Building Your Credit Score: Are Credit Cards Your Best Option?
Published on - March 29th, 2012 (Modified on - January 2nd, 2013) (by Tim Sullivan) This post is by staff writer Tim Sullivan.
I recently had dinner with my friend and fellow 20-something, Gwynn. When the check came, I put down plastic; she put down cash. The following conversation followed:
Gwynn: Would it be easier to just take the cash and put it all on your card?
Me: No, I’ll just have him split it. I tend to do this awesome thing where I take the cash, thinking I’ll get the miles, and then spend the cash on whatever. When the bill comes a month later, I’m wondering why I spent $50 on dinner for myself.
Gwynn: I just don’t trust those things.
Me: Credit cards?
Gwynn: Yeah, never had one, never will.
Gwynn and I kept talking and not only has she never had a credit card, but…
- The only school loan she took out for school was directly from her father.
- She’s never had a car payment.
- She’s never had a mortgage.
Gwynn has never taken out any loan whatsoever.
Do you know your score?
Gwynn has worked at the same non-profit since graduating college and saves with every paycheck. When a big purchase comes up, whether it be a plane ticket or a vacation, she saves and pays out-of-pocket. For her lifestyle, it works great. That said, after our conversation, I got curious about her credit score, and Gwynn said had no idea what it was or really what a credit score is at all. According to the 2011 Financial Literacy Survey by National Foundation for Credit Counseling, two in three adults haven’t checked their credit score in the past 12 months, and one in three have no clue what their score is.
I’ve had a credit card for years now and find it helpful in pursuing my longer term goals. By that I mean, I’m young, but I still want to own a house one day. Although length of credit history is only 15% of my credit score, or FICO score (as it was created by the Fair Isaac Corporation), I still consider my credit card to be my number one way of building a solid credit line, and perhaps more importantly, establishing good credit habits for the future.
Quick overview of credit scores and home mortgages
Let’s review the anatomy of a credit score. There are a few categories that determine your final number. All you Gwynns out there, lend a quick ear…
A FICO score serves as a quick reference guide for lenders to determine the risk level for them to give money. It’s a number between 300-850, the higher the better.
Lenders take your credit score and a few other pieces of information into consideration, such as age and salary, and make a decision about how your loan will play out. In short, a high score will be less risk, therefore a lower APR and less overall cost to the borrower.
Here’s a chart comparing APRs and total cost for a 30-year fixed mortgage on a $500,000 house:
| Credit Score | APR | Including interest, your house will cost… |
| 760-850 (best) | 4.014% | $860,760 |
| 700-759 | 4.236% | $884,160 |
| 680-699 | 4.413% | $902,880 |
| 660-679 | 4.627% | $925,560 |
| 640-659 | 5.057% | $974,880 |
| 620-639 (worst) | 5.603% | $1,003,560 |
Source: myfico.com
What I get from this is that by keeping a good solid line of credit from now until the purchase date of my home (whenever that may be), I will lower my monthly mortgage payment almost $500 a month and end up saving myself near $150,000 in the long run.
What are Gwynn’s options?
Building a solid credit score with my card is working for me. I know my habits, like how I shouldn’t take cash from friends at a restaurant to get the miles on my card.
But if Gwynn wants to start paying more attention to her FICO score, what are her alternatives to credit cards? I called Gwynn and asked her if she had looked up her score with myFICO since we talked. She had, and found that she had no credit record at all, making her one of the 22 million Americans who doesn’t, according to Craig Watts, public relations director at FICO (he adds that another 30 million have very thin files.).
Gwynn says her cardless system is working for her now, but she still wants to build her credit. What are her options?
- According to the FICO website, she can take out a small personal loan from her bank. She already has established a good relationship over the years and should be able to get a small personal loan. When she pays it off quickly, her credit record will start to thicken. Yes, it will affect her score and doesn’t involve a credit card, but this seems like debt for debt’s sake. This isn’t what I would chose to build my score from the ground up.
