Podcast: Obermeyer Wood's Dollars and Sense - Episode Five
Obermeyer Wood’s Dollars and Sense Podcast - Episode Five
In this episode, we talk about the importance of a credit score and how we can use financial products, such as credit cards, to further improve that score.
Effie:
What was your favorite game to play as a kid? Were you into Monopoly? Maybe Super Smash Bros? Or did you get really obsessed with Wii Sports because that was the only place you'd ever be a tennis prodigy? Maybe that's just me. Whether you're super into video games now, or begrudgingly pick up Pictionary for every family event, there is one thing that we all know about games. Whoever has the highest score wins. Wait, what does this have to do with personal finance? Surprisingly enough, there is a number that determines a big chunk of your financial life, and that is a credit score.
Effie:
Obermeyer Wood Investment Council presents Dollars and Sense, a podcast where we talk about our dollars in a way that makes sense.
Effie:
Welcome to the game of life. Not the board game, but follow along, will you? Your task, player number one, is to have the highest credit score possible. You're probably thinking, what is a credit score and why do I need one?
Effie:
Your credit score is a number that is used to determine how credible you are to lending institutions. Let's say you want a house or a car, but you don't have all the money up front you need to purchase those. When you apply for a mortgage or a car loan, lenders look at your credit score to determine whether you have been approved for the loan, also the interest rate that you'll end up paying on that loan. The higher your credit score, the more likely you are to get approved-
Effie:
... as well as get a lower interest rate. You may not be thinking of purchasing those items now, but it's great to start building your credit score now, so that you can purchase those in the future.
Luke:
I didn't actually need my credit score, truly, until I was 26 years old, when I bought our first condo.
Effie:
There are actually two types of credit scores, your FICO score and your Vantage score. Oftentimes when people are referring to your credit score, they're talking about your FICO. So, that's the one that we'll be focusing on in this episode.
Effie:
Then what are the rules of the game? How can I get the best FICO score ever? Alrighty, let's break down how a FICO score is calculated.
Effie:
There are five things that make up your credit score. First, your payment history. Second, the amount of money you owe. Third, the length of your credit history. Fourth, any new credit that you've applied for, and fifth, the mix of credit that you have.
Effie:
Let's start off with payment history. Now this makes up 35% of your credit score, so it's pretty important.
Ali:
You should start considering doing a credit score when you're ready to be credit worthy. The worst thing to do is have a credit score and actually not have it very high, because you forget to pay your bills on time, or you have an overdraft on your bank. Because it's really hard to dig out of a bad credit score. So, the best time to have a credit score is when you're ready to be able to send in payments on time and things like that, because you want to build it for the future.
Effie:
Creditors definitely want to make sure that you're paying your bills on time. This is often the biggest trap that a lot of people fall into, so definitely take note.
Effie:
The next aspect to your credit score is the amount of money you owe compared to your credit limit. A credit limit is the maximum amount of money that you could use that's being lended to you by an institution. So let's think credit cards, right? If you have a credit card and the credit limit is a thousand dollars, you're unable to spend more than a thousand dollars until you start paying off the money that you owed. Speaking of credit cards, that's actually a good way to increase your credit score.
Brian:
You want to start building a good credit score, right? The best place to start with that might be to look at opening a credit card.
Effie:
By taking out a credit card, you're not only increasing your credit limit, but you'll have more opportunities to show that you can pay payments on time.
Brian:
So what I would say is pick one credit card that you think you can get. Apply for it, open it, and start spending responsibly on it. Another thing you want to keep in mind is that you want to make payments on time. You want to think of spending responsibly and making on time payments to your credit card company as the financial gym that you go to that's going to make your credit score stronger over time.
Kimbo:
If you have a credit card, there's also benefits. If you don't go crazy, but benefits like points. There's great credit cards out there that, in the course of just living, you're able to rack up points.
Effie:
Although credit cards are a great way to start building up your credit score, there's a few things that you want to keep in mind when using them, namely interest.
Luke:
I understand why people are anti credit cards because I think that it preys on people that don't necessarily understand credit, and understand what happens when you don't pay your credit card bill. Interest rates on credit cards are like 26%, so if you let that go for months and months and months, you're digging yourself into a trench that's going to be incredibly difficult to get out of.
