Oct 19, 2023
How to Master Credit to Build Your Financial Future
October 19 is National Get Smart About Credit Day. We sat down with Maspeth Federal Savings Credit Manager Akshay Mehandru to understand the role that credit and debt play in our daily lives and how to maintain good credit.
Q. What exactly is credit?
Technically, credit is a contract between a borrower and lender to borrow something (money, goods, or services, etc.) with the promise to pay over-time. The amount you owe is your debt to that lender. But borrowing isn’t free: It comes at cost. That cost is the interest rate the lender charges, which is the cost of borrowing.
If you want to purchase something but don’t have the cash on hand, you may be able to buy it through credit. Examples of buying through credit include:
- “Buy now, pay later” programs like Amazon Affirm
- Smartphone payment plans
- Mortgage loans and rental agreements
- Student and auto loans/leases
- Credit cards
In essence, your credit is your capacity to borrow. That capacity is measured by your credit score—a number on a scale of 300-850 that represents how reliable you are as a borrower, i.e., how likely you are to repay what you borrow.
Think of your credit score as your financial GPA: Just as colleges use your GPA to decide on admission, lenders use your credit score to decide whether and how much they’ll let you borrow. The higher your score, the more likely they are to decide in your favor, but remember: Using credit is a privilege, not a right—no lender is ever obligated to give you credit just because you need or want to buy something.
Q. Why are credit and debt important?
If you want to make a large purchase, rent an apartment, buy a house, buy or lease a car, apply for private student or business loans, or obtain insurance (basically, whenever you seek to acquire assets) lenders, insurance companies and landlords will look at your credit history and score to decide whether they will lend you the amount you want. Good credit increases your chances of getting not only approval but also a preferential (lower) interest rate. Conversely, bad credit may prevent you from getting approved for a loan.
What do lenders want to see? A person who is responsible enough to consistently take on debt and repay it in a timely manner. This is why “debt” isn’t necessarily a dirty word. In fact, having debt can be helpful: If you have zero credit history, meaning you’ve never taken on debt or you don’t have a credit account that’s at least six months old, then lenders cannot asses your credit worthiness. Without a way to gauge how likely you are to repay the debt, they might instantly decline your application for credit.
Q. What happens if I don’t pay my debts?
Remember that credit is a contract. Missed medical, utility, car, rental, credit card, and loan payment— are all contractual agreements you’ve failed to fulfill. If you fail to repay debts, then there will be an adverse impact on your credit history and score. Creditors can seek to collect the debt owed via judgements against you and potentially garnish wages if the debt is not paid.
Q. What’s the first step to building good credit?
Check your credit score, which is tracked and managed by three major credit bureaus: Equifax®, TransUnion®, and Experian™. You can access your report from each bureau for free once a year, which you can do easily at AnnualCreditReport.com. I always recommend checking your reports once a year and looking for unfamiliar entries, which may indicate fraud. You can also see your credit report for free whenever you apply for a loan. Just ask the lender to see the report they obtained from the bureau(s) they consulted.
Note there are two brands of credit scores available: A FICO® score and a VantageScore, which is just a brief summary of factors that affect your full FICO® score. Most lenders use the FICO® score to make their decisions, so go by that. Just be aware that when you’re viewing your score on sites like CreditKarma or your credit card dashboard, they’re likely showing you the VantageScore.
Each credit bureau has its own way of scoring based on different loan types and industries, and each lender has its own criteria when evaluating your credit report. But the key factors that affect your score and your approval include:
- Payment history: Have you consistently paid off your debts in a timely manner?
- Credit utilization: How much credit is available to you vs. how much do you borrow? Do you show restraint by borrowing a small percentage of what’s available, or are you constantly maxing out your lines of credit, which implies risky behavior?
- Credit mix: The different types of loans you have, like credit cards, auto loans or mortgage.
- Length of credit history: How long have you been borrowing and repaying debts? The longer your history, the more reliable you seem.
- New inquiries: How many times has someone requested to see your credit report recently?
Q. What if I don’t have any credit history?
A long credit history increases your chances of getting a higher limit or a better loan, so start building credit as soon as possible. Here’s what I recommend (and what I did myself):
- Become an authorized user: Starting at age 16, you can be added as an authorized user to a parent’s credit card. This can help you learn good financial habits and build credit. Please note the age requirement for being an authorized user on a credit card can vary by lender.