- Again, according to FICO, a very low-risk solution is to start a secured credit card. A secured credit card involves putting down a given amount of money as collateral ($200 on the low end), and your line of credit is equal to the initial money down. There’s a great article on it here that includes suggestions on specific cards with low annual fees.
A third option? Get a credit card and use it only for automated expenses. Yes, this option involves opening a credit card, but she could only use it to automate a few payments. In about an hour, Gwynn could set up her card to automatically pay off her utilities, cable, and Netflix (or whatever else), and then automate a payment from her checking account to pay off her credit card in full. She’ll get e-mails before transactions go through telling her everything is working like clockwork.
She can put her card in an ice cream carton filled with water and stick it in the freezer if she wants. She can give it to her father and say, “never ever give this to me ever.” She won’t have access to the numbers, but will still be building her credit score.
An alternative to the credit card alternatives?
There is a philosophy growing in popularity that having no FICO score is just fine, that everything should be paid without using credit, including a house. There are alternatives to a traditional mortgage loan, such as a bank doing manual underwriting. There are a few forums that discuss pros and cons, such as this one here.
I can understand the philosophy that all purchases, including very large ones like houses and cars, should be made with cash. As with all things personal finance, you have to do what works for you, just as Gwynn does what works for her. I, on the other hand, like how credit cards are improving my credit-worthiness. Cash-only is one option, but I’m not ready to close any doors yet.
There have been some great articles on Get Rich Slowly representing a lot of different credit card viewpoints. Here are a few of my favorites:
- Anatomy of a Credit Score — J.D.’s simple and concise overview of what’s in it and how to obtain it.
- Proper Care and Feeding your Credit Score — Features a few mistakes to avoid.
- Reader Story: My Failing Credit Score (And Why It’s Not the End of the World) — One reader’s story about how bad behavior led to a drop in his credit score, how good behavior fixed it, and then how good behavior caused it to drop again.
What are ways you recommend taking a credit score from zero to hero? Do you think of your credit score as a friend, a necessary evil, or something you can live without?
GRS is committed to helping our readers save and achieve your financial goals.Savings interest rates may be low, but that’s all the more reason to shop for the best rate.Find the highest savings interest rate from Ally Bank, Capital One 360, Everbank, and more.
This article is about Credit Cards
Disclaimer: This content is not provided or commissioned by American Express. Opinions expressed here are author's alone, not those of American Express, and have not been reviewed, approved or otherwise endorsed by American Express. This site may be compensated through American Express Affiliate Program.
Discover is a paid advertiser of this site. Reasonable efforts are made to maintain accurate information. See the Discover online credit card application for full terms and conditions on offers and rewards.
SEARCH FOR RECENT ARTICLES
It’s so tempting to take the cash and put it on your card for points, good on you for knowing yourself well enough to resist!
loading....
I totally agree – I have done this numerous times in the past and ended up frittering away the cash. Not anymore!!
loading....
OOps. I’ve definitely been guilty of that. What I do now is that I try to deposit that money as soon as possibe – if I get the cash from a group lunch, I’ll go to the ATM that afternoon. If it’s a group dinner, I’ll go the next morning. That way the cash doesn’t have a chance to get frittered away, as I know it will.
loading....
Same here. I’ll pay the dinner bill online as soon as I get home. Keeps me honest.
loading....
I trust myself to pay the card with the cash I receive. I often suggest that I will pay the bill if they give me cash. Not only do I get cashback rewards, I build my credit and I may get $22 from them for a $21.60 bill if they are not among the more frugal minded. Of course sometimes I offer to pay their bill for a round dollar amount slightly under what it costs, but it builds goodwill as well as my credit.
I haven’t had any problems with this method so far, but I know I will use the money responsibly to pay off the card so I understand it may not work for everybody.
loading....
I think the best thing is to deposit that cash, whatever be the amount, in the bank, the very next day. That way you’re not spending it and also earning interest!
loading....
