Episode: 04-11-2023 | Credit 101

Hosted by Kevin J. Zywna, CFP® and Allison K. Dubreuil, CFP®

Allison Dubreuil, Wealthway Financial Advisors: Tonight we’re going to talk about one of the building blocks of personal finance. We’re going to give you Credit 101 if you need a little refresher on what credit is and how it works. We’re going to give you a run through of what it is and some tips on how you can impact your credit. Credit is really, really a big part of your financial power. It is the ability to borrow money or access goods or services with the understanding that you’ll pay it later. It is how you can get a loan for a car or a credit card and not have to pay today with the promise of paying later. We want to talk about how you manage credit.

Kevin Zywna, Wealthway Financial Advisors: The proper use and responsible use of loans and debts. Not all debt is bad debt, as we’ll talk about later. In fact, responsible use of debt can actually help grow your net worth faster in the right circumstances. But there’s a fair amount that goes into it. And in the great old United States of America, there’s a lot of people who don’t use debt wisely. And it’s a very slippery slope. A dangerous hole that, once you start getting yourself into with too much debt, it’s hard to dig out of. We’ll try to prevent you from getting in the hole in the first place. Or we’re trying to throw you a lifeline and help you get out of debt quicker.

Credit History: Your Use Of Credit Over Time

Allison Dubreuil, Wealthway Financial Advisors: If you’re looking to access credit, what are lenders looking for? We can boil it down to the five C’s of credit: credit history, capacity, collateral, capital, and conditions. Don’t worry, you don’t have to memorize that. We’ll take each one at a time. Credit history I think is pretty familiar to most people. That is a record of your use of credit over time. It includes accounts that you have opened previously and even accounts that have been closed for some time. A minute includes a history of your payments typically over the past seven to 10 years. All of that information can be provided to lenders to help them determine whether you are someone that will actually make good on your promise to pay when they lend you money.

Kevin Zywna, Wealthway Financial Advisors: Right credit history very important to your proper use of credit and whether you even will be granted credit from a lending institution. Credit History is sort of like a little bit like your report card. It tells the different loans, different credit facilities, credit cards, gas cards, store cards, personal loans, that you may have taken out over student loans, mortgages, that you may have taken out over your lifetime, and then your payment history on those loans. Credit is a little bit like exercise, you need to do some to be financially healthy. Done properly, it can make you very financially strong. You do too much, then you can harm yourself. You want to have some credit as early as possible in your lifetime. So usually, if you graduate from high school, get your first job, great opportunity to get your first credit card, use it responsibly. If you go to college, and you get student loans, (even though you don’t have to pay them back), as soon as those student loans are issued to you, they start showing up on your credit report. And the sooner you can build a good credit history, the better off you’ll be from a credit standpoint.

How Do You Access Your Credit Report?

Allison Dubreuil, Wealthway Financial Advisors: Your credit history is pretty well detailed on your credit report. Everybody has a credit report. Well, not everyone, I guess if you haven’t used credit. But if you’ve used credit, you have a credit report. There are three different reporting agencies that track your credit. And you have the ability to pull a credit report from each of the three reporting agencies once a year at no cost. And you can do that through www.annualcredit report.com Not to be confused with free credit report.com.

Kevin Zywna, Wealthway Financial Advisors: Don’t just Google that because there are a lot of imposters out there. The only safe reliable place to get access to legitimate free credit reports is through www.annualcredit report.com. And there you can access Equifax, Experian, and TransUnion credit reports in your name.

Allison Dubreuil, Wealthway Financial Advisors: And what you want to do when you pull your credit report is you want to make sure there are no accounts that you have no recollection of. You want to make sure there’s no fraudulent activity, and that everything you see on the report matches what you yourself have experienced. And if there is a mismatch, that’s when you want to take action as soon as possible. So that’s why we always recommend pulling each credit report once a year. And you might just want to spread that out pull one every four months and then you can cover your bases throughout the year.

