The Transparency Series: A Beginner’s Guide To Understanding Credit

"Paying your debt on time takes the stress out of blocking those debt collector calls and wondering if your friend, who you know is waiting for you to contribute to gas, has been stale because you haven’t paid up."

Everybody talkin’ ‘bout credit! “Get your credit up! You can’t buy this without a good credit score? You gotta have credit!”

This begs the question: What is credit and why is it so important all of a sudden? The truth is, credit is and has always been important. And while you may have been introduced to it through college loans or an early credit card, the importance of credit must be known now as it greatly be impacts your life, from purchasing airline tickets to purchasing a home. So, what exactly is credit?

Credit is trust. Credit is a contract between you and a lender (Mom, Bank, Investor, etc.) that binds you to paying back whatever was lent to you (some money, a car, jewelry, etc.) in a specified amount of time, so not to break that trust. Trust is built and maintained by consistently returning these borrowed goods on time. The more you pay your debt on time (on-time payments), the more debt you’ll be allowed to take on (credit line), the more other lenders will trust you (options), and the more likely you’ll pay less on what you borrowed in the long term, (interest).

“The ability to take on more debt is based on a progression up a set of proportionally uneven stairs. Each stair represents a credit line amount. You have to build the trust of the lender to get to the next step.”

Credit is based on the demonstrated responsibility to manage borrowed collateral or funds and return those funds, sometimes with an additional fee for borrowing.

It’s also not calculated equally – certain factors are more beneficial or detrimental to your credit score. Look at it this way, you have a pie cut up by your friend who doesn’t eat corners and sides, and cuts a piece for them self. The pizza now is unequal and sometimes messy–just like credit.

Credit is made up of 5 factors broken into percentages:

35% Payment History

There are two types of friends — the type that you let borrow your clothes because they always return them in a timely manner, and then, there is the friend who you let borrow one of your favorite garments but you never see it again…until, 5 years later at your college reunion. You see the garment out of its original shape and with a swash of irregular stains. Don’t be the second friend.

Paying your debt on time takes the stress out of blocking those debt collector calls and wondering if your friend, who you know is waiting for you to contribute to gas, has been stale because you haven’t paid up.

What you can do:

  • Budget – Account for all of your debt and fixed expenses before spending a night with Shonda and Vino.
  • Set up auto-withdrawal – Once you know the debt is to be paid, let the robots do the exchange for you.

30% Amount of Debt

Do you owe Sallie Mae a few hundred, your mom $50, or a $2000 payment on a $500,000 mortgage? The ability to take on more debt is based on a progression up a set of proportionally uneven stairs. Each stair represents a credit line amount. You have to build the trust of the lender to get to the next step. (30%)

What you can do:

  • Keep your debt under control by only using what you need and having a plan to pay that back. HAVE A PLAN TO PAY YOUR BORROWING BACK!
  • Keep your debt utilization at 30% or lower. (exp. $1,000 limit, use $300 or less).

15% Credit History (Length)

How long have you been a borrower?

  • Check this using the account you made on one of these sites 1, 2, 3.
  • Pay off your debts, yes, but don’t close the credit card(s) that has been open the longest. It’ll drop your history and your credit score.

10% Amount of New Credit

How recently were you granted a line of credit? (10%)

  • Only if you need one (you do to build credit), have no more than 3 active credits in which you’re utilizing no more than 30% of the credit line

10% Credit Mix

The credit line you were granted, what was it for? Car loan, House loan, School loan, Clothes, etc.

  • Your mix of credit gives lenders an understanding of your ability to manage various types of debt.

The Credit Spectrum: What Your Scores Mean

If you’re on the 650 and below end, you either haven’t had the opportunity to build trust or have a difficult time managing.

Up to 750, you’re doing alright, you pay less in fees and interest than the former.

Everything beyond 750, well you don’t get many nos, do you?

Depending on where you are on the spectrum raising your score becomes increasingly more difficult as you get closer to the 800.

Here are a few ways you can have an impact now:

  1. View credit report, understand your score and credit mix
    1. If you notice any discrepancies call and politely, but firmly request for it to be removed. I found this to be particularly helpful in this situation
    2. See if they’ll remove any delinquencies you’ve handled
  2. If you haven’t established any credit, apply for a secure credit card or one with a low limit, to get going. You could use this for small bills like utilities that you normally pay every month.
  3. Get caught up:
    1. Missed a few payments? Each missed payment stays on your report for 7 years. Allocate these payments as a fixed expense in your budget.
    2. Paying on time is essential, set up auto draft.
  4. Stay under your credit limit
    1. Less than 30% utilization
    2. Make two small payments each month to cover your statement balance
    3. Ask for a credit limit increase (said cautiously)

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Imani Johnson is a writer based in Los Angeles, California.

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