b&b 218: Back to Basics: Understanding Your Credit Score

Music Featured In This Episode:

Credit Scores by J.A

Bad Credit by Siras WorthDMention and DJ FenixFly

Episode Highlights:

Pam: On our back to basics episode today we are going to be talking about understanding your credit score.

Dyalekt: Well, the thing about credit score is like, credit is such a pervasive thing that I’ve seen people who well joke about because I haven’t been on but, like I see people joking about how like their tinder profile they’re looking for people’s credit score rather than their height and dating interests and stuff like that. It’s such an important thing and it matters in all these areas of life that we’re gonna get into but none of us really knows what it is and it’s not your fault if you don’t really know exactly what it is or how to do it. I’m going to be honest with you we don’t either because we haven’t been given all the information we do the best we can.

Pam: It is definitely a black box. They tell you sort of what goes into your credit score, so we’re gonna be able to go through that with you but everyone’s formula is different and they change all the time.

Dyalekt: The thing about credit scores is you know, don’t feel terrible if it’s confusing. It is intentionally done so and there are folks who are busting their behinds right now trying to change things, trying to make it more equitable, trying to make it actually just make more sense but we have the system we have right now and we’re gonna walk you through it and we’re gonna do the best we can.

Pam: Yes, but before that, we do have a little New Year’s investment appetizer for you guys. So the investment appetizer today since we are talking about credit and debt. I figured we should talk about bonds. What is the bond? And the reason why I want to talk about bonds is because a bond is something you can buy where you lend someone money and they have to pay you back. So someone is indebted to you.

Pam: So with a bond there are lots of places and entities that issue bonds so you can get a bond from a corporation. You can get a bond from a municipality or basically local government,  you can get a federal bond and there’s lots of different types within that. Basically a bond is an IOU. They’re trying to raise money and one of the ways that they can raise money is they can borrow money from investors. So they issue bonds and they say okay if you give me $1,000, if you give Amazon a thousand dollars then they agree to give you that $1,000 back in five years but every single year that they’re holding on to it, they’re gonna give you an interest rate.

Pam: And so that’s the basic way that a bond works. Now the thing is, of course, there is what’s called a secondary bond market where bonds get traded at the same time between actual investors themselves. So the company itself like Amazon is issuing the bond and they’re saying whatever happens we’re paying you the interest rate and we’re giving you your money back in five years. So if you keep that bond that you paid $1,000 for, in five years you’ll get $1,000 plus a little bit of interest also. The thing is though you have $1,000 let’s say Amazon is paying you 5% interest right and you’re like, okay that’s so great. Thousand dollars. I’ll get it back in five years but suddenly something happens and you’re like crap two years later you need that bond money back and Amazon’s like I’m sorry you said we could have it for five years, so we’re not giving it back to you. This is where you go to the secondary bond market and you say okay, let me try and sell this bond to somebody else right and that’s fine, right? Hopefully, you can get your thousand dollars, but the risky part about bonds and I know bonds are not considered risky because if you keep that money in there you get paid that interest rate and then you get the money back at the end. But if for some reason you need to get that money back and trade in the bond. Let’s say you are getting a five percent interest rate for that bond, Amazon all of a sudden two – three years later they issue a bond that has an interest rate for six percent and so if you’re trying to sell your Amazon bond that’s paying five percent on the secondary bond market why would someone pay you a thousand dollars to get five percent when they can just pay Amazon a thousand dollars to get six percent?

Pam: So the risk with bonds is that the interest rates change all the time with every new bond that’s issued. So your thousand dollar bond that you bought that’s only paid five percent interest is inherently going to be worth less than another bond that also someone paid a thousand dollars for it but it’s paying six percent interest. The thing about bonds is because they’re considered not very high risk if you want to lower the risk in your portfolio, yes have some stocks in there, but it’s also a good idea to have some bonds in there to lower the risk because bonds are considered more stable as well. What I mean by that just to give you an extreme example 2008/2009 the market crashed. Stock market went down 40% and the bond market only went down 10%. So the amount of risk that you’re dealing with when it comes with buying bonds is significantly less, especially when the market is going down.

Dyalekt: A lot of this information and a lot of these rules are contradictory a lot of them don’t make practical sense a lot of them are antithetical to practical sense. But they are what they are and we figure out how to juggle this as best we can so we can get our scores to do what they do.