Kevin Zywna, Wealthway Financial Advisors: And as somebody who used to make loans as a loan officer early in my career, I can tell you that it is not uncommon to have mistakes on your credit report. Especially for men if you are a junior a senior or a third name. Yes, that often can be mixed up. Sometimes credit card companies or lenders banks will misreport information they might have a loan balance wrong, or initial loan amounts wrong. They’re usually pretty good about payment history. A note on payment history: you have your due date of whenever you have to make your payment of credit card or loan. Typically, you get 30 days’ grace period after that before you are reported by the lending institution to a credit bureau as being late. Know that there is a little bit of grace period in there. But once you are 30 days or more late, then typically that negative information gets sent to a credit bureau and then becomes part of your credit file. So not a game you want to play. You want to try to avoid that at all possible.

What Is a Credit Score or FICO Score?

Allison Dubreuil, Wealthway Financial Advisors: So that’s your credit report. Now, most people are familiar with a credit score. Most banks are boiling down your credit history to a credit score or what you might know as a FICO score. That score is important because it can impact the terms of loans that you’re offered. When you go to a bank or a lender, it will determine how good of an interest rate you get, what kind of terms they’re willing to give you and the amount that someone is willing to lend you. The higher your credit score, the more you’re able to borrow and the lower your interest rate could potentially be.

Kevin Zywna, Wealthway Financial Advisors: Right. And there’s no shortcut to building your credit score. One of the biggest components of your credit score is the length of time in which you’ve had credit. That’s why I was saying earlier that the earlier you start building credit, the better off you’re going to be. But yes, the higher the credit score, the more favorable terms you typically get from lending institutions, the lower the interest rate, maybe the higher dollar amount you can borrow, or the longer you take to pay back, all that becomes more favorable to you when you have a good credit score.

Allison Dubreuil, Wealthway Financial Advisors: Your credit score is a three digit score. It can range typically from 300 to 850. Now, each reporting agency uses a different scoring system. You could have a different score at each agency. But hopefully, they’re relatively close to each other or something might be off, and you might want to look into it. We have some broad guidelines on what would be considered a poor, fair, good, and exceptional FICO or credit score.

Defining Credit Score Ranges

Kevin Zywna, Wealthway Financial Advisors: Yes, so a poor credit score 300-570, typically in the FICO range. Fair 580-670 in the FICO score. Good is about 670 to 740. Very good 740 to 800. And then exceptional is 800 to 850. Now, I can also say from my early days in lending that an 850 credit score is like a unicorn. Allegedly, they exist, you’ve never seen one. One has ever really seen one that I’m aware of. It’s highly unlikely that you’re ever going to get 850. And if you don’t, don’t kill yourself trying, it’s not that important. What is important is to try to get your credit score up into the very good to exceptional range. So somewhere in the upper 700s, the mid to upper 700s or higher is going to open a lot of credit doors for you.

Allison Dubreuil, Wealthway Financial Advisors: And I saw some statistics that about 38% of people with credit have very good or exceptional. I thought that was actually pretty good.

Kevin Zywna, Wealthway Financial Advisors: Yes, each sort of grouping of credit score from very poor to exceptional as about 20% of the pie. 20% of the population falls in one of those categories. Something that you can monitor yourself. Banks typically are giving this information for free. Some credit card companies are giving it to you for free. Or you can look it up at www.annualcredit report.com as well when you check your free credit reports.

Kevin Zywna, Wealthway Financial: Tonight, we’re talking about the five C’s of credit. The responsible use of lending and debts and ways that you can maximize your borrowing terms. I guess not necessarily opportunities, but, borrowing power. Yes. Good one. All right. We’re going to go up to Hampton and speak with George. Good evening, George. You’re on Dollars & Common Sense.

Caller: Hi, how you doing? I just want to highlight the importance of checking when you’re turned down. In the past, our limit can proceed with trying to attain a house. The mortgage lender told me, they couldn’t put my credit was bad. I wasn’t planning child support. I’d just got separated from my wife. And I say, well, what’s the name you have on the report and say, George Owens. Okay, what’s the social security number? It was a guy who lived at that house before I did whose name was George Owens, also. He had a different social security numbers. And I say, that’s not me. And I’m a junior, and my father is a senior big time where they took me into to be my father. So it’s important when you’re turned down to double check and make sure they’re talking about the right person.

