PRINTCredit counts
Staff
October 9, 2008 | 12:00 a.m. CST
Big Brother exists. Every time you pay your rent, take out a loan or get a credit card, he’s watching, noting every unpaid bill and late check. He knows where you live, how you spend your money and all about your debts. Big Brother takes the form of credit reporting agencies, and you might be surprised how much the agencies know and how much your credit will affect your life.
Betsy Couch and Tressa Kelly share a glance when asked about credit. Both women, now MU law students in their early 30s, have had to pay for the credit mistakes of their college years. “I learned by getting into trouble with it,” Couch says. “I had fun. I didn’t realize I was living beyond my means.” Meals and concert tickets were paid for with credit cards until Couch couldn’t make minimum payments. It took a year of working two jobs for her to pay off about $15,000 in debt on three credit cards that went into collection.
24: percent of college graduates who leave school with more than $5,000 in credit card debt
$16,858: debt carried by the average American (excludes real estate)
93: percent of 18- to 24-year-olds who worry about their finances
$6,982: average U.S. credit card debt
$2,748: average U.S. college student credit card debt
300-850: standard FICO credit score range
15-30 percent: considered high interest rates for credit cards
723: median U.S. FICO credit score
678: average U.S. FICO credit score
740: highest FICO credit score needed to obtain best interest rates
550-620: considered low FICO credit scores
14: number of accounts listed on the average person’s credit report
4: average number of open credit cards held
8-11 percent: considered low interest rates for credit cards
1: average number of past-due accounts a person has
--Rose Raymond
Kelly had a similar experience with a credit card her parents gave her. “They sent me to school with a credit card under the auspices that I would be using it for emergencies, which turned into there was an emergency sale at the Gap; there was an emergency dinner,” Kelly says. When her parents stopped paying the bill and her spending didn’t change, she went from credit riches to rags all over the course of her freshman year.
“It doesn’t seem like money at that point,” Kelly says. “It’s a piece of plastic.”
On the other end of the spectrum is Reid Garcia, a 20-year-old junior at MU. “I’m afraid I’ll get myself into a lot of debt,” he says. “I’ve been debating about getting a credit card for two years.” Garcia uses a debit card but has never opened a credit card. He knows that he needs to build good credit for the future, but concern over the
lure of credit holds him back.
Garcia, a business major, has gone out of his way to learn about credit by taking an MU class. “It wasn’t until I took a class my second semester of college that I really got it,” he says. “It was called Financial
Survival. It was about credit cards, how to consolidate loans, how to survive college.”
A combination of interest in business and parents who taught him about finance has probably put
Garcia ahead of the average 20-something’s credit learning curve.
There is a middle ground between the stress of credit debt and the credit phobia that keeps some people from even carrying credit cards, but it takes a bit of work to get there.
“Credit is not evil,” says Jana Castanon, community outreach director of Consumer Credit Counseling Service. “It’s a necessary thing in today’s society, but it depends on how you use it.”
What is credit, and why do you care?
Credit can mean two things: tangible money or goods you receive now and pay for later, or the track record of
payments that results in good or bad credit.
Common forms of credit are loans and credit card charges that can be paid off incrementally. Paying these bills on time every month builds good credit, which becomes useful when you need a large loan or mortgage. With good credit, a bank will be much more likely to trust you with a large loan at a low interest rate than if you have bad credit or no credit. But credit doesn’t just affect your business with banks and creditors. Landlords and even potential employers might review credit reports to assess your stability and trustworthiness.
“I almost wish we called it debt instead of credit,” says Brenda Procter, associate state extension specialist in MU’s personal financial planning department. “You always have to keep in mind that you are reducing your future buying power because you’re paying interest.” Procter says that credit can be a good thing when a person needs to borrow money to make a large purchase, such as a house or a car, but that it can also drive a person into bankruptcy.
How can you build good credit?
Nearly every bill you pay influences your credit. Paying gas and electric bills late, getting evicted from an apartment or never paying that last phone bill will negatively affect your credit report.
Many businesses will not report a payment that is 30 days late, but most report a late payment at around 60 days, Brenda Procter says. Late payment or lack of payment stays on your report for seven years, and bankruptcies remain for 10 years, according to a consumer protection resource published by the Federal Trade Commission.
To build good credit, Robert Weagley, chair of MU’s personal financial planning department, advises that people begin by charging only what can be paid at the end of the month. “Do the same thing with their utility bills, their phone bills,” he says. “Those are forms of credit because you get the service before you pay.”
Reid Garcia makes the point that people run up credit debt because the expenses don’t seem tangible. “It’s tempting because they’ll never have to see it,” he says. “If it’s just a number on a computer or a number on a sheet, it doesn’t register as well.”