Pam: The most frustrating thing is your credit score has become a thing that a lot of places, a lot of companies, and a lot of people use determine whether or not they want to do business with you and that’s ultimately what it is. There are three credit bureaus. Equifax, you know the guys who lost all of our data, Experian and Transunion are the three credit bureaus who issue credit scores essentially or who help calculate credit scores. Then you’ll also hear about FICO, they use Experian, Equifax, and TransUnion’s data to actually calculate a FICO score. So there’s three credit bureaus and they all calculate their own credit score and then FICO is this other entity that uses these three credit bureaus data to calculate a whole other credit score. A lot of the major lenders like mortgage companies banks financial institutions in general use FICO for whatever reason as the gold standard for what your real credit score is quote unquote, it’s really difficult, your credit score is a moving target in general because all of these companies use a different calculation to actually determine what you’re score is.

Pam: The thing about credit scores is, especially I’d say in the last 10 years, the awareness around credit scores and the significance of credit scores I feel like has increased ever since I started working in the industry.

Pam: We are talking about understanding your credit score today and the importance of it. We were just talking before the break about why it’s important to maintain and how it has become kind of this cultural thing of what your credit score? What’s your credit score? The thing about it is that it’s still remains a mystery I don’t know if that adds to the kind of conversation around it but it remains a mystery how it’s exactly calculated because you can have the exact same credit report across all credit bureaus and every credit score is gonna be different. It could be different by up to like 50 80 sometimes a hundred points. I’ve seen even what it looks exactly the same and so I want to talk about the credit score rules and then I also want to talk about the importance of looking at your credit report from each credit bureau separately because often what can happen is the disparity between credit scores may mean that there are some things being reported to one credit bureau that’s not being reported to other credit bureaus.

Pam: So the credit report you can get it for free at annualcreditreport.com. That website is funded by the three credit bureaus and you are allowed to pull your credit report for free once a year at annualcreditreport.com and you can pull your credit report from Equifax, Experian, and TransUnion. There are three private companies that determine your credit score based on who reports to them. So lenders, any creditors anything like that and I’m saying credit card companies, student loan companies, mortgage companies, anyone who sends something to collections like a medical bill utility bill, you know, a late rent payment something like that all of that stuff shows up on your credit reports. The thing is that some may not show up on all of them. So, you’ll find a lot of mistakes on the credit reports and you will also find a lot of situations where they don’t match up. Sometimes you’ll see a credit card on two of the three credit reports or you’ll see a medical bill only show up on one of the credit reports and all of this stuff affects your credit score in different.

Pam: And so a credit report is the actual thing that FICO and all of the other places use to calculate your score. And just to start off with the scores go between 350 and 850.

Dyalekt: So there’s a thing in advertising where they say to create uneven numbers, and I don’t mean not even but like ones that don’t operate on this channels. That’s why you’re if you’re buying something that’s $10, it will be like $9.97 because that’s psychologically does something to your brain where it confuses you a bit which is more likely to make you a make you purchase something.

Pam: So basically if you have a score below 600, it’s considered needs improvement which basically just means it’s not good. If your score is below 600 it will be very hard for you to find credit products like credit cards or personals loans, things like that that don’t have a high interest rate or possibly be very hard for you to get approved at all. If your score is between 600 to 650 when it’s like more in the mid 650s, then you have a better chance of being able to qualify for credit cards for lower interest loan things like that. But really 700 is kind of the magic number in terms of being able to have the best interest rates, being able to qualify for the credit cards with all the rewards, being able to qualify for low interest personal loans, low interest auto loans, things like that.

Pam: They’ve done studies where they found that your score doesn’t really need to be much higher than 760 to be able to qualify for the best of everything including the best mortgage rates and things like that. So, you know, trying to get a score of 800 plus is just like a trying to get extra credit but really 760 and you’re good.

Dyalekt: Credit scores are about access and rates. If you get yourself to above that 650-700ish area that is when you start to have access to stuff. When you have sub 500 then you just can’t get things.

Pam: Let’s go into what makes up your credit score, brace yourself. None of this makes any sense. We teach this to 16 17 year olds and you just see their faces like fall and they’re like that can’t really be how it works.

