Hi friends,
What is credit? How do I grow my credit? I’m not even sure what other important questions I should be asking.
My parents are immigrants and I’m also one. I moved to the U.S when I was 11. Unfortunately my parents didn’t have the chances that I had and they didn’t get much of an education. Sometimes I feel like I’ve had to navigate a lot of life in the US by myself (SATs, college applications, school loans, etc.) on top of helping my parents navigate it too. I’m a young adult now and I don’t have any guidance and would really like to start thinking about my future. I think credit is a good place to start. Any info/advice is welcome, I literally barely know much about the system. Thank you.
In: 6
Presuming you are in the country legally and have a social security number, you need to start a banking relationship with a bank. They will report data about you to credit bureaus, that’s the data they use to calculate credit scores. Then you’ll need to get them to loan you some money. The easiest way to do that is a secured credit card. You put money, let’s say $300, into a bank account in exchange for a credit card with a $300 limit. This is better than just using a debit card on your account because it reports as “credit card”. Use the card, and then pay the bill. Every month you do that your credit takes a step from “unknown” towards “good”.
Credit is the willingness of other people to loan you money. A basic type of credit would be a credit card. The credit score is a way of taking note of how well you have paid back previous credit, how much credit you currently have relative to income and some other factors.
So let’s say that you have applied to me for a credit card. I look at your information in the credit bureaus and see that you have always paid your car loan on time, have never declared bankruptcy and have never had a loan go bad or get charged off. I see that your salary is 36,000 per year. So I decide that you can have the credit card with a $1000 limit. If you pay it in a timely manner and pay off the car loan, I would be willing to raise it to $2000 in a few years.
A credit score or a credit rating is a measure of how likely a credit agency thinks you are at paying back any loans (credit). A higher score is better. Anyone who ever loans you money, be it a credit card, car loan or just utility payments will report this back to the credit agencies. When you want a new loan these companies are able to pull your credit score from one of the credit agencies and based on your score they can decide what interest rate they want to give you if they even want to loan you.
There are lots of techniques going around for how to quickly get a good credit score but naturally these tricks get found out and they change the algorithm to give you a worse score. The best advice for a long term good credit score is to just be a responsible adult. Do not shy away from getting loans like credit cards or low interest car loans or mortgages, however keep up on the payments and pay down the loans as soon as you can. If you have a hard time even getting a loan in the first place you can often get parents to cosign so you can use their credit score as well as yours or you can get a secured credit card where you put down a deposit on the card first. You should also look at /r/personalfinance for more information.
Credit is ability to borrow money… credit cards, home mortgage loans, car loans, student loans, etc.
All those credit/loan accounts get reported to credit bureaus and compiles into credit reports, which are centralized repositories for borrower info that banks and other lenders can refer to when choosing to lend to you. They show all the accounts you have and had, whether you paid on time or were late paying (more than 30 days), any negative marks like bankruptcies or accounts charged off.
Credit scores are algorithm that parse various info about your credit history into a number from 300-850 that allows for quicker decision making in most cases. Rather than a loan officer having to pore through pages of reports and deciding what they consider more import and less important, a credit score is an instant number they can use to qualify you.
The score uses info like number of accounts, age of accounts (ie. length of credit history), types of different accounts, credit card utilization (balance relative to limit), any negative marks, recent HARD credit pulls (like when you apply for a loan, not just checking your own credit scores as that’s a soft pull).
Okay, so right now I don’t know anything about you. You’re just a person on Reddit. If I run a company that loans people money, then you are a complete unknown.
If I loan you money, will you pay it back? I have no idea. I need some information before I decide if I want to loan you money. Information like, how much money do you make? How much do you save? Do you owe other people money? How much? The last time you borrowed money from someone, did you pay it back on time? Have you ever declared bankruptcy? Have you ever had people sue you because you didn’t pay them back?
Those are all important things for me to know, if you are asking to borrow money from me. It helps me decide how big a risk you are. So, we have a system to figure that out. It’s called a “credit score”. There are several companies that can create an assessment of you, and determine how likely it is for you to pay back your debts on time. But if you have never had a bank account, never had bills in your name, and never borrowed any money, they don’t really have much information to go off of.
The first credit card you get is going to have a low borrowing limit, and a bad interest rate. Nobody is going to want to loan you a lot of money until they know more about how reliable you are. Generally getting a bank account, paying some bills that are in your name, and borrowing small amounts of money (and then paying it off) will help improve your credit score. It doesn’t happen instantly, you need several years of that to build up a good rating. But as long as you are paying your bills on time, you should be okay.
As others have noted, credit is when a bank loans you money with the expectation that you will pay it back. However, there is a risk that you might not pay the money back, so the bank needs a way to assess how much of a risk you are. That is where your credit score comes in. Every month, all the banks report information to the 3 credit bureaus, Experian, Equifax, and TransUnion, about their customers. The credit bureaus then use this information to calculate credit scores. When you apply for any kind of credit, the bank will run a credit check with one or more of the credit bureaus to see what your score is plus all the information that is contributing to that score. This helps the bank determine how much, if any, money to loan you and at what interest rate.
Now, here are the components of a credit score:
1) Payment History – Do you pay your current credit bills on time, or do you have any late payments? Very Important
2) Debt-to-credit Ratio – How much of your available credit are you using right now? Very Important
3) Derogatory Marks – Have you ever declared bankruptcy or defaulted on a loan? Very Important
4) Credit History – What is the average age of all your open accounts? Somewhat Important
5) Number of Accounts – How many accounts do you have and what kind? Not Very Important
6) Number of Hard Inquiries – Have you been applying for a lot of new credit recently? Not Very Important
Let’s say you have 3 people. Alice is your dear friend. You’ve known her for 20 years. Every time you lend her $20, she pays you back $20 and gives you a beer. Bob, isn’t quite so great. You’ve known him for almost as long as Alice. He pays you back sometimes. Other times, his wallet is empty, and he says he can’t pay you back, he’s having a rough time. And Cynthia. You just met Cynthia. You have no idea who she is really.