Kevin Zywna, Wealthway Financial Advisors: Yes, George, that’s a good first-hand account there. Thanks for that information. That’s a classic example of how oftentimes you can find mistakes on your credit report, especially when you have a common name. There’s probably a fair number of other people in the United States, it’s easy for wires to get crossed like that. It’s important that you be vigilant and make sure you guard your own credit history.

Allison Dubreuil, Wealthway Financial Advisors: All right, not something you have to worry too much about ,right?

What Can Show Up On Your Credit Report?

Kevin Zywna, Wealthway Financial Advisors: No, no. I’m about the only one on the planet, of course. But George brought up a good point. And that is in addition to lending information like credit cards, personal loans, car loans, mortgages and stuff like that, other legal information can find its way to your credit report if you owe it. He mentioned unpaid child support. That can show up on your credit report. Tax liens, if you still owe municipalities or the state or federal government taxes, that can show up on a credit report. Medical bills, unpaid medical bills that go to judgment can show up on your credit report. Court costs basically, anything that a lender would have to go to court to get a court to certify you actually do owe. Even though it’s not a loan, it can find its way onto your credit report. In most cases, if you have that on there, that’s a big negative mark. Lenders are usually going to require that you clean that up, you either satisfy the obligation, or if it’s incorrect, you get it straightened out with the credit bureau before getting any loans, or any reasonably priced loans put it that way.

Understanding How Capacity Impacts Your Credit

Allison Dubreuil, Wealthway Financial Advisors: So that’s a pretty good overview of credit history. The next item that will factor into your ability to use credit is capacity. So capacity is something that lenders will look at to determine how likely you are to be able to make a payment on this new loan that they’re considering lending you. They’ll review your monthly income and compare it to all of your debts or financial obligations. They will calculate what is called your debt to income ratio, that shows what percentage of your monthly income that has to go to mandatory expenses, like rent loans, credit card payments, things that are obligations to lenders, and that is going to help them determine if you have the capacity to make payments on additional credit.

Kevin Zywna, Wealthway Financial Advisors: Yes, so the lower your debt ratio, the lower the amount of obligations that you have to pay compared to your income, the more likely you are to be able to repay whatever new loan you’re trying to get. It’s something that you want to try to manage and prepare for, especially if you’re getting ready for a big loan, like a mortgage. That’s where it’s going to be most important. Lenders tend to be a little bit more flexible when it comes to credit cards and car loans, consumer type of lending. But the terms are more rigid and restrictive when it comes to mortgages. So, the lower your debt ratio, the better your chances of getting a loan.

Defining Debt to Income Ratio Ranges

Allison Dubreuil, Wealthway Financial Advisors: When we look at debt to income ratios, 50% of debt to income that’s kind of a red flag. If more than half of your income is going towards debt payments. If you’ve got 36-49% there’s some opportunity to improve but it doesn’t mean that you absolutely can’t get a loan and then if your debt to income is 35% or less, you’re looking good. Your debt is at a manageable level, and you will be likely able to get the loans that you’re looking for.

Kevin Zywna, Wealthway Financial Advisors: And I should note in this area specifically sometimes there’s a little bit more leeway given to sailors here in the Hampton Roads area who just literally have started out. Moved from Oklahoma and are stationed on a ship, their take home pay is relatively low because a lot of their other expenses like room and board is being paid for and other capacities. So just getting a car loan of $250 – $300, it really maxes out that debt to income ratio. But if you set up an allotment, or that’s the only other debt you have, you can find some sympathetic lenders here in the Hampton Roads area that know the circumstances that you’re under. We’re going to run up to Williamsburg and speak with Bill Good evening billion Dollars & Common Sense.

Caller: Hey, thanks a lot. Hey, good show. Good topic. I think everybody knows what credit’s about whether you get it or not. They like to know. If you take out a loan, no loan, I’m sorry, a credit card. And let’s say you took it out in 2000. And just making example of you and you pay on it for two years, and then you don’t pay on it anymore and then ended default on it, and then they write it off. When does that fall off your credit? Is that when you took it out in 2000? And then it drove in 2002? Is it seven years from 2002? So it wouldn’t fall off your credit till 2009. And just follow up to that, if it does come off, then does the customer individual have to write into the, you know, one of the three different agencies and ask them to remove it or do they automatically know after seven years? So just let it drop off? Yes. Okay.

