keep an eye on your score and to know how to keep your score up.
Here are some basic common tips on improving or up-keeping your score:
-Pay off any charge off accounts (they kill your score)
-Do not max out your credit cards.
-NEVER be late or default on a home loan.
-Never be late more than 30 days.
-Do not open unnecessary cards or accounts.
-Do not close all the cards you don’t need at once.
-Build a history with 1-3 credit cards.
-Check your report twice a year (not every month)
-Do not pay the minimum on your cards, always try to pay 10%.
-If you must be late, then pay your big items first (house, car, etc…)
-If you must be late or can’t pay, call your creditor and negotiate.
Those are just some basics around your credit that can help you restore or increase your score, and remember the biggest factor that impacts your score is how long you have had credit. Don’t plan on your score fixing itself overnight because it takes time.
So what are the different categories that your credit falls in:
The categories all depend on the creditor and how conservative they are, some creditors will only lend to the best and have strict guidelines around what they consider “A” credit (EX: 720 is “A” credit to some lenders, but 750 is to others) Here is a basic guideline:
850-800 (Platinum) – You can have it all, no questions asked
799-720 (A credit) – You are golden and trusted
719-680 (B Credit) – You are good but not everyone trusts you
679-620 (C credit) – You have made mistakes, it’s possible but will cost you
Below 620 (D Credit) – No one trusts you, need a cosigner, higher rates
What else do creditors look at when approving/declining your application?
The next great number called the DIR (Debt/Income Ratio).
This number tells a creditor what the likelihood is that you will be able to repay this obligation based on your income. First, they know if you are trustworthy and if you are in good shape by looking at your FICO score, then they want to know if the purchase you are about to make makes sense for the money you make. Since the DIR is a ratio, it is usually in % form and does not appear on your credit report, simply because your income changes with time and the report would have no way of knowing that.
There are no guidelines that tell what is acceptable and what isn’t, but all lenders use their own guidelines to determine what a good number is. The guidelines vary based on what you purchase (Car loan is very different from a mortgage and treated as such). It would be too complicated to go into details around this but remember this, the lower the number, the better off you are. There are two DIRs that the lender looks at; the first one is where you are currently, prior to the loan. The second one where you will be after they give you loan.
How do you know what you can afford?
Well, here are some good calculations to remember:
House loan: Total annual payments less than 35% of income (Priority)
Car loan: Total annual payments less than 10% of your annual income
Indulgences: If you can’t repay in 10 payments, you can’t afford it.
Why credit matters and how it can work for you?
We have all heard the phrase “Money is Power” and to an extent I believe it and so since “Credit is Money” then you do the math. Credit is real money, money that you don’t have, but will have someday. It is vital to your growth and necessary to your survival. Let’s look at a small scenario of how credit can positively work for you…
You buy a house, a normal car and have 2 credit cards. You make your payments on time, drive your car, and use your credit cards as absolute emergency money.
After 10 years you have a house and $100,000 of equity and 2 paid off cars.
Let me explain how you made money from someone else’s money.
You purchased your house for $500,000. Payments are $2500 a month.
You purchased one car for $20,000. Payments are $350 a month.
Both were necessary for you to survive, as you needed somewhere to sleep and a car to drive.
After 10 years, the market increased the price of your house to a conservative $600,000 and you owe $350,000 on the balance of your loan. You just made $250,000 the minute you sell your house. You can take the $250,000, put it down on your brand new $500,000 house and have a nice $1600 payment on the same type of house you were paying $2500 for. The best part of this is that you are getting back most of the interest money you pay towards that $2500 in your taxes at the end of the year. Better yet, don’t sell your house, get a Line Of Credit on your own money, pay a low interest rate and start the business you always wanted with the $250,000.
You drive a car about 12,000 miles per year. After 5 years your first car had 60,000 miles on it, then you bought another car for $20,000 for another 5 years that also has 60,000 miles on it. Now you take both cars sell them at 40% of their value and buy a new car for $16,000 outright or keep two nice $20,000 cars with no payment.
That scenario might seem too good to be true but it is a very conservative, worst way scenario.
So you see credit can be a great tool to help you accumulate wealth in the simplest way but it can also become a nightmare. Whenever you reach in your wallet and purchase a large item with your credit card, think twice. You will wake up the next day regretting that purchase only if you couldn’t really afford it. Use your credit wisely, do not over extend yourself especially not on items that are “wants” and not “needs.”
Keep in mind that once your score falls and keeps falling it can sometimes take years for it to correct itself after you get back on track, all those years are dollars that are going to waste because you wanted a TV?
Be Smart, Be Educated, Be Responsible and Be Honest with yourself.