As the registration numbers crept higher and higher for last week’s Money Talks webinar on credit, we knew we were hitting on a topic that needed exploration. And for good reason – credit is both complicated and important, with real-world effects on your day-to-day finances and future options in housing, employment, access to capital, and more.
Luckily, we know that the better you understand something, the less scary and overwhelming it becomes. With knowledge comes power! Below we have gathered some of the questions we are asked most often about credit (and a few specific ones from the webinar) in the hopes that our answers will help demystify this subject and set you on your way to building and maintaining good credit – and reaping all the benefits that come with it.
General Questions about Credit
Why does having good credit matter?
In short, good credit increases your options and makes many things in life more affordable. Credit makes it possible to purchase things you need. Many items, from cars to houses to assistive technology, are too expensive for most people to pay for all at once. With good credit, it’s possible to pay over time and access products and services when you need them.
By establishing simple habits to build good credit, such as paying your bills consistently and on time, you make your debts more manageable and ensure you aren’t limiting your options for the future. With good credit, when an unexpected expense comes up (for example, your car breaks down and needs a repair) or you need something you can’t afford, being able to borrow money could be a lifesaver.
Good credit increases affordability, access, and options for things such as:
- Rental housing
- Loans and lines of credit (such as a mortgage, car loan, or credit card)
- Insurance (such as auto, life, renter’s, or homeowner’s insurance)
- Cellphone plans
- Asset building (for instance, a student loan could enable you to attend college which increases your earning power; a mortgage could help you buy a home; or a small business loan could help you start a business – all of these are assets)
In short, even if you don’t see a need for credit right now, having good credit is like a safety net, and it takes some time to build. Take the time right now to establish good credit-building habits and it will pay off in the long run!
What is credit?
Credit is money that you can borrow with the promise to repay it at a later date, usually with interest and fees. There are two main types of credit: installment credit (also called a term loan, such as a car loan or a mortgage) and revolving credit (also called a line of credit, such as a credit card).
**Not sure what some of this credit terminology means? Credit Builders Alliance has a helpful glossary of credit terms.**
What does it mean to have good credit?
Good credit means you pay your bills on time and you don’t have too much debt (money you have borrowed that you still need to pay back) compared to how much you make in income. When you have good credit, you have shown that are a responsible and reliable person to lend money to.
What is a credit report?
Your credit report is a record of how much you owe and how well you pay it back. A credit report will also include information such as where you live, whether you’ve declared bankruptcy, or whether your credit accounts have been referred to a collection agency. Negative credit history usually goes back seven years; however, a bankruptcy will remain on your report for ten years from the date of discharge. The good news is that positive credit can remain on your report for a long time. Having more good information helps strengthen your credit history and increases your credit score. Credit reports are available from three main credit bureaus: Equifax, Experian, and TransUnion.
How often should I check my credit report?
Checking your credit report regularly is a good habit – you can catch errors, check for fraudulent activity, and stay on top of your overall credit picture. Consumer Financial Protection Bureau (CFPB) has a helpful credit report review checklist that includes what you should be looking for and steps to file a dispute.
Under normal circumstances, you can check your report from each of the three major bureaus for free once a year using AnnualCreditReport.com. We suggest spacing these inquiries out, so in the first four months of the year you might pull your report from Equifax; in the second four months you might pull from Experian; and in the last four months you might pull from TransUnion.
**NOTE: Through the end of April 2021, the three major credit bureaus are offering consumers free weekly credit reports.
What is a credit score?
Your credit score is calculated based on the information in your credit report, and it is an indicator of your ability to repay a loan on time. Lenders use your credit score to determine if they should lend to you, how much they should lend, and what kind of interest rate they should offer.
Your credit score is made up of the following:
Scores range from 300 to 850 – a higher score is better and means the risk of lending to you is less. It is also possible not to have a credit score. This usually means that someone doesn’t have enough of a credit history to receive a score.
Questions from February’s Money Talks Webinar
Do you recommend websites like Credit Karma or Credit Sesame?
Your credit report from AnnualCreditReport.com will not include your credit score. Services such as Credit Karma and Credit Sesame are a great way to track changes to your credit score for free. Many credit card companies also offer to include your credit score on your statement each month.
*A word of caution: It’s easy to get caught up and stressed out about fluctuations in your credit score. Instead, focus on what you can control – your behavior. Keeping an eye on your score will help you learn how your financial habits are affecting your credit, and help reinforce good habits that benefit your credit over time.
Will pulling my credit report affect my score?
There are two types of credit inquiries – a hard inquiry (also known as a “hard pull”) and soft inquiry (also known as a “soft pull”). Hard inquiries can cause your credit score to drop by a few points and are usually noted on your credit report for 12-24 months. A creditor will do a hard credit inquiry when you have applied to open a credit account, like a loan or a credit card.
A soft inquiry, on the other hand, will not affect your credit score and is visible only to you when you view your own credit report. Examples of soft inquiries are when you pull your own credit report and when a potential employer, landlord, or utility company checks your credit.
How often do creditors report to the credit bureaus? And which credit bureaus do they report to?
Creditors are required to report to at least one of the major credit bureaus once every month. Because they are not required to report to all three bureaus, your credit report from each of the bureaus will look slightly different depending on where each creditor is choosing to report.
How do I dispute something on my credit report?
CFPB covers how to dispute an error on your credit report thoroughly on their website as well as in this helpful credit report review checklist which includes steps to file a dispute as well as an example dispute letter.
If I don’t have any credit, how can I establish credit?
It’s a catch-22: it’s hard to get credit without credit. So where do you begin? Here are a few good options:
- Apply for a secured credit card – you back the card by making a cash deposit upfront; that amount is then your credit limit. So, say you deposit $200, now you have $200 you can borrow. The same as any other credit card, if you pay it back in full each month you will avoid paying interest. And when you close the account, you receive your deposit back.