Pam: I will say that we have gone to conferences and talk to people in policy who are actively working to change how this is calculated because as you will hear a lot of the things that go into making up your credit score also penalize people of color and poor people and people in marginalized communities on purpose. That is also by design. The whole thing about needing to have credit to get credit already keeps a lot of people out of this game.

Pam: The very first thing the most important thing is 35% of your credit score is made up of your payment history. What that means is any late payment negatively affects your credit score for seven years. Anything that’s 30 days late or more will be a negative mark on your credit score and it will not stop affecting your credit score for seven years.

Pam: When we say late we mean 30 days or more. And the reason why is because a lot of creditors its not worth it to them to report to the credit unless it’s that late. Most creditors, the 30 day mark as soon as it’s late, they send a report to the credit bureaus that you didn’t make that payment.

Pam: A pro tip we have for you in terms of this payment history is we recommend, if you can, to set a minimum payment to auto pay. As long as you make the minimum payment on a credit card that counts as not being late.

Pam: 30% of your score is calculated based on how much you owe versus how much you’re able to borrow. This is called a credit utilization ratio. What it means is, let’s say you have a thousand dollar limit and the rule is that they don’t want you to spend more than thirty percent of that limit. If your limit is a thousand dollars you don’t want your balance to be more than three hundred dollars. Once it crosses that thirty percent mark then your credit score will go down.

Dyalekt: Having a credit score is like dating a narcissist.

Pam: It’s also the quickest way to lower your credit and the quickest with to increase your credit. because the credit bureaus report credit card balances every 30 days. I often recommend if you want to use your credit card and you want to get it close to that limit but you have the ability to pay it off regularly then don’t wait till the end of the month to pay it off. You can pay off your credit card as many times during the month as you want. I will sometimes pay off my credit card balance every week. Some clients have decided they’re gonna pay off their credit card balance every time they get a paycheck just so they can use up the credit card balance, they can get the points or whatever they’re trying to do, but they also know that the high balances won’t get reported to the credit bureaus.

Pam: So another tip that I have that I’ve seen clients find success with. Is you can call your credit card company to increase the limits on your cards periodically. So I had clients who have done this every six months where they called their credit card company and they asked increase the limit. There are some situations where you already pre-approved for a limit increase and you just take it and there are some situations where they have to check your credit score to see if you qualify for a higher limit and your credit score goes down and we’re gonna talk about why that happens in a second.

Pam: Let’s say that thousand dollar credit card gets bumped up to a $2,000 limit if you still spend three hundred to six hundred dollars now all of a sudden you can spend a little bit more money on the credit card and not have an affect your credit score negatively. Also the more credit you have the more you have as an ability to borrow or the more limit that you have on your credit cards essentially, the higher credit score is.

Pam: Then the next thing it affects your score is 10% of your credit score is based on opening new credit. So opening or trying to open new lines of credit negatively affects your score. That’s the other thing too, every time you apply for credit whether or not you actually get approved your credit score goes down.

Dyalekt: If you are not already able to participate in terms of having the resources, the time, and all that stuff, they don’t want you to ever participate.

Pam: The credit scoring system for some reason has become a marker financial health when ultimately, it’s just about whether or not you’re able to get in the credit game. It doesn’t make any sense that your credit score isn’t tied to the fact that you pay a rent on time every single month, the fact that you pay your cell phone bill on time, and you pay your utilities on time every single month. It’s solely tied to you and your ability to have been able to get into the credit game that’s it, that’s all it is.

Dyalekt: When you think about fundamentally what makes somebody a trustworthy spender, studies have shown that people pay their rent, people pay their important bill and credit often tends to be extra stuff that wasn’t part of your day to day and now you’re gonna try to buy that but hey, if things don’t work out I’ll stop spending money on that thing and then just let it slide and then that will say that you are untrustworthy.

Pam: When it comes to the important stuff, you’re paying your rent, most people are paying their necessary bills and prioritize that over discretionary stuff like credit card payments, but this credit score system that’s become a marker of financial health doesn’t really tell the whole story because it doesn’t take any of that into account, It’s just about credit it’s just about being in the credit game. Because 10% of your score is made up of opening new lines of credit then we recommend that you don’t apply for one line of credit more often than every 12 months. It usually takes 12 to 24 months for this to roll off. This is called a hard inquiry.

