As I mentioned many times before, I moved to the United States in 2012. Back then, you were able to purchase a brand new iPhone for “just” $199 (plus a 2-year contract, of course). As an Apple lover, I couldn’t wait to get my hands on the shiny new device.
I went to Apple’s website, chose the model I wanted and started the checkout process. At some point, it asked me for my social security number, which I happily provided. Right before finalizing the purchase, a popup appeared saying it was verifying my eligibility. A few seconds later, boom! “Your application was DENIED”. My credit score wasn’t high enough for me to get a phone with a wireless plan. In fact, I didn’t have a score at all!
This same thing repeated over and over again during the first few after I arrived in the U.S. Opening a credit card, renting an apartment, setting up gas and electricity (also known as utilities). All denied due to lack of credit. It took me a while to get my head around this concept and understand how the system works.
What Is This Whole Credit Thing All About?
Suppose you need to buy a car, but you don’t have the cash to pay for it in full. You will go to the bank and ask for an auto loan. The bank will give you the money upfront and you will promise to pay them back later, in monthly installments. Similarly, when you sign up for a cell phone plan, the carrier will let you use their services for a whole month before you have to pay for it. This same concept applies to a lot of other things such as credit cards, leases, and utilities.
On the other side of these transactions, these businesses are taking a big risk by lending you money or providing you with goods or services before you pay for them. What if you just never pay them back? Sure, they can take legal actions and sometimes seize your property, but still, they are going to lose a lot of money in the process. Businesses need a way to assess the likelihood of you paying them back so that they can control their risks. In other words, they need a way to determine your creditworthiness.
In the U.S., the way this is accomplished is through your credit history. Lenders and service providers alike pull what’s called a credit report where they can see your credit history as well as your credit score. With this information at hand, businesses can quite accurately determine the amount of risk involved in doing business with you.
This is a critical component of the financial system in the U.S. that you will most likely be dealing with frequently. Learning the ins and outs of the credit system will help you keep your credit history in great shape and can save you a lot of money down the road.
Understanding Your Credit Report
Your credit report, as the name suggests, is a very detailed report of your credit history. Lenders and other businesses use your credit report to get a sense of how you have handled your finances, more specifically, your debts.
In addition to details about your credit cards and loans, your credit report also includes other information such as personal information and other public records. Let’s take a look at everything that’s in your credit report. Due to the distributed nature (more on this later) of your credit report, not all information is present in all of your credit reports.
The first section of your credit report is all about you. It includes the following information:
- Social security number;
- Name, including all names you have ever used, typos, and different combinations of your first, middle and last names;
- Current and previous addresses you lived at;
- Date of birth. Some reports will only include the year, not the full date;
- Current and all previous phone numbers associated with you;
- Employer, including current and previous employers.
This is the meat of your credit report. It lists every credit card and loan, current or previous, you have in your name. Credit cards and loans are called accounts and the report lists the following information for each of them, regardless of the type:
- Account name, which is usually the name of the financial institution;
- Account number, such as the credit card number, loan number, etc. This information is redacted and only a few digits are present in the report;
- Account type. For instance, mortgage, credit card, auto loan, student loan, etc;
- Whether you own the account individually, jointly, or if you are just an authorized user on the account with no repayment obligation;
- The date you opened the account;
- Whether the account is opened or closed. It also notes if you have always paid this account on time, if it was sent to collection, or if it was included in a bankruptcy.
- Date the account status was last updated;
- Current account balance and the date it was last updated;
- Date of your most recent payment;
- The date the account, if closed, will be removed from your credit history (accounts stay in your records only for a limited number of years once it is closed);
- A list of all payments you have made to this account. It includes the amount and whether the payment was made on time or not;
- A month by month breakdown of your account balance;
- Address and telephone of the financial institution where the account is held;
- General remarks about the account.
For credit card accounts, some additional information is also listed:
- The total credit limit;
- The maximum balance you ever carried.
Loan accounts, such as a mortgage, have some additional information of their own:
- The original value of your loan;
- Loan type, such as a conventional mortgage, auto loan, etc;
- The terms of your loan. For instance, 30-year mortgage, or 5-year auto loan;
- What the monthly payment for this account is;
- For mortgage accounts, it will list the agency name, which is usually Freddie Mac or Fannie Mae.
