Beating Broke

Personal Finance from the Broke Perspective

How to Build, and Use, Rockstar Credit

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Unless you’ve taken the vow of debt celibacy, you’re gonna need credit.  There’s plenty of reasons to have credit, and plenty of reasons to not need the debt instruments that determine your credit score.  Unfortunately, if you’re going to need credit, you’re going to have to make use of a few debt instruments in order to not only get a credit score, but get a rockstar credit score.

Building Rockstar Credit

Building a credit score isn’t particularly difficult.  Any Joe (or Jane) off of the street can get a credit score.  You’ve simply got to have some form of debt that reports your history with that debt to the credit bureaus.  Simple right?  Let’s move on to using your credit score then…  Or not.  Listen, getting a credit score is the easy part.  Getting a rockstar credit score is another thing altogether.  If you want to build a good credit score, you’ve got to know how to use the debt instruments in a way that demonstrates your credit worthiness.  If you want a rockstar credit score, you’ve got to have rockstar credit worthiness.

Know what goes into a credit score.

img credit: kspsycho83, on Flickr

Knowing what goes into a credit score will make it that much easier to build that rockstar reputation with the credit bureaus.  The factors that the bureaus take into effect vary a bit from one to another, but they have the same basic bones.  35 percent of your credit score is all about payment history.  There’s lots of factors in that payment history, but if you keep one thing in mind, you’ll never have a problem with this 35% of your score.  Pay on time.  If you pay on time, you will never run into any of the other things, like bankruptcy, length of delinquency, and amount of delinquency.  Frankly, it’s the easiest part of your credit score, because you can pretty much nail it down with a good bill pay system.

Another 30 percent of your score is determined by the amounts owed.  That is, the category of things that falls under amounts owed.  This includes the total amount you owe, but also includes things like the number of accounts with a balance, the amount of available credit, and even the type of debt you owe.  What this category boils down to, is a score on utilization.  If you’ve got nothing but credit cards (unsecured debt), and you’ve got nearly all of them maxed out, the chances of you defaulting in the future are higher, and so, you’re score goes down.  If, on the other hand, you’ve got a mortgage (secured debt), a car loan (more secured debt), and a few credit cards with low balances on them, your chances of defaulting are lower and your score will go up.  Of all the factors that go into your credit score, the amounts owed factor is the most complex and hardest to balance.  If you’ve got the patience, some experimentation with available credit, types of credit, and distribution of credit can yield some interesting changes to your score.

The remaining 35 percent of your score is split (15%-10%-10% respectively) between length of credit history, new credit, and types of credit used.  The first, length of credit history, takes into account how long you’ve had your credit accounts open, and how often you use the accounts.  New credit takes into account how much of the credit you have is new to you.  In short, how many new accounts you’ve opened, and how many times your credit report has been pulled by a potential new creditor. Finally, the types of credits used category takes the type of accounts you have and scores your usage based on that.   Unlike in the amounts owed category, the types of credits used category doesn’t take the balances on the accounts into consideration, but merely weighs the ratio of one type of account against another.  With all three of these categories, the emphasis is on smart credit usage.

The bureaus want to give the best credit scores to the rockstar credit users.  A rockstar credit user is someone who pays their bills on time and is never late, has “good” balances on their credit accounts with a higher ratio of secured debt versus unsecured debt, has a long history of being a rockstar credit user, isn’t actively trying to open a whole bunch of new accounts (and hasn’t recently added a whole bunch of new debt), and isn’t overusing any one type of credit.  A simple rule, to fill all of those requirements, is to just be a smart person with your personal finances.  Don’t take on more debt than you can afford, and make the payments on time.

Tools for Rockstar Credit

Along your journey to building rockstar credit, there are some tools that you will want to use.  The first, and most important, is your free credit reports.  You can get one per year from each of the three major credit bureaus.  A smart way to use them is to get one from one of the bureaus in one quarter, one from the next the next quarter, and then once more in the third quarter of the year.  While the free credit reports don’t include your FICO score (credit score), they do show you all the information that the major credit bureaus are using to determine your score.  Look over them carefully, and make sure that any inaccuracies are fixed, and reflected the next time you pull the free report.

The second tool (really tools) is to have a full complement of programs and apps to help you along the way.  A good bill-pay system is beneficial to keeping your payments on time, while programs like Mint and Adaptu can help you keep track of where your money is going, and keep it all under control.

If you want more detail on what makes up your credit score, I encourage you to check out The Beating Broke guide to Your Credit Score. (it’s FREE)

Using Rockstar Credit

Ok.  So you’ve got a rockstar credit score.  Now what?  Well, we didn’t spend all that time building a solid credit history to not use it, right? Right.

Depending on where you are in your personal finance journey, you will find that there are certain benefits to having a rockstar credit score.  The main key, when using your credit, is to remember that your usage will reflect on your credit score, and use it accordingly.

Negotiating a better interest rate.

If you’ve managed to improve your credit score by quite a bit, one of the first things you should try and do to take advantage is to negotiate a better interest rate.  In most cases, this will be done with your credit cards, but it sometimes doesn’t hurt to call other creditors as well.  Call them, explain that your credit score has gone up significantly, and you’d like your interest rate lowered.  One of the advantages of having a great credit score is that you have some leverage in that you are more likely to be able to secure a balance transfer to another card at a lower rate.  If the creditor won’t lower your interest rate, consider trying to find a new card with a good rate and a good balance transfer rate.