Pam: There’s a difference between a hard inquiry and a soft inquiry and a heart inquiry this affects your credit score and the only time something affects your credit score it is when you are trying to borrow money from someone. So, you know, you checking your credit score every single day is not going to affect your credit all that’s considered a soft inquiry. But you trying to borrow money from a bank or from a credit card company affect your credit score negatively.

Pam: The next thing the effect your credit score, 15% of your score is made up of your credit history, which means both how long you’ve had your oldest credit card and the average length of your credit lines. One thing one of the first pieces of advice I got when it came to credit is to never close your oldest credit card because that determines the length of your credit history.

Pam: It’s not considered that you have a long credit history until you’ve had a credit card or some line of credit open for at least seven years before that it’s not considered you to have a long enough credit history for the creditors to determine that your score should be as high as whatever it is. Don’t ever close your oldest card even if you have an annual fee which I do on my oldest card, but I’ve never gonna close it because it affects your credit score, you will see your credit score go down anytime a card gets closed.

Pam: The other thing is the average length of all of your credit cards. So what that means is you have a credit card that is 10 years old and you have another credit card that is five years old so the average length of your credit history is seven and a half years. Which means that all of a sudden the average length of your credit history also goes down every time you open a new card.

Pam: There’s 10% more if you all were keeping track. There’s 10% left. It’s this little one that like you won’t really think about but 10% of your score is made up of the different types of credit that you have. They call it credit mix in use. So basically what I’m saying is if you have three credit cards then you’re not using enough different types of credit to get this 10%. Your credit score will not be as high as someone who has a credit card in auto loan a student loan and a mortgage. Even though you have the same line amount of lines of credit, it will not be the same as someone who has different mixes of credit. So, they not only want you in the game. They really want you in all parts of the game basically.

Pam: I want to mention too because the reality is yes, your credit score is important. It’s important for you to understand it. It is very confusing it’s a very convoluted. There are a lot of rules that don’t make sense. There’s a lot of misinformation out there too. Like when we do these workshops people ask all kinds of questions. The thing is that you don’t need to look at your credit score every day. I don’t recommend it. You don’t even need to look at your credit score every month or on a super regular basis. You really need to start paying attention to your credit when you want to use it for something, right? Let me take a year, let me take 18 months to really pay attention to my credit. Otherwise the simplest things to think about are don’t open too many cards, pay your balance is on time, and keep your balance as low.

Dyalekt: One thing that we haven’t talked about is that getting from 350 to 700 is easier than getting from 700 to 750.

Pam: One thing that I wanted to bring up before we talk about who checks your credit is the difference between revolving debt and installment loans. This is really important too because this is where that 30% credit utilization ratio comes in. That really only affects revolving debt. Revolving debt are balances that can go up and down every single month where you paid off and you put a back on so credit cards, home equity lines of credit, lines of credit in general. Those are the things that are considered revolving debt and those are the only types of debt subject to the credit utilization ratio.

Pam: The other type of debt that people borrow is called an installment loan and that’s basically I borrow this big chunk of money for instance to buy a car, right? I borrowed $20,000 to buy a car and every single month. I’m making an installment payment essentially to eventually pay down the balance over a certain period of time and that’s where the balance continuously goes down and you’re not like re-adding to the balance on a regular basis, so it’s not revolving, it’s called an installment loan. Those types of loans don’t affect your credit as much as revolving debt because revolving debt is the only debt that is subject to that 30% credit utilization ratio.

Pam: Car insurance companies are allowed to check your credit score to determine what car insurance rates they’re gonna charge you. If your credit score is lower, they’re allowed to charge you more money for your car insurance. Again, penalizes poor people, marginalized people, people of color.

Dyalekt: There’s so many like little coded dog whistles totally in there to make sure that not just people who are currently poor but people who come from poor backgrounds of all of the different marginalized ones, you can see little pieces of all of them in there.

Pam: Your employer, you may know this, is allowed to check your credit score to determine whether or not you’re responsible as an employee again, which makes no sense.

Dyalekt: I would say this one at least sort of sounds like it would make sense in some industry.

