credit building question

[Lickitysplit]

When the RE market has cooled sufficiently (or when I get fed up and move elsewhere), I will purchase my first house. I want to make sure I’ve done everything I can to build up my credit score in preparation for that first morgage.

I’m sure we all understand the basic principle of credit scores, in that they seek to quantify your value as a borrower. I’m sure we also all understand the basics associated with protecting your credit score; pay all your bills on time. What I don’t understand is some of the more nuanced aspects of the scoring process.

For instance, I’ve had only a VISA check card for around 15 years. I didn’t like the idea of having the option of spending money I didn’t necessarily have, and hate the idea of paying interest unless absolutely necessary (more on that later). I didn’t realize until about a year ago that not having a true credit card was impeding my credit. I didn’t realize that you need credit to build credit; that just paying your bills on time doesn’t do it. So I got a credit card (high rate, “first time borrower” card, what an insult) and use it a couple times a month solely to help establish more credit history. I pay no annual fees and no interest as I have it set to pay in full automatically every month. Sure wish someone had explained this to me 10 yrs ago.

My only current debt is the remnants of a student loan. It’s adjustable rate, and currently sitting at 7.140%. I’d like to pay it off now and be debt-free, but am not sure if that is the best play. I’ve heard that having a loan in repayment is good for your credit. But… I hate losing money to interest. Anyone out there know how this works? How would my scoreing differ between paying the monthly amount, paying a big part now then continuing to pay the monthly amount for a year or two to kill it, and paying it off immediately?

[Carlsbadliving]

Paying it off immediately wouldn’t help your credit score. You’re better off to try to refinance to a better fixed rate. I know that typically college loans can be financed at pretty low rates. I know that my wife was able to get hers down to 3.4% or something like that. That was a few years ago so obviously it would be higher than that.

I’d also suggest you use your credit card regurarly. As long as you have self control it’s actually a good idea to use a credit card. We have no annual fees, pay it off every month, and get cash back. If our minds, we’re actually making money from the credit card company. Plus it looks good on our credit.

I agree though, the credit world is very tricky. You’ve got to have credit to get credit. I’ve always joked with my parents that they’d have trouble getting a loan.. house is paid off, pay cash for cars. It’s definetly good to have at least some debt constantly going to prove you can make payments.

[powayseller]

Your credit score rises with the length of time you’ve had each card, and the amount of unused credit.

Switching cards to get the next 0% deal is not so good, because now you’ve got a new card without a history. Closing an old card is not good either, because you lose the established card that has a history.

Having $20K of credit, with only $2K on it, is actually good. This example shows that you have a high credit limit, but are using only a little bit.

I am writing this off the cuff, based on what I remember reading recently, so please don’t quote me exactly on this stuff. I wanted to point out the nuances of having established cards that are spent much below the limit.

[lindismith]

I noticed my credit improved when I started using an American Express card a few years ago. Perhaps because it forces the user to pay it in full every month.

[Lickitysplit]

PS, Your understanding matches mine, aka the stuff I really wish I had learned 10 yrs ago 🙂

Part of the insult from the bank was how little they extended to me on this “first timers” card… the card limit is equivalent to about 5% of the funds I had AT THAT BANK at the time, and that ratio has been halved since. At least they didn’t make me secure it. Others, if you can believe it, were worse. All this with no dings on my credit report, just “no prior history with a credit card”, even though I’ve carried a VISA check card since the early 90’s. As it is the limit is so low that if I used it instead of always reaching for my check card I’d max it out and have to pay it off at least every other week.

I was offered an unusual alternate attack which I’m doing in addition to the hoop-jumping with the beginner card. A very dear friend offered to make me joint on their well-established, high limit, low balance, always-paid off platinum card. Yes this requires an incredible amount of trust and responsibility, which fortunately we have, as we are both 100% liable for the account usage. I would not suggest that anyone actively look to build credit this way, this just happened to be a good fit for us.

I feel I’ve got the credit card approach in good order. The joint account establishes good credit line, and I’m building personal history with my bank’s credit card. The beginner card will be transitioned into a higher limit, lower rate card in the not-to-distant future without sacrificing the history established. Hopefully a few folks out there with thought processes similar to mine read this and are better informed as a result.

