Can I Have Your Number? Understanding Credit & Debit
- 2:31What does debt mean to you?
- 1:45How does a credit score affect you?
- 3:36What determines a credit score?
- 1:37How can you improve your score?
- 2:01How should you pay off your current debts?
- 4:29What is good and bad debt?
The title of this course isn’t a pick-up line. No matter what kinds of grownup stuff you try to do—apply for a job, buy a car, take out a small business loan—chances are someone is going to take a look at your credit score. And what they see could mean the difference between "yes" and "no". In this course, you'll get an overview of different types of debt, as well as a good look at credit scores, credit reports, and how that one number could be affecting all your grownup goals. You'll also learn about free tools and resources to help pay down debt and improve your credit score.
Before beginning this course, it's helpful (though not necessary) to have some financial information handy, like your credit score and what you spend monthly on different types of debt payments (car loans, students loans, mortgages, etc.). So you might want to have what you can nearby before we get started. (Don’t panic; we’ll help you do this!).
What you'll learn
- Understand credit scores and reports, including the biggest factors that influence your score.
- Get tips for understanding different types of debt.
- Leave with a list of free resources to help you keep tabs on your credit.
Society of Grownups Resources
- Explore a variety of articles on our blog about strategies to help you eliminate debt.
- Ready to pay off debt? Use our Loan Repayment Calculator to learn how to tackle your debt.
Welcome to Society of Grownups. My name is Rachel Rabinovich. I'm a certified financial planner and part of the team here.
At Society of Grownups, we consider ourselves a master's program for adulthood. It's the kind of place where people can come and learn about all sorts of grownup things, like how to handle finances, appreciate wine, save for retirement, and negotiate salaries. But most of all, we encourage people to keep their values in mind along the way. Today, we're going to be focusing on the ways that your credit score can be helping or hurting your attempts to reach your grownup goals.
So since I don't know your personal situation, this class should only be considered educational in nature. This is not tax, legal, or investment advice, and may not apply to your particular situation. If you have an issue that you would like to discuss, I would suggest you make an appointment with a financial planner. I may reference third-party resources and websites. We try to pick the ones we like the best. But we cannot be guaranteed of their accuracy. You will see an attachment with this video. It would be great if you could download it, try to follow along.
Periodically, in order to complete exercises, the video will pause. When you have completed the exercise, please restart the video.
So today, we're going to examine our relationships with debt.
We're going to talk about some common terms related to credit and debt.
We're going to discuss the importance of a credit score and what goes into it.
We're going to talk about different types of debt.
We're going to talk about good versus bad debt.
And finally, we're going to test our knowledge and try to dispel some myths around credit and debt.
So as we go into adulthood, many of the goals that we want to achieve are going to involve taking out a debt of some kind. It could start in college with student loans and credit cards and follow us into our post-college years with mortgages, car loans, or business loans. But no matter what our goal is, somewhere along the way, somebody is probably going to be looking at our credit report and our credit score.
As we become established grownups, the debt we accumulate can begin to feel unmanageable. Or we make mistakes because we don't know any better. And it often happens without us even realizing it. I'd like you to take a moment, look at the attachment page 2, and indicate what your personal relationship is with debt. The video will pause now. When you've completed the exercise, you can start it again.
So as you went through that exercise, you may have found that your relationship with debt is conflicted. Or maybe it's changed over time. I know mine certainly has. I used to have a lot of nagging feelings about my debt. And sometimes, it would actually keep me up at night.
When we were younger, my husband's and my student loans kept us from realizing so many of our goals. And it wasn't until we actually got a financial planner, got help getting ourselves organized, and were able to create a spending plan, that we were able to start realizing our goals. We were able to buy a house and start moving forward.
So debt can cause all kinds of difficult feelings. It can cause anxiety, stress, fear, and resentment. It can be like a heavy yoke on your shoulders making it really hard to move forward. But you can control it. And you can reduce it. And when you do that, the feeling of accomplishment can be really tremendous. And you can finally start moving forward with your goals. But in order to control it, you first have to understand it.