A credit inquiry, also known as a credit pull, is when someone requests a copy of your credit report. Your credit report will include a list of all credit inquiries you received.
There are two types of credit inquiries:
- Hard inquiries: This type of inquiry is generally associated with a credit card or loan application. The financial institution will pull your report as part of its decision-making process. Hard inquiries may negatively affect your credit score and will remain in your report for at least two years;
- Soft inquiries: Usually associated with companies checking your credit report to see if you qualify for certain “offers”, or as part of a background check when you apply for a new job. A soft inquiry also happens when you check your own credit report. This type of inquiry does not affect your credit score and is only visible to you when you pull your credit report.
This is the section of your credit report you want to make sure is always empty. That’s because the public records section lists major debt-related delinquencies, such as bankruptcy, a judgment against you, or a tax lien. Depending on the state where you live, your credit report also lists foreclosures and repossessions.
Public records entries generally stay in your credit report for seven years and they severely affect your credit score. Some entries might stay for even longer. Chapter 7 bankruptcy, for example, can stay in your report for ten years. In some cases, certain delinquencies can stay in your report for fifteen years!
Having a public record delinquency listed in your credit report can severely limit your ability to obtain a loan, credit card, or even renting a house.
Your Credit Score and How It Is Calculated
Your credit score is a three-digit number that a lender can request along with your credit report. This number, which usually ranges from 300 to 850, is based on your credit report and represents how healthy, or unhealthy, your credit history is. The higher the number, the better your credit is.
The first thing that lenders typically do is to look at your credit score to quickly gauge your creditworthiness. If it is too low, some lenders will not even look any further and will reject your application right away. On the other hand, if you have a good credit score, lenders might still dig deeper into your credit report before determining whether to approve or reject your application. A good credit score is essential but does not guarantee a lender will approve your application.
How Your Credit Score Is Calculated
Not all credit scores are created the same. There are two major credit score types that are used by most lenders: FICO Score and VantageScore. Each type has its way of calculating the score based on a combination of data from your credit report. Below is a list of what goes into the calculation of your credit score:
- Payment history: This tells lenders if you’ve been paying your credit obligations on time. A payment that is 30 or more days late will make a big dent in your credit score. Make sure to always pay your bills on time!
- Credit utilization: Just because you have a lot of credit available doesn’t mean you should use all of it. Consistently utilizing too much of your available credit can signal to lenders that you may be overextended and could be at a higher risk of not paying your obligations. Try keeping your credit card utilization low to avoid damaging your credit score.
- Length of credit history: Having 100% on-time payments on a couple of credit cards you opened 3 months ago is not that impressive. Lenders are more interested in a long history of on-time payments and responsible credit utilization. That’s why the length of your credit history is important. Note that the length is generally based on the oldest open account of your credit report or the average age of all open accounts. For this reason, it is sometimes not recommended for you to close that very first credit card your opened many years ago as it could impact the length of your credit history.
- Credit mix: Lenders also want to see that you have been exposed to a different mix of credit types, such as credit cards, mortgage, auto loan, student loan, retail lines of credit, etc. Just because you managed your credit cards well doesn’t mean you will handle a mortgage the same way. But don’t worry, you don’t have to have one of each.
- New credit: Opening too many lines of credit in a short period of time can signal to lenders that you are desperate for credit and therefore represent a higher risk. This is especially true for people with no or short credit history. Lenders will use the information about open accounts and the list of hard credit inquiries from your credit report to make a determination. Whenever possible, try not to open too many new accounts in a short period of time.
FICO Score was first introduced in 1989 by Fair, Isaac and Company. Today, it is the most widely-used credit score out there, used by the vast majority of lenders in the country. The table below shows a breakdown of what goes into the calculation of your FICO Score, which ranges from 300 to 850:
|Length of credit history||15%|
What Is A Good FICO Score
You already know that the FICO score ranges from 300 to 850. But what exactly is considered a good (or bad) score? The table below breaks it down for you.
|580 – 669||Fair|
|670 – 739||Good|
|740 – 799||Very Good|
While the higher the better, if your score falls within, or above, the Good range, you are in good shape. You will most likely not have much trouble getting approved for credit.