Kevin Zywna, Wealthway Financial Advisors: Good questions there, Bill. And there’s a fair amount of information there. You’re correct. When you have a legitimate negative event on your credit history, then it typically stays on your credit record for seven years from the last date of negative information. In your hypothetical there, I think it was 2002. Right? Seven years from the latest negative information. And then in that case, then you shouldn’t have to do anything to clear it after seven years. It should be automatically dropped by the credit aid didn’t cease. As long as negative information is on there, it’s going to be a at least, if it’s not an outright denial for credit, it’s going to be a conversation topic with whoever you’re trying to borrow from. Or you’re going to find yourself subject, just really disadvantaged credit terms, much higher interest rates for loans than otherwise would be applicable. It’s that important, it’s something that you need to keep an eye on and manage. But once it occurs, seven years and then should be automatically dropped by the credit bureaus.

What Is A Collateral and How Does It Impact Your Credit?

Allison Dubreuil, Wealthway Financial Advisors: We’re talking about credit 101. And the basic C’s of credit, we talked about credit history, and capacity, we’ll run through the others real quick before we get to some more practical tips about what you can do to impact your credit score. The other C’s of credit are: collateral, capital, and conditions. Collateral, I think most people understand what collateral is. Collateral it is a personal asset, could be a car could be a savings account could be your house, that can help offset risk for lenders. If you pledge collateral, then you give the lender the ability to repossess that asset if you default on the loan and you don’t pay it back. This can help give lenders more security, get them more comfortable with lending your money.

Kevin Zywna, Wealthway Financial Advisors: Yes. In practicality, if you don’t make your loan payments on time, you get too far delinquent, then the lender would foreclose on a house, or repossess a car or whatever would be used as collateral for the loan. If the loan is not paid as agreed, the lender would seize that property, take ownership of it through court actions, and then sell that property, sell that vehicle for whatever they could get for it to help to recoup the remaining amount of the debt. And it’s a highly negative event, you don’t want that to happen. You want to try to avoid that as much as possible. But if you come to a lender with collateral for a loan, obviously, a mortgage, by default has the house as collateral, a car loan, by default, the lender puts a lien on the title to your car loan. But sometimes you can get a permit, you might own a car free and clear. And maybe you don’t qualify for an unsecured personal loan. Or you might want more favorable lending terms, a lower interest rate, you can offer your title to your vehicle that you own free and clear as collateral for a loan. And so sometimes that can be used to sort of sweeten the deal, if you will, for both parties to get a loan done.

What Is a Capital and How Does It Impact Your Credit?

Allison Dubreuil, Wealthway Financial Advisors: Capital is another way that you can help increase your lending ability. Capital is typically something like your savings, your investments, your retirement account, lenders may want to see what kind of capital you have so that if you were to lose your job, or have some sort of financial setback, they’ll know the chances of you being able to repay this loan. And we do see this come into play with people who are maybe retired and don’t have as much regularly earned income in retirement who are still trying to get financing to help maximize their use of their assets. You may be asked to show what kind of capital you have to help get a regular loan.

Kevin Zywna, Wealthway Financial Advisors: Yes, this is the one that drives a lot of consumers crazy, because they’re like, if I had enough money, if I had enough investments, I wouldn’t need the loan. The banks only want to make loans to people who already have the money. Right? Well, yes, and no, it does certainly bolster your case. But there are times where, if you have enough capital to pay cash for a car, or a house or some other big ticket item, it can be more financial financially advantageous to use somebody else’s money to buy that house or that car. Borrow, when, for the last decade almost, we’ve had an incredibly low interest rate environment. Mortgages were going in the twos, the threes and the fours. When you can borrow at that low of an interest rate, then it’s more financially desirable to keep your money at work – in investments, on average long term, than taking money out of those investments and paying cash for some vehicle. Depending on where we are in the interest rate cycle and what prevailing loan rates are doing, even if you have the money to pay cash, it can be better to borrow from a bank. So, they like to see and know that you have it. In case you need to pay back the loan.

What Are Conditions and How Do They Impact Your Credit?