Now there are a lot of misconceptions out there about credit and debt. So let's take a quick look at the quiz on your attachment. I'd like you to run through it and indicate true or false. What do you think? And then at the end of the class, we're going to come back. And we'll go through the answers and see what you've learned. So the video will pause now, and then restart it when you're done.
On page 3 of the attachment, you'll see an illustration of how a credit score can affect your ability to get a car loan. Now we'll be looking at a $25,000 car loan for 60 months. And we'll be using Massachusetts averages. As you look at the chart, you realize there's really a dramatic difference between the rate that a person with a high credit score will get versus the rate that a person with a low credit score will get.
There's essentially, in this illustration, a 10% difference. You'll also see that person at the lowest end of the credit score will actually pay $7,500 more for that same car.
On the second part of the attachment, you'll see the same kind of illustration for a mortgage. So we'll be looking at a $300,000 mortgage and a 30-year loan. And again, we're using Massachusetts averages. Now you might think that the differences are a little bit more subtle here. But basically, the person at the bottom end of the credit score range is going to pay $100,000 more for the same house.
Your credit score can affect you in other ways too. Some car insurers in some states can actually have access to your credit report.
Employers that are looking at potential job prospects can get a limited credit history on you.
Cell phone providers and landlords can also get access to your credit score.
But also, there are now dating sites that actually match people up based on their credit scores.
And there was a major study that was just completed that has found a correlation between the strength and similarity of a couple's individual credit scores and the strength and longevity of their relationship.
OK, so we know credit scores are important. But what goes into them? Well, a FICO score, essentially, is made up of five components, each with a different level of importance.
The most important element in a credit score is your payment history. And it accounts for about 35% of your score. Now your payment history is the most important thing that a potential lender is going to look at. And it's the best indication of your long-term financial behavior. A late payment is essentially any payment that's 30 days or more past due. Now while we know that 100% on-time payment rate is excellent, but even having 97% of on-time payments is considered poor.
The next most important element taking up about 30% of your credit score is the amount you owe on your credit, or your utilization ratio. So how much credit card debt or loan debt do you owe against how much available credit you have? Essentially, lenders want to see that you're not maxing out your available credit. This could indicate that you might be in some kind of financial trouble or you're overextending yourself. But basically, you want to keep your use of your available credit under 30%. Well, what does that mean? So what it means is if you have a credit card with $1,000 credit limit, you want to keep the balance under $300. You also want to keep old cards open because that'll keep your available credit up and your utilization ratio down. So while we know that 30% is the rule of thumb, having a utilization rate of zero to 9% is actually considered excellent. But if you're using more than 75% of your available credit, that's considered poor.
Your score looks at the age of your oldest account, the age of your newest account, and the average age of all your accounts together. Now 9 plus years is considered excellent. I was going to get rid of an old store card. But then when I found out that it was 25-years-old and it was doing.
Inquiries for new credit account for about 10% of your score. So any time a lender requests your credit report, that counts as a hard inquiry. And a hard inquiry stays on your credit report for two years. It affects your credit score for one year. Now if you're shopping for the same type of loan, like a mortgage or a car loan, if you keep that within a short window of time, that should count as only one inquiry. Now you can check your credit at any time. And that's considered a soft inquiry, and it doesn't affect your credit report or your credit score. But having more than nine inquiries on your report is considered poor.
Finally, the total number of accounts you have and your credit mix account for 10% of your score. So having a number of accounts and a good mix of revolving and installment loans indicates that you could be a good financial risk. Believe it or not, having 21 lines of credit is actually considered excellent.
OK, so now we know what goes into a score. And we know what's important. But what if you want to make your score better? What are some things that you can do?
Well, the first thing you can do is pay everything on time. So even though being late on a credit card payment by a day or two is going to affect your interest rate, it could cause you to have a late penalty. It doesn't get reported to the credit bureaus until it's 30 days past due.