Use your credit to leverage debt.

This usage is likely to get a few comments.  It’s frowned upon a bit, and can be dangerous if not done properly.  Further, it can be dangerous in that you can over-leverage and end up losing everything if it falls apart.  Which makes it all that more interesting, and something to learn about, in the same way that learning about pyramid schemes helps avoid them. 🙂

Leveraging your debt comes in many shapes and methods.  The easiest way is something you’ve probably heard about before.  Using low balance transfer rates and low introductory rates, you can use the credit to earn income on the money.  Several years ago, this was very popular as people were getting transfer and intro rates of less than 2%, while online savings accounts were earning more than 5%.  It didn’t take a rocket scientist to figure out that a person could earn 3% on the credit card company’s money with little to no work besides making sure that the payments were made and the debt was paid off at the end of the rate period.

A similar method, that is a bit more popular today, is to use the transfer/intro rates and lend the money out on something like the peer-to-peer lending site Lending Club.  With return rates of 13% possible, it could be a lucrative proposition.  It would require extremely good investing, and a good amount of luck in avoiding delinquencies and write-offs however.

Another way that you will see used more often is to use the debt as a means for investment into assets.  If you can get a card with a large enough limit and a low enough transfer/intro rate, you can then use the money as a down payment on an investment property (think rental property).  I shouldn’t have to tell you this, but there are a lot of people around the nation (and the world) who got burned in the last 5 years by using this method.  To be honest, I wouldn’t use it, but it is a method that is available to you.

I’d like to reiterate that leveraging your debt can be dangerous.  A market downturn, or sudden loss of income can not only ruin your leverage attempt, but can also quickly send you into a spiral that could lead to bankruptcy.

Keeping Rockstar Credit

Keeping rockstar credit can be super easy.  If you’ve got rockstar credit, you’ve already mastered the steps to building a good credit score.  Keeping a good credit score calls for more of the same.  Yep.  Just keep on doing what you’ve been doing while building your credit, and you’ll keep it.

Return of the Rewards Cards

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It wasn’t that long ago, as the economy was crashing down around us, that people started noticing a drop in the number of credit cards that were offering the 0% transfer rates, and a drop in the number/quality of the rewards associated with rewards cards.  Higher default rates and changing regulations seem to have been the culprits, making it harder for credit card companies to offer the great rates and rewards while still maintaining their (already bloated) margins.

But, as the economy levels off (if not starts a recovery), there have been an increase in cards offering the great transfer rates, and now, there’s been an increase in rewards cards too.

Just the other day, Chase announced the British Airways card, with a pretty good rewards system. Then, today, I got an email announcing the Hyatt card. It too, has some pretty good rewards.


 

The thing I don’t really like about cards like these is that you get locked into an airline or hotel chain. Also, they both charge an annual fee. I think in a pinch, you might be able to call Chase and be able to get that fee waived once or twice, or at least get your value out of it in flights and stays. Aside from that, the rewards are pretty good. The British Airways card has a potential for 100,000 Avios (BA’s points) which should be able to get you a couple of trips overseas or quite a few domestic trips on their partner airlines. The Hyatt, with it’s 2 night free stay bonus, is pretty good as well. And in both cases, the points accumulate at a good rate.

As always, responsible credit card use is a must. You’ll pay way more than what the rewards are if you don’t pay the balance off, and lose money on the whole deal. It’s just not worth it. If you do pay your balance off, however, it’s something to look at.

I might even have to think about that Hyatt card, as the Financial Bloggers Conference this year is at the Denver Hyatt, and while the even rate is pretty good, it’s not as good as two nights free!

Editors Note: As with any financial offer, credit card or otherwise, YOU are responsible for reading the full terms and disclosures in order to understand what it is that you’re applying for.  Don’t read them, don’t come crying to me.

Back to a Cash Economy?

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With the recent increase in new fees at banks, and the backlash it has caused, people are starting to determine what the alternatives are.  At the moment, there are still banks and credit unions that are maintaining their current fee structure without adding anything new.  Many of those are also maintaining their “free” accounts.  But, if the Durbin Amendment remains, it may be only a matter of time before they buckle under the costs and start removing “free” accounts and adding fees.

What then?  It that happens, we might see a financial world where all debit cards have a monthly fee.  We might see more annual fees on credit cards, and higher interest on credit cards.  We might see more and more checking and savings accounts having a minimum deposit amount and/or a monthly fee.

Use Cash OnlyAs a card-carrying member of the NGPAF (Not Gonna Pay Any Fees) club, that might just make me decide that I don’t want to use any of their services anymore.  My depository institution might just have to become the coffee can in my backyard.  Seriously, though.  If all of those services become services with fees, we might see a pretty drastic increase in the usage of cash again.  Many of us don’t use cash all that much.  I know I don’t.

And what happens if we return to a cash economy?  The banks get even less transaction fees.  Their income drops because of it.  And we all see what happens when their bottom line is threatened.  More fees.  It could send the banking industry into a never ending spiral of more and more fees until the only people who still use banks are the ones who don’t feel comfortable keeping thousands of dollars in a coffee can in the backyard.

Luckily for me, I belong to a credit union that isn’t likely to add any additional fees anytime soon.  What about you?  Do you belong to a Credit Union or Bank that hasn’t added fees recently?  What if they did?  How long do you think it will be before we have to choose to either pay fees or carry cash?

photo credit: flattop341