VantageScore was created in 2006 by the three credit agencies, also known as credit bureau: Experian, TransUnion, and Equifax. Similar to FICO Score, VantageScore also ranges from 300 to 850.
One of the biggest differences between the two scores is that VantageScore is single model that can work with the data from all three credit agencies instead of being custom-built to adapt to the different data structures from each agency. This drastically reduced, but not eliminated, the discrepancies between the scores obtained from the three different agencies.
Another difference is how the score is calculated. Here’s a breakdown of what goes into calculation your VantageScore:
|Credit utilization||Extremely Influential|
|Credit mix||Highly Influential|
|Payment History||Moderately Influential|
|Length of credit history||Less Influential|
|New credit||Less Influential|
What Is A Good VantageScore
Although the score range is the same as that of the FICO Score, what constitutes a good or bad VantageScore is slightly different. See the table below:
|< 500||Very Poor|
|500 – 600||Poor|
|601 – 660||Fair|
|661 – 780||Good|
Again, you should strive to have at least a Good score to avoid having trouble when applying for credit.
Where the Data Comes From
Your credit report contains very detailed information about your financial life. It includes things like your current credit card balances, loan payments information as well as some personal information. This might make you wonder: where does all this data come from?
There are three major companies, known as credit agencies or bureaus, responsible for collecting all this information and generating your credit report: Experian, TransUnion, and Equifax. Most of the information they have come from lenders themselves.
For example, when you open a credit card most financial institutions will send details about your current balance and payments to one or more bureaus. The same happens when you take out a loan. The lender will, in most cases, share your initial and current balance as well as payment information. These companies also gather information from your public records, such as bankruptcies.
Your information is then packaged and sold in the form of a credit report and credit score. Because the three companies are independent and not all lenders report your accounts to all three, your credit report, and therefore your credit score, vary from one bureau to another.
Why It Is Important to Have a Good Credit Score
Having a clean credit history and a good credit score is not just something nice to have. In the U.S., it is actually a very important thing to have. It is something that you should really put an effort towards.
While having a good credit score can unlock many benefits, such as access to loans with better interest rates, that’s not the only reason to strive for a good score. Not having a good credit score can make your life in the U.S. a little bit more difficult, and in most cases, more expensive. Below are some examples of why it is important to have a good credit score.
Renting an Apartment
When you rent a house or apartment, the landlord or property manager will usually pull your credit report before they decide whether to accept your application or not. They want to know if you are someone that pays your bills on time and is financially responsible.
If your credit is empty, or too short, they won’t be able to tell. Now, if your credit is a train wreck, that will certainly scare them. In either case, your application would most likely be rejected.
There are some ways around it, especially if you are still building your credit. You can offer to pay a few months’ rent in the form of a security deposit. Another option is to have someone with better credit than you co-sign the lease, which is not always an easy thing to do, especially for an immigrant.
Buying Big-Ticket Items Such As a Car or a Home
If you are on the market to buy a house or a car, odds are you will have to resort to financing. These items are very expensive and most people don’t have the means to pay for them in cash. That’s when your credit score comes into play.
When you go to your bank to apply for a loan, the first thing they do is pull your credit report and credit score. The better your score, the better the terms they can offer you. Having a bad score, or simply not having any score at all, can quite literally affect where you’re going to live.
If you don’t have a good credit score, the bank may determine it’s too risky to give you a loan. If they approve it, the interest rate on your loan will most likely be much higher than that of a person with a good credit score. A higher interest rate will then increase your monthly payment which can price you out of the house or car that you really want.
As a personal story, I just recently purchased a new vehicle for my family. Because I have always put an effort to nurture an excellent credit score (> 800), I was able to qualify for a 0% APR financing. This saved me at least $2,000 in interest over the life of the loan compared to someone without a good credit score that would not qualify for the special offer.