I’m still curious to hear more thoughts on the student loan though. The current 7.14% rate is the national average for out-of-school stafford loans, and taking a quick look around it looks to be the going rate.

[an]

What I would do with the 7.14% student loan is to open a new credit card with those 0% balance transfer offers. You can pay it all off by the deadline to eliminate your debt interest free. At the same time, the additional credit card will improve your credit history as time goes on. Of course opening up alot periodically doesn’t help, but since you don’t have alot of credit history, it might be ok to open a bunch at once, so in 18 months from now, those cards won’t be a negative mark on your record anymore. They then inturn help your credit because after 18 months, you’ll establish a longer credit history and have a lot of credit available. If you don’t spend/use it, then your debt/credit available ratio would be low, which will also help increase your credit too.

[powayseller]

From his comments, I doubt he is getting any 0% offers. He doesn’t have established credit. Interesting idea, though.

Can you transfer student loans to credit cards? If you use the free checks, then don’t you pay a higher rate, i.e. the cash advance fees. To get the 0%, you have to make a balance transfer and give the other credit card account number and it’s done electronically.

[carlislematthew]

There have been some really good replies so far, but I’ll add my experience too.

I was in a similar situation about 3 years ago. I arrived from England in 1999, didn’t need credit and didn’t want it anyway. A couple of years later, I realized that I needed a credit history and did some research. Here’s what I did (that got me up to to a FICO of about 700 in a year). I have included some general advice too.

1) Got a crappy VISA card with $250 limit and $75 annual fee! After one year they waived the fee..

2) Got a SECURED credit card through my bank. No annual fee. They took $300 of my money and gave me a $300 credit limit. Make sure that they report the account to credit agencies – they usually do.

3) Bought a car and financed a small portion. While others were getting 2.9%, I got 7.9%. Pay off loan regularly, as agreed.

4) Paid off all credit line accounts every month – carrying a balance on credit line doesn’t help your score (I’ve been told that by a few financial advisors).

5) Try and not use too much of your credit – like under 30% if possible. Tricky when you only have $500 of credit, but it’ll get easier once they start to trust you.

6) Get 2 or 3 credit cards, keep them (age of accounts is a critical score measure), and every six months or so you’ll find your limit increasing. If it doesn’t after some time, then call the credit company and ask them if they’ll increase it.

7) Do not go crazy with store cards. The temptation to get that 10% off is high, but don’t do it if you’re planning on needing a good score in the next couple of years. It will cost you more in the long run with a higher interest rate.

8) Do not open new accounts all the time, and don’t go for mortgage pre-approvals unless you’re serious about it. Just check your FICO score every 6 months… These “inquiries” can count against your score. Someone looking for more credit is more likely to get into more debt! That’s the theory anyway… Your FICO score “inquiries” do NOT count against you.

In general, you should have lots of old, established credit (but not “too” much, whatever that is), not be using the bulk of it, be paying it back on time ALWAYS, and not be looking to borrow more.

FYI – I’ve got about 5 years of credit history now and my FICO is 785. After 2 or 3 years I was in the 700s.

[Lickitysplit]

Thanks to all responders thusfar…

I do get 0% balance transfer offers in the mail every week, just threw a few out yesterday. I don’t know how the balance transfer would work with stafford loans. Also, the 0% balance transfer lasts 1 yr, then goes to somewhere around 11%, so it would just push my payoff out that additional distance. While it would save some interest if I don’t pay it off now, I don’t see how delaying the payoff 1yr helps my credit. Perhaps it does, but I don’t understand how that would work. I also wonder how truly “preapproved” I really am given my previous experience, and I don’t care to be denied credit or have unnecessary credit checks. It is my understanding that each credit check lowers your score 5 points. Oh, and my credit score was 690 when the credit card fun was going on… should be higher now after 9 mo of responsible plastic activity. I don’t understand how a clean report and 690 score = “risky”, but there you have it.