You want to reduce your revolving credit or credit card debt. Remember?
You want to keep your utilization ratio under 30%.
You want to pay at least the minimum on all of your credit accounts.
But with the debt that has the highest interest rate, think about taking extra available cash and putting it towards that card because that is the most expensive debt that you have. Once that's paid off, direct that money to the next highest interest rate.
Don't max out your cards. Remember?
You want to keep your use of available credit low. And if you have a corporate card, be aware of what your company's protocol is. You could be personally liable for any late reports.
And finally, check for and correct errors on your credit report. Mistakes can and do happen. And you want your report to be as accurate as possible. It's also a way for checking for fraud.
So first of all, you want to prioritize which loans get paid off faster. So I spoke a moment ago about directing extra payments towards the loan with the highest interest rate. Well, that's called the avalanche method.
There's another method called the snowball method, which can be a great motivator if you have a lot of small accounts out there and you just want to see them get ticked off quickly. That's where you direct extra money to the account with the lowest balance. Once that's paid off, you direct all those newly available funds to the account with the next lowest balance.
Consider refinancing or renegotiating the terms of your debts. So you can always consider refinancing a mortgage or a car loan to a lower interest rate if it's available to you. This could save you money. And it could increase your cash flow. However, just be careful if you extend the payment terms. You could end up paying more in the long run.
You could also consider renegotiating the terms of a credit card debt. If you're a longtime customer and you have an excellent on-time payment history, and if you're getting credit card offers in the mail, it's always worth a phone call to see if you can lower that interest rate.
You can always consider a balance transfer to a 0% promotional rate card. This can be a great way to help you whittle away your debt, but there are things to look out for. You have to understand what the terms are. There could be a fee associated with the transfer. The promotional period ends after a certain period of time. And you need to understand how long that is and what the new interest rate will be. It could actually be higher than what you're paying now.
And finally, just stop using the cards for a while. Put them away. Put them in the freezer or in a drawer. You want to make them tough to get to. And just use cash for a while.
So let's talk a minute about good debt and bad debt. Now, it's debatable if there's any such thing as good debt. My grandfather will certainly tell you there is no such thing as good debt. However, that's not the world we live in right now. And many of us are going to have to incur a debt of some kind.
So with that in mind, let's think about what some of the better types of debts might be.
So in my mind, a good debt could be the kind of debt that increases your net worth or your value or saves you time and money somehow. So some examples of this could be mortgages. A mortgage can increase your net worth, can build equity in your home. And it can give you some tax deductions.
Loans to renovate or do repairs on your home can increase the value of your home. And they can increase the efficiency of your utilities and ultimately save you money in the long run.
Taking out a loan to fund your education is a way of investing in yourself and in your future potential earnings. And it can also provide you with some tax deductions as well.
And finally, a business loan-- it's a way of investing in you, again, and your value and your ability to grow your business.
Now there are some caveats to good debt, always things that you have to look out for. And those are things such as high or variable interest rates, not taking advantage of available tax deductions. You also want to be careful not to carry long-term debt into retirement. That can really handicap your standard of living in retirement.
And also, too much debt is too much. You want to keep your total debt load under 36% of your income.
So let's talk a minute about bad debt. So bad debt is that kind of debt that doesn't increase your value or your net worth, and may end up costing you a lot more money in the long run.
So some examples could be credit cards with high interest rates. We all know that if you carry a credit card debt and you only pay the minimum, you're going to be paying for that for a long time. And the things that you used to purchase with that card are going to end up costing you a lot more than they were ever worth in the first place.
And certainly payday lenders and finance companies charge exorbitant interest rates and have very restrictive terms. So you want to be really careful about those.
There are a couple of other debts whose merits can be debatable, depending on your point of view.
So car loans is one of them. Now, a car is an essential item for most of us. And most of us will have to take out a car loan to get it. But if you do so, think really carefully and try to put down as much as you possibly can for a down payment. And try to keep the terms of the repayment period as low as possible, like three years or less.