- Get a student card: A special credit card designed for high school/college students. Terms may vary depending on the lender.
- Get a “secured” credit card: You open an account with $200 and receive a credit card with that limit on it. So you’re essentially borrowing your own money but paying interest on your own money – for the sake of building credit. Make on-time payments for six months to a year until you see your score improve, then apply for a regular credit card and close this one out to get your $200 back. This is how I started.
- Leverage your utility bills: Look into services like Experian Boost that allow you to integrate utility payments into your credit score.
Q. What if my application for a credit card gets denied?
Most lenders use automated decisioning systems that factor in your stated annual income, housing costs, credit score, and a variety of other factors that vary by lender and industry. If they deny your application, you may receive an “Adverse Action Notice” explaining why, but it’s unlikely they’ll reconsider.
Start thinking about ways to lower your expenses and increase your income. Easier said than done, but these are important factors that affect lender decisions. Also resist the urge to apply to many lenders within a short timeframe. A denial will not impact your credit score (as this is not reported on your credit report), but lender inquiries stay on your credit history for 2 years and could raise a red flag to future lenders: Why is this person trying to access credit from 10 different places? Is it fraud related? Are they desperate for fast cash and therefore a risky investment?
Q. How do I improve my credit score?
The most important thing is to pay your bills on time. When it comes to credit cards, always pay more than the minimum amount due on your monthly statement if not the entire balance in full. If you only pay the minimum amount, you’ll still be charged high interest rates on the remaining balance.
The next thing is to aim for a credit utilization rate of about 30%. So if you have a credit limit of $1,000, cap your monthly charges at less than $300. Reaching a 90% utilization rate or maxing out your credit card implies you’re acting risky. If you absolutely must incur that extra debt due to an emergency, your score may dip temporarily but will rebound as long as you keep paying more than your monthly minimum going forward.
Additionally, don’t close out your first credit card. Use it periodically, pay it off, and keep it as long as possible. This will help increase the length of your credit history, which is the average length of each credit account you have. That also means that you shouldn’t be opening new credit cards every time a retail cashier offers you a deal at the register, because in addition to the inquiry showing up, each new account opening lowers your average length of credit history.
Q: What do I do if I have bad credit?
Access your credit report to find out why it’s low. Are there accounts you don’t recognize? If so, contact the credit bureaus to start a fraud investigation. Are there collections on your report? Reach out to the lenders for proof the debts are yours and ask to negotiate settlements in full or at a discount. This could be as simple as calling the billing department of a hospital and asking to claim hardship. Most of the time, lenders will work with you, but you have to ask nonetheless. In fact, this is part of what credit repair services do. They reach out to creditors to ask about settling on your behalf, which you can do on your own for free.
Once you’ve sorted your credit report, the most important thing is to continue paying your bills on time. It could take years to improve your score, but you’re on the right track.
Q. What are some common credit-related risks to watch for?
1. Fraud: Checking your credit report once a year is a good start, but if you’re not applying for credit or a loan anytime soon, contact the credit bureaus to freeze your account. When criminals try to open lines of credit on your behalf, they won’t be able to. When you’re looking to apply for credit again in the future, just unfreeze it.
2. Fine print. Whether you’re signing for a personal loan, an auto loan, a mortgage, etc., read the fine print. Take your time to ask questions and understand the final terms and numbers. You have the power to walk away at any point before you sign, even at the closing table. Trust your gut and don’t succumb to high-pressure salespeople or sketchy lenders.
3. Spending: It’s the best way to build credit and the best way to destroy it. Beware of spending money you don’t have and overborrowing. Avoid increasing your credit card limits or number of cards unless you absolutely need more borrowing capacity. Remember: Every swipe is a promise to pay with interest.
4. Balance transfers: Be careful of balance transfers as most are only for 1 year. After that, your balance will accrue interest at a high rate, upwards of 30%. Please note there is generally a fee between 3-5% charged by the creditor – please read the fine print.
5. Social media. While TikTok and Instagram shorts promise exciting financial strategies and payoffs, half of that stuff doesn’t actually exist—it’s just for content and you should always do your own research. Be wary of financial and real estate investment advice from social media.
Akshay and our team at Maspeth Federal Savings hold regular financial literacy sessions at local schools and college campuses. Follow us on Instagram to find out when the next one is, or reach out to finlit at maspethfederal dot com to request a seminar at your school.