I’m hesitant to get any more credit cards… I have two now in addition to the check card (detailed previously), and I don’t see how lots of plastic could be interpreted as “responsible”. Obviously my gut instints on credit have not been 100% on, so if anyone could speak to credit reporting’s “ideal” plastic setup (# cards, total limit/income, balance/total limit, etc) that would be quite informative.

I’ve thought (briefly) about getting a small loan just to pay it off to build credit, however I’m not convinced the ROI is really there as I don’t need a loan for anything short of a home purchase. My vehicles were purchased with cash and I have no need nor much desire to increase my transportation costs. 😛

Perhaps the answer is to keep the 7.14% stafford, pay $100 for the Zeal monthly, and add the payoff amount to my investments! If my ROI w/ Zeal’s recommendation is above the loan rate, this makes sense. If not… oops. 🙂

[an]

PS: I don’t think you can do a balance transfer directly. However, there are ways around it. Cards from Citibank will allow you to send yourself a check, and there is no fee for your balance transfer. For other cards/banks, there is a fee and you can only send it to another credit card. So what you can do is transfer $ to your citi card, then send yourself a check for that amount.

Lickitysplit: The reason why I suggested the 0% balance transfer is because it will save you $ on interest. Of course the balance transfer would not increase your credit, but having one or more cards being paid on time for a year would. Those additional card(s) will make your credit history longer. The length of your credit history is one factor in determining the score. Like I discussed before, one other factor is the debt to available credit ratio. The lower that number is the better, which will also increase your score. In order to have that ratio low, you would have to have alot of available credit. Only way to do that is to get more credit cards. Remember, this method I’m suggesting assume you pay off your loan w/in the period of that 0% offer. If you don’t, then they would charge you for the interest during that period after the into period is over. So be careful.

[Lickitysplit]

asianautica: Thank you for the suggestions & clarifications, they are much appreciated. I certainly want to cut back the interest paid, either by paying it off now or through a creative balance transfer as you suggest. This option has the benefit of allowing me to still invest the payoff amount, but need only to show a positive return to come out ahead.

I’m confused on how additional cards would make my credit history “longer”. Are they additive, i.e. one card for two years = two card for one year, or some variation there of? If so, additional cards make sense to play catch-up, but again this is counter intuitive to me.

[an]

I’m almost certain it’s additive. Because accord to my credit history, it say I have 19-20 years of credit history, and I’m only 26. I do have several cards. So it only make sense that it’s additive. Remember, new cards/loan only hurt your credit the first 18 months, after that, it becomes helpful to your credit. So if you must open new cards, I suggest open all you would open in one shot, so 18 months from now, there would be no negative marks on your record. If you stagger them, then that period would be much longer.

[Lickitysplit]

Just found these MSN Money articles that are quite relevent:

4 steps to building great credit

9 ways to build a killer credit score

The articles contain much of what has been suggested here, but do have some additional detail. Key additions:

…the two most important factors in your score are:

* Whether you pay your bills on time.
* How much of your available credit you actually use.

* Apply for department store and gasoline cards. These are usually easier to get than major bank credit cards such as Visa or MasterCard.

* Once you’ve been approved for one card or loan, don’t rush out and apply for several more. Applying for too much credit will hurt, rather than help, your score. Most people need only one or two bank cards, a gasoline card and a department store card, acquired over a year or more, to start a solid credit history.

* Don’t max out your credit cards. In fact, don’t even come close. Try to avoid using more than 30% or so of the credit you have available to you — even less, if you can. Your credit score measures the difference between the credit available to you and what you’re actually using. The smaller that gap, the more it hurts your score. Lenders will worry that you’re becoming overextended and won’t be able to pay your bills if you charge too much.

[carlislematthew]

Additional *credit* is additive, but adding more cards just makes the average age of your credit less, which is bad.

[Anonymous]

Usually lenders like to see three active trade lines when looking at your credit. So you don’t need to go crazy opening credit lines, but you ahould have at least three.

As an aside, underwriting standards have gotten so lax that some lenders have considered active collection accounts an active trade line!! How ridiculous is that???

[Author]

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