Follow these steps to build good credit from scratch:
1. Avoid thinking of credit as Monopoly money. Make a simple budget, and stick to it. Setting up automatic bill pay is another way to maintain a monthly reality check.
2. Open two or three credit cards, and use them sparingly. Pay off all your charges every billing cycle. “The ideal is to have a couple lines of credit that are used consistently and paid off in full each month,” says Andy Carey, senior vice president for consumer banking with Regions Bank in central Missouri. “Show that you can manage a few different sources, and show that you can pay every single month.”
3. If a utility bill for your home or a cell phone bill is in your name, pay the bill in full and on time each month. Although these accounts don’t help you build good credit, Carey says paying late or not at all will negatively impact your credit score.
How to maintain that good credit:
1. Don’t charge the maximum amount (called “maxing out”) on a credit card. This sends a sign to anyone who views a credit report that you have financial problems and might not be able to pay debts.
2. Don’t cancel all your credit cards at one time, even if all bills are paid. Jana Castanon says that if you must cancel most of your cards to stop out-of-control spending, do so. But this will indicate to creditors that you can’t handle credit, and it lowers your credit score by decreasing your total amount of available credit.
3. Use no more than 40 percent of your credit line, Castanon says. Your credit score will be higher if you have an outstanding charge of $500 and $3,000 available credit than if you have a $500 outstanding charge and $750 available credit. You want to demonstrate that you can control spending and don’t take your credit anywhere near the limit.
4. Avoid applying for many credit cards in a short period of time. This results in companies checking your credit report. If a potential lender sees that your credit report has been viewed often by credit card companies in a short period of time, it makes you look desperate for credit and financially unstable. Landlords or potential employers checking your credit report won’t have the same damaging effects because lenders understand that these inquiries are different.
If you have bad credit or no credit and have trouble getting a credit card, you can apply for a secured credit card, which requires a cash deposit in an account that will be used to cover your charges if you don’t make payments. When looking for a secured credit card, shop around for one with low annual fees. Reputable secured cards generally have an annual fee of $30 to $60.
What to look for before you apply?
Young people are blood in the water to credit card companies because many people applying for their first cards have no idea what to look for.
Brenda Procter, who has counseled students who have filed for bankruptcy because of credit card debt, recommends reading the fine print and researching online before getting a credit card.
One of the most important things to understand in the credit world is APRs, or annual percentage rates. According to the Federal Reserve’s publication “Choosing a Credit Card,” APR is the yearly interest rate you will pay if you carry over a balance, take out a cash advance or transfer a balance from one credit card to another. Some credit cards have fixed rate APRs, in which the company must inform customers of any rate change. Other credit cards have variable APRs, which are linked to other interest rates, such as the prime rate or the Treasury Bill rate.
Currently, a person with excellent credit could get an 8 percent APR from a credit card company while someone with good established credit can find APRs in the 10 to 14 percent range. Jana Castanon says that many people applying for credit for the first time will be offered an APR in the 19 percent range, but if someone with good credit will co-apply with you for your first credit card, you can get a lower rate. Castanon warns against applying for credit cards with APRs of more than 20 percent. Unless you have established poor credit, you can get a better APR.
“Most people are not taught at the high school level or at the college level what the terms of a credit card mean,” Procter says. “A lot of times the credit cards that are issued to students are not the best deal.” These are cards with high APRs, which can end up costing you a lot of money.
Because of students’ limited understanding of credit, allowing credit card companies onto campuses is “kind of inviting the wolf to the door,” Procter says.
APRs are important if you carry a balance on your card. For example, if you pay down a balance of $2,000 at 18 percent over 12 months, you’ll have paid $200.32 in interest over the course of the year. If your APR is an astronomical 30 percent and you pay that same $2,000 debt over a year, you’ll have paid $339.69 in interest.
Another common credit lure is the store discount card. It would be easy to open several cards a month to get a one-time discount at stores you frequent, but of course, there’s usually a catch. “Don’t open a credit card to save 10 percent,” Castanon says. “Most of those department store credit cards have a very high interest rate.”
For example, after you establish good credit, First National Bank of Omaha’s Visa Signature Card offers you a 9.99 percent APR, and Mastercard’s Citi Diamond Preferred Rewards Card offers a 10.49 percent APR, but the APR on an Old Navy credit card is 21 percent, and the APR on a Macy’s credit card is 22.99 percent.
So remember, just because a credit card company gives you a free hoagie, a water bottle or 10 percent off
some jeans, doesn’t mean it wants the best for your credit.
Take these steps to avoid ending up with a credit card that will cost you big time.