I’m just wondering – don’t utilities affect your credit score? I know the first time I applied for electricity (which was almost 3 decades ago) I had to leave a deposit of maybe $100 or $200 because I didn’t have credit except for an accruing student loan balance. I also know late payments to a utility can show up on a credit score – years ago a slow payment on my Philadelphia Electric (PECO) bill almost derailed my mortgage.
loading....
Utilities, like cell phones, can hurt your credit but never help. They don’t say a peep to the credit bureaus until you slip up. Then it’s all negative.
loading....
On the taking cash for shared restaurant meals, I usually do this, for the points and set it aside to be deposited with The Husband’s weekly paycheck. Seems to increase the odds of actually using it for it’s intention quite a bit. If I leave it my wallet… no worky.
There used to be a loop hole, that I think has since gone away, for adding someone as an authorized user to an account. They got a card in their name, and it went on their credit report, but establishing the account happened long ago and obviously didnt count against their credit. Viola! Instant credit history! This worked like a charm for establishing The Husband’s credit before we got married.
loading....
I think this must still work. I arrived in the US under four years ago, and at 24 I was a brand new Social Security number holder – with zero credit. My husband (who has excellent credit and a long history) immediately added me to all his accounts as an authorized user. I haven’t paid much notice to it as I’ve had no need for a credit check until recently when I refinanced our house and finally my name was added to the mortgage. Somehow, I now have better credit than he does!
loading....
This does still work. My father added me to his card years ago and it has clearly affected my credit score. My credit report lists my oldest card has have been opened 2 years before I was even born. I’m 25 now and have my own card, but I’m afraid to break away from that account because I don’t want to hurt my score!
loading....
I have taken the cash so many times at restaurants for the miles! (It’s all about the rewards). I agree that you have to be disciplined when doing this. I usually just schedule a payment to my credit card when I do this, that way the money is spoken for, and I won’t be tempted to let the charge “roll”
loading....
This post is very timely! My boyfriend and I are planning to move in together in a few months and he has no credit to speak of. The problem is…by the time you get to be 25 with no credit, no one trusts you and he can’t get approved for any credit cards.
I on the other hand, got a credit card at age 18 and now have excellent credit only 3 years later. So I have a feeling the apartment and utilities and such will be in my name until he can build a decent credit score.
Oh.. and I use a site called Credit Karma instead of paying to get my FICO score. Only used it a few times, but I recommend it. I also check the free official credit reports once a year to check.
loading....
A friend told me that when someone gets to be ~30 or so and has no credit history, creditors refer to them as “ghosts.” Sort of sad really that if someone is responsible and doens’t need credit that they’re just a phantom in our system.
But to you specifically Stacie, be careful about putting everything in your name becuase your boyfriend has no credit score — if anything goes wrong you really don’t want to be stuck footing the bill while he gets to walk away scot-free!
loading....
Believe me, that’s something I am considering. Putting everything in my name would be a last resort option. And I would probably have us draw up a separate sub lease agreement or something like that so that he can’t get off scott-free. But I wouldn’t consider moving in if I thought that was an option…but then I am a hope for the best, plan for the worst sorta person
. This is why we’re starting to think and plan a few months out.
loading....
I became an authorized user (not reporting any more) on my mother’s card when I was 15 years old. At 18 – when I could actually apply for a card of my own – I could qualify for just about any card you could imagine.
I also started off my adult experience with a 720+ score, just from inherited history and a couple months of my own credit card. This helped tremendously when it came to get my own apartment, etc.
I think a credit card is almost always the best option, given that it is not required that you pay interest on the account – you can always pay off the balance in full.
Alternatively, provided you buy new cars, now is a good time to consider a zero-interest car loan as a way to get new types of debt balances to show up on your credit report. Installment debt and revolving debt can be very beneficial. Don’t go too far out of your way for installment debt, but I wouldn’t pass it up if it does not change any other constants in the car purchase equation like the vehicle price, insurances you carry, and so forth.
Either way, you can make awesome progress with a single credit card. The first account gives you the biggest gain. The second account, no matter what type, will never aid as much as the first. Just open one – I think most people will be glad they did.
loading....
