A Plan For Young People

This post is a continuation of a topic I started in Intro to Credit Gaming - Part III, which is that of a young person just starting out in the world with little or no credit history. As a somewhat young person myself, I have been there recently and can offer direct advice on the matter, as it's all stuff that I've done personally. If you're a typical college student, 1) You don't make very much money and 2) You're still counted as a dependent on your parents' taxes. #1 makes it hard to get credit (ever try to get a real (i.e., unsecured) credit card with $10,000 in claimed yearly income? Hahaha!). But #2 makes it easy to use a little trick to get credit. On credit apps, they never ask for your personal income; they ask for the household income! As long as you are claimed as a dependent on your parents' taxes, you are still technically a part of their household, even though you may live in different states.

So, simply write in an approximate amount for the total household income, including both parents' incomes and any other dependents'. Assuming that your family isn't barely scraping by, it should be no problem for you to get lines of credit in the $1k range, even with no credit history.

Of course, I am in NO way saying that you should USE all of that credit that you can get from inflating your income. Credit card debt is definitely a life-sucker. I ended up about $8k in CC debt a couple of years out of college, and it is no fun place to be. (And I know that $8k is pretty minor compared to many others' experiences!) Use the credit card as if it were cash; if you can't afford something, don't put it on your credit card! (There can be exceptions to this rule which I will discuss in a later posting, but only if you know yourself to be responsible with your credit.) If you cannot trust yourself, lock up your credit card somewhere and set it up for automatic payments of your cell phone or other bills to the tune of $50-$100 a month. Pay off your credit card every month.

All of the advice presented here is intended for responsible individuals who have enough self-control to keep from over-spending. It is intended for the person who wants to maximize his credit score as if it were a game. Falling deep into debt is an easy way to lower your credit score very easily. In this post, I am trying to tell you how you can establish a credit history when you are young and have very little income. Above all else, you do not want to establish a BAD credit history. (Note: Just carrying a lot of debt will not give you a "bad credit history," but it will depress your credit score until you pay off the debt. Missing a payment will definitely be a 7-year negative mark on your credit history, though.) If you cannot trust yourself with a credit card (if the thought of doing this scares you at all), you may want to hold off on this whole thing until you are a little more mature. For example, if you have never held a job or a bank account at all, you probably do not have the basic financial skills necessary to do this.

So, my "plan for young people" would be the following:

1. Get your first credit card ASAP, using your parents' income on your app if you have little or no income of your own.
2. Get subsequent cards every 6 to 12 months, and ask for credit line increases on your cards yearly.
3. Spread your cards out. I recommend one from every major company: Visa, MasterCard, Discover, and American Express. If you always buy gas from the same gas station, get their branded card if it will give you a discount. If you have frequent flyer miles with a particular airline, get a card that will earn more miles. There are many credit card benefit programs out there, so shop around. Always avoid annual fees. I will write later about choosing a credit card, but this short piece of advice is good for now.
4. After you get 4 cards (one from each of the major companies) you should stop unless there is some particular reason to get another one. Pay off all of the cards every month, online. It is very easy to set up a certain day of the week (usually I take Sundays) and log into ALL of my credit card websites, as well as my bank account, to see what is due. At the moment, I am paying off all of my cards as soon as a statement is generated. It takes about 45 seconds to set up the payment online, and in most cases it can be processed the same day. (It will take longer the first time you pay online, because your bank account has to be linked. This delay, which may be several days, could cause you to be late if you wait until the due date to make your payment.) This is probably the way you should do it too, until you reach a place where you can use more sophisticated methods. It saves you from having to worry that something is overdue. Check your online account weekly and pay as soon as you get a statement.
5. By the time you graduate from college and start working, you will have a solid foundation for your credit report. You will have a solid history of payments (35% of your FICO score), and your credit limits will be bumped up so that you can have a good debt to limit ratio (30% of your FICO). You will also have a good start on the 15% length of credit history component (and the sooner you start, the better off you will be).

Note: I had to change the timestamp on this post, as I had originally started it last week and saved it as a draft. I had no idea that Blogger would keep the original time that I started it! When I first posted it, it was 3 posts down the page. I will try to keep that from happening again, and in general, I am going to try to keep from editing posts that have already hit the page.

Intro to Credit Gaming - Part III

Or, Establish Credit - NOW!

After the juggernauts of payment history and debt/limit ratio, the next-largest factor in your credit score is length of credit history. The maximum length of credit history that appears on your credit report is 7 years or 84 months (looking at my most recent credit report from Equifax, it appears that their history only goes back to a maximum of 81 months -- close enough).

My own credit history is creeping up into the 7-year range (earliest account opening was in March of 2000), so it has not yet hit the maximum. Therefore, this is something that still holds down my credit score a bit. When I look at my credit score (which I will cover soon), I can see the "primary reasons" for my score (i.e. "why is my score lower than the maximum?"), and one of the two reasons is this:

The length of time your revolving/charge accounts have been established is too short.

This factor is based on the age of the revolving/charge accounts on your credit bureau report (the age of your oldest revolving/charge account, the average age of your revolving/charge accounts, or both). Research shows that consumers with longer credit histories have better repayment risk than those with shorter credit histories. Also, consumers who frequently open new accounts have greater repayment risk than those who do not.

So this is one of the reasons that my credit score is currently in the 770 range (the December update had it at 766 instead of 772) instead of the 830-850 range.

The only cure for this is time. There is no way to jack up this component of your credit score, other than to wait it out. In March, my first-opened account (opened when I was 19) will hit the 7-year mark. In September, the next oldest one will hit 7 years. After that, it will be another few years before my next oldest accounts will hit 7 years. There is nothing I can do about this except wait and keep those accounts open.

I read a lot of articles and blog postings by twenty-somethings who state proudly that they have graduated from college and have no credit cards. While this is good in many ways, it is bad for your credit score to have no credit history. If you take the effective range of credit scores to be 500 (from 350 to 850), and accept the claimed 15% weighting for this component, that means that this can affect your credit score by up to 75 points. That is more than enough to make the difference for many people to be approved for a loan or not; to get a lower rate mortgage or not; to move into a new apartment or not.

The "take-home message" from this is: if you don't have credit, get some NOW. You can't retroactively build a credit history when you need it. If you are young and currently have no credit, you are doing yourself a disservice. If you are older and have never had a credit card or other revolving credit account, you are doing yourself a disservice.

Of course, I am NOT suggesting that you throw yourself willy-nilly into a bunch of debt! I did not carry a balance on any of my credit cards for several years. I would charge maybe $50 a month to them each month and pay off that amount each month. Maxing out a credit card can be useful for other reasons (e.g. if you want a credit line increase to help out your debt/limit ratio), but it is not recommended that you do so without a plan and the financial wherewithal to pull it off without piling up a lot of interest. In my next post I will discuss a technique for young people to use to help them establish their credit history.