- Become an authorized user on someone else’s credit card – after they add you, that card’s payment history will be added to your credit files (so choose a card with a long history of on-time payments).
- Take out a credit-builder or secured loan – a credit-builder loan operates backwards from a typical loan in that you make your repayments first (which are reported to the credit bureaus), and receive the loan funds once you’ve fully repaid the loan. A secured loan is a loan where the money is backed either by money you have saved, or by collateral such as the car being financed with a car loan. Secured loans typically have higher interest rates, though, particularly if you do not have credit or do not have good credit.
- Use a co-signor on a loan – this can make it easier to get an unsecured loan or credit card. Just be sure the co-signor is aware that they will be legally responsible to pay the debt if you don’t pay.
- Self-report the bills you already pay – services such as PayYourRent and RentTrack allow you to report your rental payments to the three major credit bureaus, and Experian Boost lets you add your phone and utility bills to your Experian report. You can also reach out to your utility companies and your landlord to see if they would consider becoming a data furnisher and report to the credit bureaus.
When you’re receiving Social Security can you still get credit?
Yes. You can still get credit if you are receiving Social Security or Supplemental Security Income. Creditors simply want to have an idea of your income – it doesn’t matter whether that income is earned or unearned. What is most important is the ratio between your current debt and your income. When creditors make a decision about whether or not to lend you money, they review your capacity to pay that money back by looking at your credit history, the amount of credit being requested, and your income. If your income is low compared to the money you already owe in debt, that might affect how much credit you can obtain.
COVID is having numerous effects on people’s credit – are there any resources for people experiencing financial hardships due to COVID?
CFPB has an excellent webpage with a number of resources for people facing financial hardship during the pandemic. They include information on mortgages and housing, managing your finances, student loans, and avoiding scams, as well as resources for specific audiences such as veterans, small businesses, parents, and older adults.
How long does it take to rebuild a low credit score?
It depends. Something like closing a credit account (for instance, paying off a loan), might cause a temporary dip in your credit score. On the other hand, something like a delinquent account (caused by late payments) will cause a larger decrease and can remain on your report for seven years or more. This means it will take longer to rebuild positive credit. The main thing to remember is that your score gets updated all the time, so as you continue to make improvements to your credit history, your score will continue to improve.
Does your credit score lower when you pay off a term loan? Why? Aren’t loans meant to be paid off?
This is a little counter intuitive. Paying off your loan is certainly a good thing financially (fewer monthly bills, more cash freed up for other expenses, etc.). However, the number of open credit accounts you have is one of the factors that determines your credit score. Creditors like to see at least a few different types of open credit accounts to show that you’re continually using them responsibly. So, when you pay off a loan (and therefore close that account), you may see your credit score drop temporarily. The good news is, this is not a huge piece of the pie that makes up your creditworthiness. Within a few months you should see your credit score rebound, as long as you keep practicing other good credit-building habits such as paying all your bills on time and keeping your credit utilization below 30% (your credit balance compared to your credit limit).
Are there any reputable debt consolidation places out there and how do they affect your credit score? Should you pay to repair your credit, or can you repair it yourself?
There are a number of ways to go about repairing your credit. If you don’t know where to begin, our recommendation is to find a reputable credit counselor. This person will take the time to understand your entire financial situation and create a personalized plan to get you back on track. The Federal Trade Commission has a great article on how to choose a credit counselor.
I have only one credit card account. It is not closed but I paid off everything and barely use it. Is this a good practice?
It’s great that you paid off your credit card. That is an excellent habit. We recommend checking your credit report/score to see if you have built enough credit to get a score. Sometimes folks have thin credit (one or two credit accounts) and their score is zero… but, your credit report will show positive payment history.
In general, a good rule of thumb is to have at least a few different types of credit accounts open, and to keep your credit usage low (how much you borrow compared to your credit limit) – ideally below 30%.
Keep in mind that if you never use the credit card, the company may eventually cancel the account. So, it’s best to use your card occasionally and always make your payments on time so your credit history shows that you use the account responsibly.
Is having no credit worse than having bad credit?
Typically, having no credit is better than having poor credit. For our PATF loans, we look more favorably upon applicants who have thin or no credit compared to applicants who have poor credit. This is because a lack of credit history just shows you haven’t used much credit in the past. It is not indicative of how responsible or reliable you are. On the other hand, poor credit is a result of a combination of financial mistakes and not enough positive credit history to counterbalance them. That being said, unlike most banks, we at PATF take the time to have a conversation with each applicant so we can understand your financial situation before making a decision about a loan. Sometimes a series of life events can lead to problems on your credit report, but there’s enough evidence that you’re working on it and that you are willing and able to repay your loan. In these cases we are often able to extend a loan despite a poor credit score. Learn more about PATF loans.
It is difficult for new immigrants to show long length of credit history. Any solutions?
Don’t worry too much about length of credit history, because it’s only 15% of a credit score. It’s best to focus on paying bills on time and keeping debt levels low. Your credit history will build over time, just stick to your good credit-building habits.
My student loan payments are suspended (deferred) because of the COVID-19 pandemic. Is that affecting my credit score?
No, your score will not be affected. Just note, though, that your credit report will reflect the deferment.
The U.S. Department of Education office of Federal Student Aid has an informative article about federal student loans during the pandemic.
For more helpful financial education topics broken down into easy-to-understand concepts, check out our Money Talks webinar series to watch past recordings and sign up for future webinars. Also, be sure to download our other financial education materials such as our book, Cents and Sensibility: A Guide to Money Management.