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Over the Limit: Charging Forward Toward Better Credit

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I got my first credit card in college.  The promoters were even kind enough to throw in a smedium t-shirt.  Parents weren’t too keen on the idea but I figured I wouldn’t have to bug them every time Mother Bear’s dropped off another pizza.  The princely $1000 credit line helped me disregard whatever the mafioso interest rate was.  But in the ensuing months, I received a crash course in compounding interest.  This was a financial treadmill I was in no shape for.
 
I quickly learned the adverse effects of debt – especially high interest, revolving credit card debt.  The additional pounds and vigorish were truly a double whammy.  But I’ve also discovered that not all debt is evil – provided is it utilized judiciously & with proper terms.  Ask any successful business person about the importance of credit lines.  It is their financial life blood.  But even for the non-tycoons out there, having a cursory understanding can be helpful to building a robust balance sheet.  Fortunately, I have an in-house credit savant: my wife, Michelle[i].  She has broadened my understanding of credit scores do’s & don’ts.  She can purr FICO[ii] like none other.  Let’s charge forward.
 
What are the range of scores?
 
850 excellent – 350 poor.  Unfortunately, I endured a troubling period of gravitating to sub-500 girls.  Here’s a demographic breakdown of scores.  Free Credit Report
 

 
How are credit scores calculated?
 
The FICO credit score is based on 5 factors:
 
  • 35% Payment History – your on-time and late payments record.
  • 30% Available Credit – the credit limit minus amount you owe.
  • 15% Length of History – the time elapse since each account was opened.
  • 10% Type of Credit – Mortgages, installment, revolving loans etc.
  • 10% Number of Inquiries – How many inquiries when you apply for credit (less is better).
 
How can a score be improved relatively quickly?
 
Pay down all revolving debts to 30% or less of the maximum credit limit.  Also check your credit report for errors.  How to dispute credit report errors.
 
What are common misconceptions?
 
Many assume if you make all your agreed upon payments you’ll have a high score.  In reality, the score is based not only on repayment but length of repayment history.  A mix of revolving (credit card) and installment (auto/mortgage) is preferable to just one type.
 
What are common mistakes young people make trying to improve their credit score?
 
Oddly enough, closing existing accounts has an adverse effect on the credit score.  Conversely, I believe old, dormant accounts – especially credit cards - should be closed for security purposes.
 
What is the best way to establish credit?
 
Open a few, secured credit card accounts.  Charge a small amount monthly (less than 30% of awarded credit) and pay off in full each month.  For the college kids, consider opening an account that caters to students.[iii]
 
The benefits of having healthy credit are numerous – especially for fledgling millennials. You’ll enjoy lower insurance rates, easier rental approval & loan negotiating leverage. Besides lower interest rates & higher credit limits; mom and dad might not have to co-sign for the maiden home purchase.   Consider this example using a $150,000, 30-year loan:
 
Excellent Erin has an 800 FICO credit score and will pay a $744 monthly payment & $117,700 total interest over 30 years. Meanwhile, Poor Patrick’s 625 credit score will cost him $891/month and $170,600 total interest. A difference of almost $53k![iv]
 
That can buy a lot of furniture. Or fund retirement savings. Or drinking craft instead of draft beer.  Having an appealing credit profile also gets you on the radar for more lucrative credit card offers.   And, given the 2018 Tax Reform, a high mortgage interest deduction may not be as worthwhile.   Initiating & improving your credit can be easily done with a few simple steps. Start small and avoid the ill-fitting giveaways.  
 
Fiscal Fitness is a publication of Houlihan Asset Management, LLC for the benefit of its clients and friends.     Houlihan Asset Management.  Wealth Counseling/Asset Management. Copyright 2018
 
 
[i]  Hallmark Mortgage Senior Mortgage Consultant – (260) 469-0926
[ii] Fair Isaac & Company – 1956 Data analytic company which originated the FICO score - a measure of consumer credit risk.
Dennis Houlihan