Getting a Credit Card
Some people love it. Some people hate it. But one thing is for sure: credit cards can be a very useful financial tool if you handle them responsibly.
Try renting a car without a credit card and you will probably wish you had one handy. They are also the safest way to pay for online purchases. In an emergency, you can tap on your credit card to cover certain expenses and possibly pay 0% interest depending on the card you have. All that without mentioning cashback and travel rewards!
But like most things, you need a good credit score to get a credit card. If you are looking to get the best credit cards out there, the ones with the best rewards and perks, or a card with a 0% APR, you will need an excellent credit score. Your credit score also impacts the limit you can get on your credit card. Usually, the higher your score, the higher the limit you will be approved for.
Once again, not having a good credit score can cost you real money when it comes to credit cards.
Purchasing Homeowners or Auto insurance
While not having a good credit score will not prevent you from getting insurance, most insurance companies will use a bad credit score against you. Your score will be used as part of their risk profile analysis and they tend to penalize, with a higher premium, applicants with a low credit score. This is yet another example of how not having a good score can cost you money.
Setting up Utilities or a Cell Phone Plan
As I mentioned at the beginning of this article, when you use gas, electricity, water, or even your cell phone plan, you are technically borrowing the service for a whole month. You only pay for it after you have already consumed the service. Because of that, these companies will want to make sure you pay your bill on time. They do that by, you guessed it, pulling your credit score. If you don’t have a good credit score they will most likely ask you for a security deposit.
A security deposit is a refundable payment you make upfront, usually for the amount of at least one month worth of service. Technically, the deposit converts a post-paid service into a prepaid service, thus, eliminating the risk of you not paying your bill. If you don’t pay, they will deduct it from your deposit and probably cut your service. They will usually return your deposit in full after a year, as long as you make all of your payments on time.
Applying for a Job
This one is a little controversial. While not very common, some employers will check the credit report of certain job applicants. This happens more often for positions that require some type of security clearance or access to the company’s sensitive information, such as financials.
Employers will not see your score but they can see your credit history and will be able to tell how you have been managing your finances. If your credit report shows lots of late payments, excessive debt, etc, this might turn your prospective employer off and it could cost you a job.
How to Check Your Credit Score
By now you should know how important it is to take good care of your credit history. To do that, you have to frequently monitor both your credit report and your credit score. There are many ways you can do that:
- Your bank or credit card company will usually tell you your FICO or Vantage credit score. They will sometimes show your score on your monthly statements. Some will provide you with your score even if you are not a client or cardholder. This article from NerdWallet lists what credit card companies offer a free credit score, and which type;
- Use a free credit score service such as CreditKarma, Credit Sesame, or NerdWallet. I personally use CreditKarma. Keep in mind that some other so-called “free” credit score services may force you to enroll in a free trial and if you don’t cancel it before it expires, you will be charged for their services;
- Buy your FICO credit score from myFICO;
- Get your free annual credit report from AnnualCreditReport.com. You are entitled to get a free copy of your credit report from all three bureaus once every 12 months. Note that you will not be able to see your score unless you pay some extra fees;
How to Build Your Credit From Scratch
Building credit can sometimes feel like a chicken-and-egg problem. You need a good credit score to get credit but in order to build a good credit score, well, you need to get credit. It is not as hard as it sounds though. Here’s a list of things you can do to start building your credit.
Apply For a Secured Credit Card
A secured credit card is similar to any other credit card, but in order to get a credit limit, you need to put in a deposit. For example, you put in a $500 deposit and you get a credit card with a $500 limit. It is the same concept I mentioned before, with utility companies. By putting in a deposit, you are pre-paying for your expenses and eliminating the risk for the credit card company.
This credit card, and all your payments, will be reported to the credit bureaus and you will start building your credit. Usually, after 12 months, unless you don’t pay your bills, the credit card company will return your deposit, in full, and finally, extend you a real credit limit. Here’s a list of secured credit cards you can choose from. The bank you have an account with can also usually give you a secured credit card. I personally got a Bank of America secured credit card back in 2012, which I still have until these days.