My credit score right now is very low. Embarrassingly low, as a matter of fact. However, I’m working to pay everything off and am on track to do so in four years. I’m interested to see how that number will change over the next four years, but not because I’m worried about getting a loan.
At this point, I actually don’t see the need for me to ever again in my life take out a loan. The house is paid for and hubby has cash in the bank for emergencies. We plan on keeping our current cars for several years and two out of the three are paid off. The other will be paid off in less than a year.
loading....
How sad to try to structure one’s financial life around a score, which we don’t even know the full formula to! I can’t imagine a responsible person like Gwynn ever wanting to go into debt, other than possibly for a home. So why play into FICO’s games?? I know 3 people who have gotten very competitive mortgages with manual underwriting because they didn’t have credit scores. That’s a great option. And one I hope will grow as people stop letting the credit score rule their lives.
loading....
Could you please tell us more about manual underwriting? The link to the forum Tim posted is broken, but after fixing it (remove the /blog/ part) you find it’s just a couple of people saying such mortgages don’t exist outside of Dave Ramsey’s imagination.
see here:
http://www.getrichslowly.org/forum/viewtopic.php?f=2&t=13162
loading....
I work for a mortgage company and there are two main ways of getting a mortgage when you don’t have a score:
(1) FHA (gvt) financing with 3.5% down and a co-signer who has a credit score
(2) Manual underwriting with 20% down and three examples of “alternate credit” (normally including 12 months on-time rent payment, letters from utilities that you pay on time)
Of course these are over-simplified generalizations and there are always exceptions… but I just wanted to be one more voice that you don’t have to get a credit card to buy a house (in fact, just one line of credit won’t help you in most cases – you would need three separate lines in order to qualify for the majority of loan products)
loading....
Thank you! That’s awesome. 20% down and my utilities and rental history should get me covered. Why would anyone finance a house with less than 20% down is beyond my comprehension.
loading....
To El Nerdo –
Because there’s no way in @#$%@# I’m going to save up $60,000 for a down payment in my neck of the “woods.”
loading....
el nerdo –
because when my mortgage runs about 3/4 what rent would be on the same house it was a sound financial decision to stop renting as soon as possible.
loading....
I have to say I don’t believe you. I’ve been trying to buy a home with manual underwriting, and NO ONE offers this, and I’ve looked EVERYWHERE — big banks, national mortgage lenders, credit unions, local banks.
But please prove me wrong.
I loved the idea of “manual underwriting” but it’s a phantasm, I have found.
I’d love to know otherwise. Do tell more.
loading....
I have no open lines of credit—I closed my CapitalOne card recently when they refused to waive a $25 annual fee—but I still do have a credit score from each of the three bureaus (middle score 807). I have only had one credit card in my life; never carried a significant balance; never had any student loans or any other installment or revolving debt.
My wife and I recently got pre-approved (not pre-qualified) with Wells-Fargo for a $625k loan (conventional high-balance) based on manual underwriting requirements. I had to provide one utility bill, contact information for my landlord, and a renters’ insurance bill. These additional requirements were due to me not having an open, seasoned line of credit.
That said, we are not doing this completely without a credit history: my wife (co-applicant) has open lines of credit (of which I am an authorized user). We are putting ~26% down on a $850k house and have about $400k in net assets — we had to provide documentation of these assets too. My wife’s a student but I am employed with a high income in a stable job where I pay taxes and can document all my income.
I can tell you more about the manual underwriting process once we have properly closed escrow on a house. I can confirm that it is not a myth, but that the requirements are stringent. The bank told us that it would not be possible to get the high-balance loan without a current credit score, but a $417k loan would still be possible.
loading....
Betsy, one lender that comes to mind is Fifth Third. I believe that they still offer FHA loans to borrowers with no credit profile. Keep in mind, no credit profile means NO credit profile. You cannot have any negatives (old paid collections, etc.). I would suggest checking out if Fifth Third lends in your state, and contacting them directly or a reputable Mortgage Broker in your area.
loading....