Allison Dubreuil, Wealthway Financial Advisors: And the fifth C, of the five C’s of credit that we’re talking about tonight, is condition. Conditions refer to a number of factors that lenders might consider before extending credit. It might be how you plan to use the proceeds from the loan. If you’re getting a home equity line of credit, they may be asking you questions like “is this for home improvement, or is this for sending your kid to college, or is this for an around the world cruise?” I don’t know, that may impact their decision.

Kevin Zywna, Wealthway Financial Advisors: Debt consolidation. Yes, the purpose does come into play and you want to make sure it’s a legitimate, ethical purpose for the loan proceeds. And it sort of makes sense in context of your entire financial life. One of the big things one of the big conditions that smaller banks, community banks, and some smaller credit unions like is how long have you been a customer. That carries a lot of weight in smaller institutions. Might not go too far at Bank of America and Truist but it certainly does at smaller community banks and credit unions. The longer you’ve been a customer at that bank, the more favorable they will consider your loan application.

Allison Dubreuil, Wealthway Financial Advisors: Credit history, capacity, collateral, capital, and conditions those all go into your, let’s say, attractiveness to potential lenders your credit.

Kevin Zywna, Wealthway Financial Advisors: Attractive. There you go. Tonight, we’re talking about the five C’s of credit. How you can strengthen your credit profile, become a more financial sexy credit user. And some credit habits that will work out the right muscles. Like I said, it’s like exercise.

Pay Your Bills on Time to Improve Your Credit Score

Allison Dubreuil, Wealthway Financial Advisors: Well, we are going to talk about how you can build and improve your credit history and credit score. And the first thing you can do is pay your bills on time.

Kevin Zywna, Wealthway Financial Advisors: At different times in your life it can be harder than others, that’s for sure.

Allison Dubreuil, Wealthway Financial Advisors: Make sure you make your bill payments on time, especially your interest bearing loan payments or your interest credit card payments. It does not make sense to pay interest. If you can we recommend paying off the credit card in full every month but you at least have to make the minimum payment so that it doesn’t impact your credit score.

Kevin Zywna, Wealthway Financial Advisors: Don’t, for a second, think that you can outrun your debts and move to another state or halfway across the country free, and they won’t know about the credit card that you didn’t pay in Hampton Roads. No, these are national credit reporting agencies. And any other time you apply a request credit, under your name, social security number, birth date, that lender is going to pull out national credit report and that negative information will be on there. Make sure you pay your bills on time.

Allison Dubreuil, Wealthway Financial Advisors: If you’re not sure that you can handle that, then it’s probably a good idea to set up an automatic payment. Almost any loan has the ability to go online and set it up so that it automatically drafts from your checking account on or before the due date so that you don’t have to worry about it. If you’re out having fun in the sun.

Kevin Zywna, Wealthway Financial Advisors: Yes, there’s less sympathy nowadays for my check is lost in the mail, or I forgot to write the check or anything having to do with a check. Most all these payment plans can be set up on automatic draft from a checking account, that as long as you have enough funds in there, they will make that payment on time. And that is a good procedure for you to adopt.

Avoid Maxing Out Your Credit Card to Improve Your Credit Score

Allison Dubreuil, Wealthway Financial Advisors: Another tip is to avoid maxing out your credit accounts. I’m going to borrow one of your famous lines, Kevin. “Just because you can, doesn’t mean you should.” We all are given a certain amount available to us for credit on credit cards or loans. You typically do not want to use the maximum amount. In fact, credit usage is one of the factors that impacts your credit score the most. You want to maintain a relatively low amount of credit usage. Usually, they want to see it below 30%, meaning you’re only using 30% of your limits at any given one time.

Kevin Zywna, Wealthway Financial Advisors: Yes, so back to the working out analogy. You want to get out and exercise. You probably want to be in like a nice easy jog pace. But you don’t want to sprint. You don’t want to use all your energy. You don’t want to use all your credit. You want to use a reasonable amount, because this is going to be a marathon, not a sprint. Your credit score is going to follow you over your lifetime.

Manage Your Credit Limit to Improve Your Credit Score

Allison Dubreuil, Wealthway Financial Advisors: Now if you have a big expense coming up, and maybe you use points on your credit card, maybe use airline miles, or hotel points, or cashback, or whatever it is, so you want to just put it on the credit card and plan to pay it off just to maximize your points, you can request an increase on your credit limit. If you know you need to use more of your credit than normal, you could, as long as you’re in good standing. If you’ve been a customer for a period of time, you can approach each lender to see if they will increase your credit limit so that you can continue to manage your usage amount.