Become an Authorized User
Another good way of starting building your credit is asking for someone you trust to add you as an authorized user on their credit card. Most credit cards will report the card to the credit bureaus for all authorized users. This will give you a kick start on your credit-building journey. I’ve done that with my wife and when we checked her score, after many years, her score was excellent! And she never had any credit card of her own.
While being an authorized user on someone else’s credit card will certainly boost your credit score, you will at some point need to get your own credit card. Going back to my wife’s example, even though she had an excellent credit score, she had a hard time applying for the top credit cards. That’s because the financial institutions don’t look only at your score but the entire credit history. They could tell she didn’t have a card of her own. Make sure that, once you have a good score, you go ahead and get a credit card of your own.
Apply For Store Credit Cards
I’m personally not a big fan of store credit cards, but when it comes to building credit, they can come in handy. Retailers such as Macy’s, Kohl’s, Target, and many more, offer a branded credit card you can sign up for when shopping. They usually offer you a good discount as an incentive.
What makes these types of credit cards a good fit for those of you building credit is the fact that they are usually much easier to get approved for than a standard credit card. You just have to make sure the retailer you are applying for a credit card will report your information to the credit bureaus. Also, make sure to keep your usage low on these credit cards, as their limits tend to be smaller, and, of course, pay your bills on time.
Have Someone Co-Sign on a Loan
When you don’t have a good credit score, it’s hard to get approved for a loan. For example, if you just arrived in the U.S. and need to buy a car, it will be difficult for you to get an auto loan. Even if you do get it, the interest rate will most likely be outrageous. That’s when a co-signer can help. A co-signer will share the responsibility of paying the debt with you, therefore, their credit score will help you get approved for the loan. If you properly handle this loan, your credit score will get a big boost.
Because the co-signer shares the responsibility of paying the debt, it can be hard to find someone willing to co-sign. A co-signer can be on the hook and their credit score can take a hit should you not pay your monthly payments on time. It is still worth exploring this option though. Sometimes it can be your only choice.
Credit Builder Loans
A credit builder loan is a special type of loan where you do not have access to the money you are “borrowing” until you pay for it in full. For example, you get a $1,200 credit builder loan, for 12 months, with a monthly payment of $100. The bank will hold the $1,200 for the entire length of the loan and will only give it to you after your final payment, 12 months later. In the meantime, they will report this loan and all payment history to the credit bureaus, which helps you build your credit (and a small nest egg).
This type of loan is usually offered by small financial institutions such as community banks and credit unions. If you opt to go this route, make sure to shop around for the best rates and fees as they can vary substantially.
Make Sure to Pay Your Bills on Time
Absolutely nothing that you do matters if you don’t pay your bills on time. Payment history is the biggest factor that goes into your credit score calculation. If you want to build a good credit score, make sure to never miss a single payment.
Setting up auto-pay for all of your bills is a great way to ensure you don’t miss a payment. You spend a couple of minutes setting it up and then you don’t have to think about it anymore, drastically reducing the risk of missing a payment. You just need to make sure you have enough money in your bank account, of course.
Be Mindful When Applying For New Credit
When building your credit, be mindful when applying for new credit. If you open too many credit cards in a short period of time, it can backfire and hurt your credit score. The same applies to loans, but there’s one important thing to keep in mind. It is OK to shop around for rates when you’re taking a loan.
You can apply for a loan with multiple financial institutions in a short period of time. Each of these applications will show up in your credit report as a hard inquiry, but as long as they are all within a 45-day window, they will all count as a single inquiry and not hurt your credit score all that much. That is, assuming you don’t actually take more than one loan.
Credit is important. The sooner you understand it, the sooner you can start reaping the benefits of having a good credit score. I’ve heard many stories of people that are completely anti-credit, especially credit cards. They would avoid credit cards like the plague arguing that they don’t need them. Inevitably, sooner or later, they face the consequences and regret their decision.
This does not mean you should go out there and open a bunch of credit cards and start spending like there’s no tomorrow. That’s now what this is about. You should handle credit responsibly, never spend more than you can afford, and always pay your balances in full. Credit should be a financial tool to help you achieve your goals and even save money. You should not become a slave of it.