Why didn’t they teach us this?! Understanding Credit and Buying assets w/ no money
Why didn’t they teach us this?!
For most of us, credit is one of those topics that get a cold shoulder. Mainly because most of us are sometimes scared to look at our scores. Some of us have even had our own family members open up credit in our names only to set us up for future failures. Credit can be the one thing that turns your life around financially and now that I have a better understanding of it, I intend to use it to my advantage. Whether buying a home or buying an investment property, credit helps you access money you don’t have. So why didn’t they “teach” us about credit?
1. It’s the banks business plan and one of the many ways they make money – debt
2. With a little knowledge, it financially empowers those who think of themselves as incapable – so “they” conceal that knowledge.
3. Ownership = control … and “they” want to stay in control.
Your credit score is your access to assets. (Wealth building tools).
But, many people use credit for access to consumerism. (Wealth destroying tools).
In my eyes, credit should be used for two things and two things only: Purchasing more assets and true emergencies.
We’re generally familiar with the three credit bureaus; TransUnion, Equifax, and Experian and while they all have their own algorithms for calculating your credit score, they all follow the same protocol.
Your score is calculated based on 5 factors:
Credit Payment History – 35% of your score
Plain and simple, have you made all your payments on time? Do you have a solid track record of paying your bills? This is the largest category and any delinquent accounts or missed payments will drastically impact your score. Don’t let this be the reason you can’t compete in the credit game!
Credit Utilization Rate – 30% of your score
You can calculate your credit utilization rate by taking the total amount that you owe on your credit cards vs. your credit line available to you. For example, if you have a total credit card line of $10,000 (whether all on one card or the sum of a few cards), but you have a current balance of $8,000, then your credit utilization rate is at 80%. Financial experts believe a good utilization rate for a healthy score is between 10-20%. Most will say anything under 30% is Ok for your score, but when you strive for better, you get better.
With the same $8,000 balance, but with a total credit line of $40,000, the credit utilization rate is now at 20% which is a much better rate even with the same $8,000 balance.
Length of Credit – 15% of your score
The credit bureaus will take into consideration how long your credit accounts have been open and active. They favor those who have established a longer credit history as time gives them more of an idea of what type of credit habits the borrower has.
Credit Type – 10% of your score
There are two main types of credit accounts: Installment and Revolving. An easy way to decipher between the two is identifying which credit accounts have an end and which can keep going forever. Car payments, student loans, mortgages, etc. are types of installment loans. Once they are paid off, they’re paid off. Credit cards, store cards, gas cards, etc are revolving credit; they can be used continuously as long as the balance doesn’t hit their limit.
An important note regarding your credit utilization rate. Revolving credit will have a more significant impact on your credit utilization rate than installment credit.
Inquiries – 10% of your score
The more inquiries or applications for credit you go after, the more strain it will put on your credit report. The credit bureaus understand that a borrower may shop around for different rates when, say, looking to purchase a home so the negative effects won’t kick in right at the time of filling out an application so you may even be able to have a few inquiries within a certain time window without affecting your score. But if you’re financing a car one month, requesting a new credit card the next month, a mortgage the next month, and then applying for a store card the following month, your score, at least in this category, will be under scrutiny.
Hacks to improve your score
With the above information, we have the basics to help improve our score at anytime, but the basics can take more time than desired. There are a few credit hacks that can help speed up the process immediately.
I’m a strong believer in the 80/20 rule and in this case 80% of your credit score is comprised of your payment history, utilization rate, and length of your credit history.
If you’ve already missed a payment, you can’t do anything about the past so going forward don’t miss another payment by any means necessary.
If you’ve just started using credit and don’t have much of a history don’t be worried. It’s only 15% of your score and if you’re strong in the other areas, they will help support a brief credit history.
One of the easiest ways I learned how to improve my score was to gain more access to revolving credit.
Basically, raise your credit limits.
When you ask your credit card company to raise your limit, you are simultaneously setting yourself up for a lower credit utilization rate which helps considering your credit use is 30% of your credit score. The quickest way to raise your score in a short amount of time is to raise your total line of credit. This becomes helpful if your credit score is in a position to request a higher limit.
If not, then you also have the opportunity to increase your credit score by “renting” someone else’s credit card.
Any individual who owns a credit card can make someone an authorized user on their card. Therefore, if I made my wife an authorized user on one of my credit cards, that credit card will show up on her credit report on the next billing cycle.
The key is to find someone with great credit and as a result, you’ll be able to “rent” their credit by becoming an authorized user on their account.
Using Credit to Purchase Assets
When purchasing your dream home, you’ll get a much more favorable interest rate when you have great credit, which will cheapen your monthly mortgage payment. If you’re an investor, this will give you access to more cash to fund your investment deals. If you’re an entrepreneur, credit gives you access to cash you normally wouldn’t have lying around and then using those funds to buy income-producing assets whether that’s real estate or other businesses.
Some people were born into boatloads of cash where they can make purchases of any magnitude with ease. The wealthy even understand that if they did, they’d still use the banks’ money against itself.
I wasn’t born into that type of family and neither were many other people so we’ll have to get creative.
The banks use our money for purchases and investments, it’s time we use the bank against itself and it starts with our credit!