Here’s the thing – I don’t see the downside to having a great FICO score and a great credit report. You can always choose to pay for things in cash, but you will also have the choice of advantageous interest rates (who really wants to or can buy a house with cash? Especially if you live in an more expensive area?) that can add up to tens or thousands of dollars – or more – over a lifetime. If you don’t have a FICO score or established credit, you might find that you need it and now must spend more time establishing it or be forced to pay higher interest rates.
loading....
It’s my understanding there are a lot more decisions made based on FICO scores than just the interest rate on your mortgage. Rental approvals, insurance rates, even employment applications can be affected by a bad credit report/score.
Since a good credit report generally = a good score (except in those cases where someone’s been “too good”) and a good score = good rates, I don’t see why people would handicap themselves by sticking to cash only.
There’s a good chance DH and I will be in a position to pay cash for a retirement property. But that might not be the wisest decision – keeping some liquid cash might serve us better over the long term.
Most people can’t pay cash for a house. Since most people want to buy a house (it seems), most people need to build a good credit report/score. It’s definitely “do what works for you” when you come to HOW to do that. But stuffing cash in the mattress – or in the bank – most certainly does not.
loading....
I signed up for a student credit card and a line of credit before I entered university. So far I have paid off the balance every month and have not touched the line of credit.
I just tried to sign up for a better cash-back rewards card though and I got turned down because I did not have enough credit history. I haven’t checked my score because it has only been 8 months since i got the credit but I am diligently using my card and paying it off to try and build my score early.
loading....
What I’ve always done on the cash of eating out like that, my wife and I also use a credit card, but we also normally budget $60 between us (30 a piece) each month for fun money and those circumstances where you have to use cash, is pocket and roll over the cash for the next month. Saves a trip to the ATM and to the bank.
loading....
I got my first credit card in college, when we all signed up for credit cards to get a t-shirt, and in the 90s when the criteria for getting a credit card was being able to reliably breathe in and out…
I’ve kept that first card, and I put everything I can on it – and never use cash if I can help it.
I’ve never been late on a payment, and never carried a balance, except for one time I calculated the advantage of getting an engagement ring one month before I could afford it versus paying the extra $30 or whatever it was in the finance charge.
When we applied for a mortgage, the lender said that while we both had high credit scores (around 800), he would be happier to see if we had a credit card that we had a balance, or a car loan or something like that. Since we weren’t “normal”, that brought up warning signs in his computer. He recommended getting a credit card, charging $100 on it, and then make the minimum payments on it.
When we bought our second house (without selling our first, which had been paid off by that point), our scores had risen to 820ish, but I was working for myself, and lenders were very leary since I hadn’t been working that long. But, after I pointed out that even my part-time self-employment income for the last three years was enough to qualify for the mortgage we wanted ($50K) they were willing to give us a mortgage, but at a percentage point higher than it should have been. We borrowed from my wife’s parents instead.
We haven’t paid off the second house yet ($30K left), but we’re aiming at buying our third house, and hopefully that will be our last house…
We’ve been able to take advantage of the housing market rates in our area (Pittsburgh, PA) and so we’ll make double to triple our money on the one house (when you start at $43K, it goes pretty well), and the second house will probably increase 15% or so.
But, I’d probably still have a hard time getting a mortgage, since the $800 car I just bought doesn’t count for a mortgage, and the water bill of $40/month or whatever it is doesn’t count much.
I don’t understand why lenders aren’t falling all over themselves to give me their money. I’d like to get the credit score higher, since it seems like there shouldn’t be any reason for it to only be in the 820-830 range, and it’s always fun to see the vendor’s face when he checks my credit score to get car insurance or whatever.
loading....
Your first lender is an @#$%@# moron. Under *no* circumstances is it ever necessary to pay interest to establish credit.