Alice has good credit. Bob has bad credit. Cynthia has no credit.
Now, if you’re deciding to lend money out, you’re most likely to lend it to Alice… second most is to lend it to Bob. And you’re not going to lend money to Cynthia… not until you get to know her better.
Your credit score is just a numerical value that measures how likely you are (based on past history) to pay back a loan. If you pay all your credit cards, and have done so for years, you’re an Alice. If you pay back your credit cards, but sometimes you miss a payment, and maybe even default on a loan, you’re a Bob. And if you’re just starting out, you’re a Cynthia.
It can be hard to build credit if you have no credit, but there are ways. Try to get a credit card with a low limit, and just pay it off every month for a year or two. Then call and ask them to increase the limit. Pay your bills on time, and keep accounts open for years.
I don’t think people understand what ELI5 means.
#ELI5
**What is credit?**
I’ve got a collection of tools. Screwdrivers, hammers, wrenches. I’ve got a pretty good collection.
You ask me to borrow a hammer. You promise to return it in a week.
Exactly a week later, you return my hammer.
If you do this over and over, returning my tool on time, that means I CAN TRUST YOU. I don’t have to worry about never getting my tools back.
**”How much I trust you” is CREDIT.**
Mary always returns my tools, but she returns them late. I trust her a little less, so her “credit is lower”. I will still let Mary borrow tools from me, but maybe I won’t let her borrow my most expensive tools.
John never returned my drill! So his credit is terrible. I won’t let him borrow any more tools from me, ever! I don’t trust him at all!
**Strangers?**
Patel came to ask me to borrow a tool. I’ve never met Patel before in my life! He’s a total stranger. Should I trust him? How much should I trust him? How will I know he will return my tool?
Well, Patel has borrowed tools from other people in town, and he always returns them. Those other people TOLD ME that I can trust Patel. So I trust him, and I let him borrow my tool.
**So credit is shared.** That is, if you **establish credit** with me, by always returning my tools, then I can share that information with others. And they share that information with me. And so we all tell each other how good someone’s credit is.
**Real World**
Okay, no more talk of tools. Let’s talk money.
You want to buy a car, or home. So you need to get a loan. You go to the bank. The bank manager asks himself, “If I loan Funky_Nebula some money, can I trust them to return the money? On time?”
So the bank asks other banks, or other institutions, “Hey, have you ever had any experience with Funky_Nebula? Can they be trusted?” And if the answer is “yes, Funky_Nebula can be trusted”, then the bank is more likely to give you the loan.
But if the other people say, “No! Don’t loan money to Funky_Nebula, they return it late!” then your bank might not give you the money.
**How do you establish (grow) credit?**
Well you have to start somewhere. If nobody knows who you are, and nobody’s ever loaned you any money, then you have no credit. Nobody will trust you.
But some people are willing to take the risk. They’ll say, “I’ll give Funky_Nebula a loan, but it’s just for $10. So if they don’t pay it back, I don’t lose a lot of money, just $10.”
So sometimes you have to start there. Take a small loan.
But if you pay it back on time, then you’ve got a little bit of trust! Someone trusts you, even a little bit! You have a little bit of credit now.
You can then probably ask another bank for a slightly bigger loan, maybe $50. And you repeat the process, over and over, until you can be trusted to pay back $10,000 or more.
And after 10 years of always paying back loans on time, especially big loans, now you have “great credit”. Most banks will trust you.
**Not Just Money**
If you want to rent an apartment, your “credit score” can be looked upon. Hey, if you can’t be trusted with paying back money, maybe you can’t be trusted to pay your rent on time!
This kind of thing happens a lot. How much trust you have, means a lot, and for more than just money.
**Personal Story**
When I first got out of college, I had no credit. I had never borrowed money from anyone, so nobody trusted me.
I went into a bank, and asked for a personal loan. They said, “You have no credit, but we’ll loan you $100 for three months”. They took a risk. It was a very small amount. I didn’t even need the money.
I took that money, and put it in a box under my bed, and didn’t touch the money. I didn’t spend it. I didn’t use it at all.
And after three months, I paid it back. Now I’ve established some credit.
And then I asked the same bank for a larger loan, $500. And I did the same thing again, I did not touch the money, and I paid it back, and my credit grew
If you can find a bank to take a risk on you, you can establish credit the same way.
If you have little to no credit, I recommend starting with a secured card. Capital One or Discover It are good choices. You put down a deposit and that it your limit. They hold the deposit as long as the card is open (discover will later upgrade you to a normal card, worth going for this one, imo).
Use the card. Pay it off *in full* before the due date. Try not to use more than 30% of the total limit in a month.
Do this for 6-9 months.
At 9 months, if you’ve never missed a payment, call Discover and ask them to upgrade you to a non-secure card. Get your deposit back.
Use this card for another 6 months. Your score will continue to rise. Follow same rules as above.
At this point, apply for a basic rewards card with *no annual fee*. There are several good options, but choose one depending on what you spend money the most on. Travel, food, shopping, Amazon, etc.
Always pay the balance by the due date. You’ll never pay interest.
Congrats! You now have a credit score and credit history!
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