Money Monday #5

how was your weekend?

mine was wonderful!  it was just so happy and fun.

and i didn't have to stress about finals/homework once!  man... it was great.

today, lincoln and i are both starting new jobs, and we have a lot going on this week.
i'm quite shocked looking at the calendar, realizing we are only 4 short weeks away from the big day.

i honestly can't believe it.
but i'll talk more about that stuff tomorrow.

today's money monday post is based on questions i've gathered from quite a few of you about credit.
my friend lindsay asked these questions:
"First of all, is it true that you need to have a credit card and start building credit before you can start making major payments like buying a car or a house? Because I'm not all that keen on the idea of credit cards and prefer to use my checking account. What are the benefits of using and immediately paying off a credit card as opposed to just using a debit/checks? In what kind of purchases is it a good idea to use a credit card?"

credit is one of my favorite things to teach about.  you can use it for your advantage or ruin it very easily.

so to answer lindsay's first question...
you don't necessarily need a credit card FIRST to build credit, but it's a fairly easy way to do it AND you don't have to pay interest on your purchases as long as you pay it off every month.

let's begin by talking about your credit history.
your credit history is basically a record of what kind of borrower you are.
your credit score is calculated from the following 5 areas:
-35% is based on payment history... so like, late payments, on time payments, etc.  it also includes any bankruptcies, judgments, charge offs, collections, or liens.
-30% is based on the ratio of outstanding revolving debt to available revolving debt.  an example of this would be if i had a $1,000 limit on my credit card and i was maxed out on it every month (my balance was close to $1,000) this would negatively effect my FICO score.  experts recommend keeping the balance below 30% of your available limit. 
-15% is based on the age of open accounts.  it's best to keep credit cards open that you've had for longest, even if you don't use them.  just make sure you aren't getting charged inactivity fees, or something like that. 
-10% is based on new credit.  for example, if you have gone out in the last six months and applied for credit like 5 or 6 times, you are usually seen as a riskier borrower... taking on a lot of debt in a short amount of time.
-10% is based on types of credit.  for example, if all you have on your credit report is credit card accounts, it doesn't necessarily reflect the type of borrower you are, because you only have one type of credit.

okay... now that you understand how your credit score is calculated, let's talk about credit cards.
credit cards can either work for you or majorly work against you.  credit cards are considered revolving credit, meaning that you have an open limit (like $1,000), which you can spend and then pay off pretty much however you please, as long as you make the minimum payment every month.  in another post i will show you the cost of credit and how long it will take you to pay off a credit card if you only make the minimum payment every month.  the interest is calculated on a monthly basis on the balance left unpaid from the previous months purchases.

this is how you can make credit cards work for you:  first, you show repayment history (remember the big chunk of your score 35%?) by charging and paying it off every month.  this can help you become an established borrower.  you can also get rebates or rewards from the purchases you make (depends on the features of the card).  AND if you pay it off every month, you aren't paying any interest on your purchases.  they are also fairly easy to get approved for.  for someone who doesn't have any credit, they usually give a small limit ($500) to begin building credit.  in my experience, creditors like seeing some kind of repayment history before approving you for, let's say, a home loan.  i'm not really sure if you could get a home loan without a credit score populating because you have no payment history.  they would have no idea what kind of borrower you are and have no indication that you will repay a pretty LARGE loan.

this is how you can make credit cards work against you:  they usually have MUCH higher interest rates than other loans.  so if you charge something on it that you won't be able to pay off for a while, it could cost you a lot more in interest.  they also can be perceived as free money.  NOT TRUE.  you have to pay it back.  it's easy to fall into the trap of putting every day purchases on there and they build fast.  before you know it... you're maxed out.  the minimum payment is also calculated by the balance, so it can change every month when your balance changes.  let's say you have a $10,000 balance and your rate is calculated by multiplying that by 2.5%?  your monthly MINIMUM payment would be $250!  that's a nice car payment. 

so back to lindsay's comment.  yes, credit cards can sometimes be scary.  just make sure you know what you are signing up for!  luckily, recent laws have made this easier and protect consumers from unfair practices.  yes, credit cards can sometimes get out of hand, but they are also really easy to use RIGHT!  debit cards are not tied to your credit history even though they look just like a credit card.  i can't tell you what purchases are good or not good to put on a credit card, but sometimes i'll recommend just charging your gas purchases for your car and paying it off every month.  if you restrict it to just gas, it's not as easy to overspend and get out of hand. 

in the end... i always say it's better to try and pay cash if you can.  there are only 3 things that i think are worth going into debt for... home, school, and maybe a car.  but that's just my personal opinion.  don't take that as counseling.

actually, don't take anything i say as counseling.  i'm just trying to empower you with knowledge and resources to hopefully help a little bit in the somewhat confusing world of finances.  hopefully it's helping.

if you have any more questions about credit cards, let me know!
thanks, lindsay.

see you guys tomorrow.


Alycia (Crowley Party) said...

My dad always told me those three things as well! Education, House, and maybe a car. :)
Great Info!

Teri Wadman said...

You don't know me but I found your blog and I really liked your advice on credit cards. I might be stopping in every now and again for Money Mondays.