And then personal loans-- they can actually be a great way to help you manage your debt. Transferring a revolving debt into an installment loan can really help you to get rid of debt. But you have to be honest with yourself. If you think you're going to spend again and run up those credit cards again, you're just going to find yourself with an extra heavy burden. You really have to be committed to paying off debt to do that.
So credit can actually be a great tool as well.
There are some wonderful strategies out there, like using cash back points, reward points, and miles. These are really great if you pay off your credit card each month and don't carry a balance. Credit cards can also be a lot safer than using debit cards as well.
First of all, you have fraud protection with credit cards in ways that debit cards don't offer, especially when you're shopping online. Credit cards can actually offer extended warranty protection, sometimes, for large purchases or electronics.
And finally, when you're traveling, credit cards are always safer than using debit cards. Again, you have fraud protection. But also, sometimes debit cards aren't even honored when you're traveling.
And sometimes a hold will be put on your account if it is honored.
So now, let's go back and take a look at that true/false quiz you did at the front of the class. And let's see if we can dispel any of the misconceptions out there. So let's run through this list again together.
So I should buy credit monitoring service.
The answer is false.
Forget credit monitoring services. The first time you ever pull your credit, you can pull all three from annualcreditreport.com. And then in subsequent years, you can pull one report every four months. And then you can monitor as much as you like on free resources, like creditkarma.com. And you don't have to pay for anything. It's always free.
I should always shop for the best rate when I'm buying a car or buying a home.
But remember, hard inquiries stay on your credit report for two years. So when you are rate shopping for a mortgage or a car loan, try to do it within a short window of time. Think about trying to do it within a 14-day period. And then it should really only count as one inquiry.
After I pay off my credit card, I should just close the account.
Well, that's false.
It's one of those counter-intuitive thoughts about credit scoring. Paying off a credit card and closing it or lowering your credit limit will actually lower your credit score. Remember, you want to keep your utilization rate or your use of available credit below 30%.
So I should just avoid credit cards altogether.
Never using a credit card is very different from paying it off each month. This will also hurt your credit if you never use a credit card. Again, remember, the number of lines of credit that you have and the amount of available credit that you have are very important in considering your credit score.
I should always just use debit. It's safer all the way around.
Credit cards are typically safer to use than debit cards.
Credit cards offer greater fraud liability protection than debit cards. With a credit card, your liability is usually maxed out at $50 if your card is lost or stolen. If your account is hacked or there's been some sort of data breach, your liability is 0. And this is where credit cards are definitely much safer than debit cards. Depending on when you report a lost or stolen debit card, you could have an unlimited liability for fraudulent charges. The bank could still freeze that amount of money until they have finished investigating their case.
So cash back, reward points, and miles make having a credit card worth it.
Well, this is true and false.
Remember these are great advantages to a credit card. This is usually how we pay for hotels when we travel. But it's only useful if you pay off your credit cards in full each month. Otherwise, you are essentially paying for the perks.
My corporate card has no bearing on my credit.
Well, this is false.
Again, you need to understand your company's protocol and what your liability is because this can affect your credit.
If I have old debt that I forgot to pay, I should just forget about it.
Well this is a trick question.
We actually didn't cover this in class. But I'd like to touch on it now. The answer to this is true and false. There is a statute of limitations, and it varies by state, beyond which a creditor cannot legally come after you for debt anymore. Now many of them can and will try to get you to waive the statute of limitations. But also be aware that if you are going for a large loan like a mortgage, the lender could require you to pay or settle that debt before they will give you the loan.
So in closing, I hope this class was helpful in helping you to understand the importance of maintaining and monitoring your credit. Please check out our loan repayment calculator on the Society of Grownup's website, which can help you strategize ways to pay down your debt. We also have a list of free tools and resources listed on the attachment. Additionally, we have a glossary of common terms which might be helpful. I want to thank you for taking the time to attend the class today.