Thursday, July 4, 2013

Messages From Readers: No credit could be just as bad as bad credit

What does a kitten have to do with personal finance and credit?
Absolutely nothing.

I've written a lot about credit, but I'm only 20 and have had a credit history for about five months. It's really nice to hear from people who are older than me, and here is a message from such a person detailing some personal experience. 

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"In one post you (nearly) recommended not to use credit at all.  I think there is some safety to this, but I don't think it's actually good advice.

Early on I was told that to establish credit, you need to acquire debt and pay it off on time. I took that to heart, got a credit card, and put all my day-to-day expenses on it (i.e. food, movies, etc. but not rent). I make sure I don't spend more than I have, and I pay it off every month completely and before the deadline.  It takes a little effort and planning, but the result is that I now have nearly perfect credit, which means I get excellent terms on car loans, etc. In contrast, if you have no significant credit history, even if you pay on time every month, you represent basically an unknown quantity to lendors, and they don't want to give you generous terms.

Please fact check me on this, as I may have been misinformed (by the lenders, maybe, I don't know). But this has been my experience, and no amount of careful planning and avoiding credit will save you money if you can't get a low-interest loan when you need it. (also, there's no harm in financing a car if you don't have the cash- just take the absolute highest monthly payment you can afford to avoid paying extra interest).


You didn't directly say not to get a credit card, but in this post: http://orphanreceptors.blogspot.com/2013/06/rewards-be-careful-what-youre-signing.html someone commented they were going to completely avoid credit cards until they got a good job, and you didn't disagree.  Aside from a general wariness in the most recent several posts, you also mentioned in the credit score post: http://orphanreceptors.blogspot.com/2013/06/ways-to-raise-and-lower-your-credit.html not to get close to your spending limit.  That's probably a good tip from a safety perspective, and honestly the debt utilization ratio being important is new information to me.

It just seemed that, to be balanced, you should mention that no credit is the same as bad credit from the perspective of actually doing anything with it.  It's important to actually establish credit early on, because it takes a long time, and that way you'll have it when you need it.



Also, don't be afraid to disagree with your commenters (or me) if we're wrong.  You're the expert!

- Anonymous

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I am pretty conservative when it comes to money, so I think I have been giving off the vibe that credit is bad. I do think that the root of financial problems for a lot of people is credit - either they go over their credit limits or they don't pay on time, etc. 

However, I didn't want to go ahead and recommend that people get credit cards to start building credit because obviously I have no idea who is reading my blog and what their habits are like. I definitely think credit cards are the easiest way to establish credit, but I also think that people need to understand the consequences of abusing a credit card before they sign up. 

As for the debt utilization ratio, here is some more information: 


Your credit score is made of many components, kind of like how your grades from all of your courses are weighted based on how many credits they're worth. Here is a chart from www.myfico.com, detailing what goes into your credit score. 

Screenshot from http://www.myfico.com/crediteducation/whatsinyourscore.aspx


There are a lot of details for each category, but here is one of the more important pieces of information I read:

"Someone who is close to "maxing out" several credit cards has a high credit utilization ratio and may have trouble making payments in the future." - http://www.myfico.com/CreditEducation/Amounts-Owed.aspx

In other words, this means that if you are really close to using up all of your credit, it reflects poorly on you and lenders will be uncertain if you can pay off all of your amounts owed. 

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As always, contact me with questions or suggestions! You can either comment directly on the post or send me an email to moneymattersjoan@gmail.com. 

Photo credit: Sergiu Bacioiu via photopin cc

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