6.04.2017

How to use a credit card: Part 2.

In my previous post, I tried to spell out the basics of credit cards by hitting the most salient points I wished I had known before I ever signed up for one. Credit can be a minefield if you are unprepared, but there is good news: you can play the game well, and maybe even win sometimes. Read on to find out how.

What is a credit score?

Your credit score is a single three-digit number which tells lenders how creditworthy you are; or, simply, how likely you are to repay the debt. Scores range from 300 to 850. Within this range are categories, as follows:

  • below 600 - bad credit
  • 600-649 - poor credit
  • 650-699 - fair credit
  • 700-749 - good credit
  • 750+ - excellent credit

Personally I think the words used to describe each category ("poor," "fair," "good") are finely tuned to keep the average person from feeling too good about their score. Just a personal nitpick I have. Also, be aware that there are slightly different credit scales depending on the credit bureau.

Creditors will extend credit with certain terms based on your score. The better the score, obviously the better the terms.

Get to know your credit score.

Your credit score takes into account six main factors:

1. Credit Utilization Ratio: this is the percentage of credit you are using of the entire amount available to you. It only applies to revolving credit, not installment loans (like school, personal, or mortgage loans), so essentially, it applies to your credit cards.

2. Payment History: quite simply, have you paid all your debts on time? Even one missed payment can really drag your score down, because this is in some ways the most important factor to a lender - will they pay me back or not?

3. Derogatory Marks: this is the serious stuff like collections, foreclosures, defaults, and bankruptcies.


4. Age of Credit History: the longer your credit history, the better picture a lender can get of your creditworthiness. Keep in mind that this is an average, so even if you've been paying your student loans for 15 years, your newer credit accounts will create an average age much 'younger' than that.

5. Total Accounts: how many open and closed debt accounts you have. Closed accounts stay on your credit report for seven years.

6. Credit Inquiries: depending on the credit report, you will see how many 'hard' inquiries you've done over the past one to two years. Any time you apply for any kind of credit, whether you're approved or denied, lenders must pull your credit score; do this too much and it counts against you.

The information gleaned from each factor is combined in a single number which tells the lender how likely you are to repay the debt. The more responsible you appear to have been throughout your credit history, the better they will treat you: higher credit limits, lower interest rates, more perks. (Why the caveat? Because your finances can suffer for myriad reasons, many of which may be out of your control, and unfortunately taking each individual's personal background into account is beyond the scope of a scoring algorithm)


How do you find out what your credit score is? 

You can pay to see it from each of the three main bureaus (TransUnion, Equifax, and Experian). Yep, it costs money. Keep in mind that this is different from the free credit report you can request once a year; the report will not tell you your score (but it is essential information as it lays out your performance in each of the categories mentioned above).

Another option is to sign up for one (or more) of the growing numbers of free credit score websites. The reason they are free is they are only an approximation of your true scores, using a single scoring model out of the hundreds available to the industry. But, in my experience, they give you a ballpark figure - well, maybe more like an infield figure - that helps you plan for your credit future. I personally use Credit Karma (and believe me, there's no way in hell I'm being paid to recommend them), but there are other apps available from credit card companies like Discover and Capital One, and you don't have to be a cardholder to use the service. As I'll say many times - read reviews. Get to know what real people are saying; it's the best way to help you decide.

Yes, that vague feeling of falling down the rabbit hole you're experiencing is correct: there is a LOT to know about credit, much more than I could feasibly go through in a blog post that isn't also secretly a book. But I'm giving you an overview of credit scoring because if you are going to take on debt in your lifetime, you absolutely have to know how to get, and keep, your best score possible.

What credit score do you need to apply for a credit card?

This is the first thing to consider once you do know your score, not "what cool card can I get?" It's very important to NOT apply for a card that you do not have a chance of getting approved for. I made this mistake after being laid off about ten years ago, and wanting to have an extra safety net for the uncertain months ahead (the two cards I did have were always within $100 of being maxed out - ugh). I set up my laptop at the local cafe and searched for cards with great terms, completely oblivious to my odds of approval. I was denied that night. Twice. The indignity was deep, and also my fault.

So, what if you don't qualify for the cards you're always seeing advertised, that "get you where you want to be" and promise cash back as a reward? Are you out of the credit card game? No, not at all.

Once you know what your credit score is, you can do a little research on the web to see what actual consumers are saying about card approval odds. (You can use search terms like 'capital one venture card credit score') This article is also a good rundown and reiterates the importance of knowing before you apply.

Another trick is to go to the card company's website and check for pre-approval offers. This is kind of like getting one of those annoying mailers - based on certain criteria the company thinks you'd be a good fit for a particular card, but ultimately you don't know until you truly apply. However, checking for pre-approvals at least gives you an idea of what card(s) you might want to apply for - and which to avoid.

What if my credit score is "fair" or below?

You still have options - much fewer, but they thankfully exist. A secured credit card is specifically for helping people rebuild credit (or build it, if their credit history is too young). How it (generally) works is you pay a deposit from your own money of between $200 and $500, depending on the card, and this serves as your credit limit. As you use the card responsibly and always pay on time, the card company reports each month to the credit bureaus which positively affects your score. After a set period you become able to move to an unsecured line of credit and get your deposit back. I think it's a great system; again, read reviews of secured cards (I'd start with Capital One and Credit One) to get the gist of how they work and how they have benefited real people.

***

Understanding the credit game is frustrating; it takes time to learn and even then there will always be weird rules you didn't know about. As you go along, you start to get the idea that nothing about your credit is certain - three different credit bureaus, hundreds of different ways to calculate a credit score, no idea which lender or score the company pulling your info will use (of course, you can ask). Two people with the same credit score, in fact, can have different levels of creditworthiness because one person is rebuilding their credit, and the other had excellent credit till they missed a payment. On the flip side, one person with a 658 FICO Score 8 via Experian gets approved for a $5,000 credit limit on a card which claims to only approve people with "good" credit, while another person with a 712 gets denied for the same card.

Still, this doesn't mean it's impossible to get a good card that serves you well. You just will have greater odds of doing so if you understand how all of this works. If you want to get a credit card, it is a great way to establish and improve your credit - but you should go into this with that goal in mind, not the goal of the illusion of having more money to spend.

So take a look at your credit reports, find out your credit scores, and meet me back here for Part 3.

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