Pam: Except if you did not get in the credit game early. I have friends and clients who are 35 years old and never had a credit card. Why should that affect their ability to be employed if they are good at saving, if they pay their rent on time, if they pay the utility bills on time?

Dyalekt: I wasn’t saying it was a good thing I’m saying it’s sort of sounds like it makes sense, especially from the employers perspective that you know, if I got two resumes and they’re sitting there in front of me and I’m like, I don’t know which one. Well this one here has credit scores higher, so that means that they’re gonna be more responsible so maybe I should think about them. The thing that it is awful about it is the whole idea of people having a right to work. One thing that has become a fundamental right of this capitalist world is the right to work. We have such an inherent need for that so to deny that is awful.

Pam: Another thing that I actually didn’t mention when it came to credit scores is one thing that can affect your credit score history positively or negatively is whether or not someone puts you as an authorized user on their credit card. I have had clients whose parents have put them on their credit cards since they were 16 years old and I’ve had clients who are 26 years old who have a 30 year credit history because their parents have had credit cards for that long and all of that gets transferred to them. You know, we talk about generational wealth and generational poverty on that show and it shows up in your credit scores as much as it shows up in your balance sheets.

Dyalekt: While you have some folks who will put you on their credit as an authorized user and then you’ll be turning 18 with a great credit score, there’s some of us who have adults messing around with our credit. You see this a lot in the foster care system or any situation where there’s like guardians and stuff. I mean, I’ve had it happen to me. I turned 18 and didn’t realize that I had bad credit from adults playing around with my score because people use your social security number and then don’t pay stuff off or make some sort of late payments or any one of those things that we just told you about, it’s gonna affect you.

Pam: Exactly so the fact that your employer, your health insurance, your car insurance, your landlord, we all know this, your potential landlord can check your credit score to determine whether or not you can pay your rent even though again your positive rent payments do not show up on your credit score. Only if you’ve made negative rent payments, then they show up on your credit score.

Pam:  And then a couple other places, cell phone companies check your credit score to determine whether or not they’re going to allow you to put your phone on a payment plan for instance or determine whether or not you’re able to sign up for a contract. Utility companies also check your credit score and they also will send your late payments to collections and it’ll show up on your credit score. It’s all a mess you guys. But it’s not hopeless.

Dyalekt: Yeah, I started out with the bad credit score. It was in I think the low 500 and I was like aghast. I was already at the type of cat world like ah, this is not gonna be a thing. I’m not gonna be the credit. I’m just gonna buy a million dollar house, yada, yada. It didn’t even take that long for me to get myself into that access place. I went and got a secured card which is something we haven’t talked about now. A secured card is something you can get if you have bad or no credit where you basically act as your own lender. I used it responsibly and I paid it off and did all the stuff and then they offered me after they saw that I was doing well with it, they offered me a regular credit card and I got that and I was able to get the ball rolling and I had got my score from the 500s to somewhere in the mid-600s in less than a year. After a few years I was able to build it up and get that mid-750s range. It’s possible, it just takes a lot of effort being placed on it.

Pam: Yes, you just have to focus and pay attention and learn a couple of the rules and let time pass. The negative stuff rolls off the positive stuff rolls in and then in a couple years you’ll find yourself able to buy a car, get an auto loan, get a mortgage by a house all of that kind of stuff because again it comes down to access. When we are in this system we want to be able to have access to these things so that we can continue to build wealth. So that we can start building wealth, wherever place you are with your family.

Pam: Really what we’ve been seeing and what we’ve been understanding is that taking care of your personal finances is not just an act of self-care it’s an act of social justice for you to be able to participate in the system, to excel in the system and not be denied access within it means that you are able to do what you want to do within it and you’re able to help others and lift others up.

Dyalekt: I feel like every activist group that I’ve been around has had some version of it where it’s basically make sure you have all of your T’s crossed and I’s dotted so that they can’t get you. So that you can still be in the game. For a lot of us marginalized folks just being alive, yo they don’t want us to be alive. Being alive is a revolutionary act and everything you can do to take care of yourself and build that up is going to be a revolutionary act so you don’t have to feel like I’m out there taking on the man and doing all this stuff. Just taking care of yourself putting on that oxygen mask first making sure that you can breathe.