1. Look at the card’s interest rate, or APR. This controls what you owe the company for a balance you carry from month to month.
2. Avoid cards that allow the issuing company to raise the APR in retaliation for late payments and cards that allow for universal default, which means that late payment to one creditor allows another to raise your APR.
3. Do not get a card that charges you an annual fee. Even people who don’t have good credit can find a card without an annual fee.
How’s credit going to help or hurt you?
A positive attitude is usually a good thing, but when it comes to building your credit, realism will get you further.
Credit mistakes made in a person’s early 20s will harm that person’s ability to get loans at good rates for seven years. If the person marries, the spouse is sucked into the bad-credit vortex. If a couple applies for a mortgage and one has bad credit, that will affect the amount and interest rate of the mortgage, Robert Weagley says.
Andy Carey of Regions Bank says many banks use a risk-based pricing model that uses your history to determine your reliability. The better your credit history, the lower the bank’s risk, the lower the interest rate. When buying a car or a house, the difference between good and bad credit can translate into thousands of dollars in interest.
An outstanding credit score, 760 to 850, will get someone who seeks a 30-year $100,000 mortgage a 5.784 percent APR, according to rates at myfico.com. A low score, 500 to 579, results in a 10.31 percent APR. The people with good credit pay $586 a month, and the people with poor credit pay $901. With the extra $3,780 a year, Good Credit and a friend can vacation in the Bahamas, but hold onto your hats when you see how much they save over the life of the mortgage: $113,400. With that, you could buy a brand new Porsche or send a kid to college.
With these numbers, it’s easy to see that planning ahead is crucial. “Be disciplined in what you buy,” Carey says. “It’s not about this weekend; it’s about the next 10, 20 years and where you want to end up.”
When it comes time to buy a car, good credit will also save you money. On a 36-month $15,000 loan, credit all-stars with scores of 720 to 850 pay $458 a month at 6.25 percent interest. The underachievers with scores of 500 to 589 pay $524 a month at 15.67 percent interest. In the end, the all-stars save $2,376, according to rates available at myfico.com.
Bad credit can also hurt beyond the financial burden of paying big interest on loans; as Betsy Couch found out, it can damage your ability to live a normal life.
With her credit card bills in collection and her credit destroyed, Couch found herself unable to do things many people take for granted. “At the time, I couldn’t get my own apartment without having my parents sign for it,” she says. “I couldn’t even buy an airline ticket without giving someone else cash to pay for it.”
Couch got herself out of debt through hard work and learning to follow a budget, but she paid for her mistakes with more than hard work and stress. Interest on her debt added up.
“By the time all was said and done, I paid several thousand dollars (in interest),” she says. “Once you miss payments, there are fees, and it just snowballs like you can’t believe.”
Is there a way out?
If you find yourself in credit card debt and making the monthly payments seems impossible, a consumer debt counselor might help. But as with all things credit, watch out. Dishonesty and fine print abound.
“It really can be a very sleazy world, and you have to be careful to do business with reputable businesses,” Brenda Procter says.
First, beware of service fees. Some disreputable companies charge several thousand dollars in service fees when that money should be going toward your debts.
The National Foundation for Credit Counseling can point people to credit counselors who create a debt repayment plan for a small fee. “That’s the best way to pick a credit counselor,” Procter says, “not off the Internet through a Google search.” Reputable agencies are for the most part paid for by creditors who want to make sure you pay them instead of declaring bankruptcy.
Castanon’s agency, Consumer Credit Counseling Service, is part of the NFCC and charges a $25 setup fee and a $25 monthly fee for advising or running a debt-management program, which is arranged by credit-counseling agencies. It allows people in debt to pay a monthly sum to the counseling service, which distributes it to the companies. A reduction in interest rates is often part of a debt management program.
So have hope, and have a plan. Micah Vitale, a Columbia resident self-employed in construction, only uses pre-paid credit cards after he got into debt in his 20s. “I had this outrageous bill; it was probably close to $9,000,” he says. “I immediately cut up the card. To keep from having to pay all the extra fees, I made a deal with my brother, and he went and paid it with his card. I worked my butt off for four months and repaid him.”
Vitale learned from his credit woes. “Before, I didn’t understand this whole thing about what a plastic money card was,” he jokes. “And now I know, crystal clear.”
Good credit can be established and maintained. Bad credit can be improved and even turned around as Tressa Kelly’s has. As a freshman in college, she found herself in debt and was embarrassed about it. “I knew that I couldn’t call my parents to tell them about the situation,” she says. “I eventually got a job that I worked 40 hours a week during my first year of undergrad, which I would not recommend. And I finally got out from under it.”
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