Effie:
Some of these interest rates, especially for store credit cards, are notoriously high. It's definitely more than a good idea to pay off your full balance every month, so you don't get sucked into all these high interest rates.
Luke:
If you understand discipline, and financing, and how to pay off a credit card, it's very similar to having a debit card, in that sense. As long as you are aware of what you're spending on it, you are not spending more than you are making, and you're paying it off monthly, that is truly the best way to build credit, in my opinion.
Kimbo:
It takes discipline to be able to pay that thing off every month.
Brian:
Some other options would be becoming an authorized user on one of your parents' credit cards. So, your parents can basically say to the credit card company that they currently work with, "Hey, will you add my child to my credit card account?" Go get a credit card in your own name that's tied to their account. Another option would be opening a student credit card, which a lot of financial institutions or credit unions will offer.
Mikaela:
So, I was in the camp of, I had a credit card in high school.
Effie:
This is Mikaela.
Mikaela:
My name is Mikaela. I am on the investments team. This is my third week, I think, at OWIC. I had a credit card in high school that was set up to my mom's account, but in my name. I think that is a really important step, if you're lucky enough to have a parent that will want to sponsor that for you. That's a great way to start building your credit early.
Effie:
Another way to increase your credit limit is to ask your bank for a line of credit.
Kimbo:
So a line of credit is essentially like a credit card, but they're using your bank account balance as sort of collateral, per se. You could ask for a line of credit of a few hundred dollars that is linked to your checking account that has income coming in all the time. But you could use that, and then just pay it back to just show that you're capable of paying back something that somebody has loaned to you.
Effie:
The third thing that impacts your score is length of credit history. The longer you've had credit, the more credible you seem.
Nick:
I know if you close a credit card, for example, I think that's a ding against your account.
Effie:
Yes, Nick is correct. By closing a credit card, you are actually shortening your length of credit, which is why it counts against your good credit score.
Kimbo:
Never close a credit card because that is part of your debt to income ratio essentially, or your credit utilization score. So if you don't want to use it, here's a good tip. You just throw it in the freezer. You freeze it in a little cup of water or whatever
Effie:
Physically?
Kimbo:
Yeah. You physically freeze it. I read this summer. I don't know if it's Ramit Sethi too, but I read it somewhere and I was like, "Oh, that's a good way to ... you're not closing it because you don't want to get rid of that credit limit that you have. But every time you're only using a certain amount of your credit, if your credit available to you can just get rid of the credit card in that way.
Effie:
The fourth aspect of your credit score is how often you apply for new credit.
Brian:
One thing that I would caution against is trying to open too many credit cards at once. That is something that credit bureaus do not look at favorably.
Effie:
There are two terms that I think are very important when it comes to credit score, a soft pull and a hard pull. So when you end up looking for more credit or looking to borrow some more money, the lender usually does a soft or a hard pull. The difference between the two is that a hard pull does affect your credit while a soft pull does not. So ideally you'd prefer a soft pull.
Effie:
And the last aspect that determines your credit score is the mix of credit that you have. Lenders like to see this mixture so they can see how you handle different kinds of credit.
Effie:
Now that you know all five factors that affect your credit score, here are a few tips and tricks that you can use to boost your credit.
Effie:
Some experts suggest that you should use less than 30% of your credit limit. That means if your credit limit's $300, then use about a hundred or less of that.
Brian:
If your credit utilization percentage is high, which would be usually be above 30% of the available credit that you have, then it could actually start negatively impacting your overall credit score.
Effie:
Another tip is to view your credit report annually. You can get a free copy at annualcreditreport.com. This way you can double check to make sure that everything looks correct from your end. And lastly, you can use a variety of apps that help you track your credit score, almost in real time. And yes, some of these, if not all, take time. So be patient, your credit score will improve and eventually you'll level up.
Effie:
The Obermeyer Woods Dollars and Cents Podcast is created by Obermeyer Wood Investment Council, an SCC registered investment advisor. The information provided is for informational and educational purposes only, and does not constitute financial investment tax or legal advice. Statements by individuals Reflect only their views and not those of Obermeyer Wood Investment Council, LLLP. The information in this podcast is not intended as investment recommendation or financial planning advice. It should not be used to make investment decisions. For more information about Obermeyer Wood Investment Council and its services, please visit us on the web www.obermeyerwood.com.