Unless your credit card is issued by the bank from whom you’re seeking credit, the only way the mortgage officer can see your charging and payment history is if you give them a copy of your statement. Somebody can correct me if I’m wrong, because I’ve never had a mortgage, but they should never need to see that.
By and large, the number reported to the credit bureaus is the statement balance when the statement closes. IOW, if you charged $1k this month, that’s the number reported. There is no way for anybody looking at your credit report to know if you pay in full every month or carry a balance. (Well, that’s a bit of a mis-truth: If your balance on your credit report keeps increasing, I’m guessing you carry a balance. If it fluctuates, I assume you pay it in full.)
If my close to 800 score ain’t good enough for that bank, I’ll take my business elsewhere, unless those interest rates were too good to be true.
loading....
My husband was cash-only until age 28, when he had to establish credit so we could get a mortgage. Being young, naive first-time homebuyers, we were surprised that his responsible handling of money and absence of debt (which was why we were in a position to buy a house in the first place) would hold us back. I added him to my oldest credit card as a joint cardholder (not an authorized user), so he instantly inherited that credit history. I don’t know if this is an option anymore, because when we tried to do that with my other card a month later, the issuing bank would only add him as an authorized user, which from our understanding meant the card wouldn’t appear on his credit history. This was 2 years ago, so I don’t know if the banks are still being strict about adding joint cardholders.
On my side, I’ve had a joint credit card with my parents since I was 16, but I never used it until I graduated college and got a job. My mom warned me about the evils of credit card interest before she warned me about boys or drugs. The credit card was supposed to be for emergencies only, but I was so nervous that I just left it in my purse and didn’t touch it for 5 years.
loading....
I think a bigger question is why would anyone need good credit in the first place? OK, you can answer, I’ll just wait…….OK, then why is it that you want or need to own your own home? We Americans are obsessed with home ownership. It’s the American Dream, and economists actually think it’s a good economic indicator (did we learn nothing from 2008?), though it would be a great economic indicator if it wasn’t manipulated so much by the government (again, did we learn nothing from 2008?).
This sounds absurd to most people, but if I do take out a mortgage for a home, I want it to be very small in comparison to what I pay for the home (maybe 25%, preferably 0%). I’ve read a lot about owning vs. renting, and crunched the numbers for my own situation, and renting, for me right now, purely financially, is better. I think people need to get this idea out of their heads that owning a home is the ultimate goal of life. Think about it: the desire to own a home convinces some people that using debt is a good thing! Our thinking on the subject clearly isn’t logical. (I know, you can pay loans off in full every month and never pay interest, but still!).
I’m not bashing home ownership, I’d like to own my own home one day. But I think we should all focus on being less reliant on a good credit score for a mortgage, and also be more focused on putting as much down as possible. My goal isn’t to get a mortgage, it’s to own a home, fully, with as much money down as possible, preferably 100%. The fact that most people wouldn’t be able to buy a home without a mortgage simply means that most people shouldn’t own a home (financially, at least).
loading....
Regardless if home ownership is pushed or not, housing affordability will still be a problem. The less people buy the higher rents will go up making it more difficult for people like me (who will probably never own a home) to rent.. The housing crisis/problem doesn’t just go away simply by making it more difficult to purchase.
loading....
If less people buy, rents go down, not up!! If less people buy, home prices come down (lower demand), then investors pay lower prices. Since the investors paid a lower price, they can charge lower rent and still make a profit. Simple economics.
loading....
Nevermind then.
loading....
The people who are not buying have to live somewhere, so they rent. More people chasing rentals puts upward pressure on rents. Fewer buyers = higher rents.
loading....
Kingston,
More renters means more competition amongst landlords. The lower purchase prices will still benefit the renters.
loading....
No, it means more competition among tenants for the limited supply of rentals. Landlords have more tenants to choose from, and therefore they can raise their prices — if one tenant won’t accept, the next one in line likely will. Hence, rents rise.
loading....