Kevin Zywna, Wealthway Financial Advisors: It’s not uncommon to get a temporary increase in your credit card limit if you’re going to make a large purchase. Like Alison suggested there, we’re going to take a big trip, that’s perfectly reasonable happens relatively frequently. Most people don’t even know you can do that. But you can do that. And that can help manage your usage of your credit limit.

Manage Your Debt to Income Ratio to Improve Your Credit Score

Allison Dubreuil, Wealthway Financial Advisors: You also want to manage your debt to income ratio. This is just really good financial sense. It’s not just to get more lending ability, or more borrowing ability, but really, to make sure that you can handle your bills, you want to make sure that the amount of your debt payments doesn’t become too high of a percentage of your income, which then becomes unmanageable.

Build Up Your Emergency Fund to Improve Your Credit

Kevin Zywna, Wealthway Financial: And then you want to make sure you build that emergency fund. Now that doesn’t have anything really to do with your credit characteristics or your credit history. But it does prevent you from getting too much bad credit to running up the credit cards unexpectedly and then having a hard time paying it off. The emergency fund is three to six months of normal expenses set aside in a comfy bank account, liquid, ultra safe. That’s your first line of defense – getting into too big of a debt hole.

Allison Dubreuil, Wealthway Financial Advisors: Yes, once you get into the hole, if you’re not able to make the payments and interest starts accruing, it just snowballs out of control and you can find yourself in a bad situation. We like a good emergency fund and ideally paying the credit card off each month.

Practice Making Your Payment Before Increasing Your Debt

One idea if you are considering taking on a new loan or debt is to practice making the payment. So just pretend like, okay, we’re looking at increasing our mortgage payment by, $500 a month. Let’s see if we can put $500 a month set aside for a few months and see how that feels before we actually commit to doing this and find ourselves in a bad situation. Budgeting, yes, the B word.

Kevin Zywna, Wealthway Financial: It’s a soft form of budgeting, self-imposed form. Yes, a way of exercising that higher credit limit to see if you can handle it.

Monitor Your Credit Report to Improve Your Credit Score

Allison Dubreuil, Wealthway Financial Advisors: We talked about this earlier, but one of the very important things you can do to help improve your credit and manage your credit score is to monitor your credit reports. Everyone has three credit reports, one from each of the three reporting agencies that can be accessed each year. We recommend pulling one credit report every four months so that you’re monitoring your credit report evenly throughout the year. And you would know relatively quickly if something was inaccurate or needed to be addressed.

Kevin Zywna, Wealthway Financial: Yes, one of the things that checking your credit report regularly can help is also identity theft. Or somebody opening up a credit as well, getting your identity and then opening up credit with your name. Social security, birthdate, all of your vital statistics, so that it appears like it’s a legitimate loan, when in fact, it’s actually somebody else, opening up the loan in your name with no intent of ever paying it back. And it’s going to stick on your credit report until you wake up to the fact that you have a problem and this is something that a lot of people are concerned about. Checking your credit report regularly can nip that in the bud.

Allison Dubreuil, Wealthway Financial Advisors: Monitoring your credit score. I know a lot of banks and credit cards will send you alerts. Will get updates on your credit score, if there’s a move in your credit score, they’ll often even tell you why. And so that might alert you to some activity that maybe you need to check into.

Kevin Zywna, Wealthway Financial Advisors: Yes, and credit reports move slowly over time, typically. So like we said earlier, the sooner you can start building credit, the better off it will be to grow your credit score.

Allison Dubreuil, Wealthway Financial Advisors: And our last tip that you can use is to think very carefully before closing accounts. Because the length of time you’ve been using credit is one of the big factors that contributes to your score. In fact, I think I have like 25 years of credit history and they’re like this is mediocre, like wow.

Kevin Zywna, Wealthway Financial Advisors: That’s what we mean by it takes a long time to really build up your credit score.

Allison Dubreuil, Wealthway Financial Advisors: Yes, keep your accounts open even if you’re not using them.