It all depends on the purchase price. If there is a bigger pool of renters, then, sure, the current landlords can charge more. However, that will attract more prospective landlords, and they will bid up home prices, and bid down rents. As long as the purchase price is less than it was before (and it would be if less people are willing to buy on a net basis), then the end result is lower rent.
loading....
What I can tell you is that, as a landlord, I have benefited from a growing number of people wishing to — or having to — rent rather than purchase homes. I don’t expect that to last forever, but it takes a long time to bring significant amounts of new rental property onto the market (enough so that I would have to reduce my rents or stop raising them). So, in my opinion, for the next few years, the trend is not favorable for renters. And I do feel for Carla, who is concerned that she is locked out of buying as well. On the other hand, I agree with Matt that homeownership is not all it’s cracked up to be. If I were Carla and really wanted to own, I’d consider being an owner-occupant of a 2-family or a multi-family.
loading....
And this has gotten way off topic, so I’ll stop now.
loading....
Haha, I enjoy the tangents. Anyway, you’re a landlord, so you know better than me.
loading....
In my area a modest three bedroom home is in the neighborhood of $170,000. I don’t know how in the world my wife and I would have ever saved up enough money to pay cash for our first house while still paying rent to someone else. Sure, we now have a mortgage payment that is about 40% more than our rent payment was, but at least we own a home where some of our payment is going to build equity on our home. With the housing market starting to go up we are also seeing more equity in our house just due to appreciation in value. So in the next five years we could have continued to pay thousands of dollars to a landlord and never see any return of that money or we can have our mortgage and put some of that money back into our own pockets in the form of equity. When looking around at houses we made sure that our monthly payments would be less than we could afford so that we can make excess payments on our mortgage. This is going to help us pay off the house faster while paying less interest.
I agree with you that renting is the right thing for some people, but taking out a mortgage that you can afford makes sense in a lot of situations as well. If you have figured out a way to save up enough cash to purchase a home more power to you. Realistically though most people aren’t in a situation to do so and are going to need to take out a mortgage at one point or another. You might as well play the credit score game so that you don’t trap yourself in a corner that you’ll never be able to get a mortgage if you decide that you need one someday.
loading....
A friend of mine, who is about 32, recently bought his first house. He’d never had any credit at all. He always paid for everything (including cars) in cash. The entirety of his credit history was one small negative mark for a late utility payment.
He got a 4% interest rate on a $700,000 house.
How did he do that? He put about $300k down, he had about enough in the bank to pay the balance on the mortgage, and he has a job that pays about ~175k/year.
Credit scores don’t matter as much as people think they do. When a bank is actually looking at lending you hundreds of thousands of dollars, the question they’re asking themselves is “will this person pay me back?” and nothing says “yes” to that question like a big salary and money in the bank. When they look at your credit history, they don’t even really weight the score very highly, they’re looking for anything you’ve defaulted on and explanations for negative marks (this is what the people who gave me a mortgage told me). An empty credit history means you’ve never borrowed money and failed to pay it back, which is not really a bad thing.
I don’t know if “manual underwriting” as mentioned above is really a thing, but if you’ve tried to buy a house in the recent past, you know that there’s a lot of manual work being done to determine whether or not they’ll make that loan to you. Is this “manual underwriting”? I don’t know. I do know it takes months and lots of paper and verification of bank balances and income and taxes, etc. to get a mortgage. It’s not like the bank looks up your credit score, sees it’s over 700, and hands you a check for $300,000.
You can’t even tell what your credit score is without doing something like applying for a loan or an apartment rental. Sure, you can pay some of the credit reporting agencies for your score, but you get back different scores than lenders get (many of these people will tell you what score they got when they check your credit – ask next time you apply for an apartment or loan). After you get numbers from a couple of these people that don’t match the scores you can pay for, you start to wonder why that is. In my experience, the scores you pay for are almost always higher than the actual scores. I think this is to discourage people from trying to dispute things or otherwise alter their scores, because any interference from the actual people being scored doesn’t really help their secret scoring algorithms.
Given that your credit scores are compiled in secret and kept private from you, and the formulas to determine what they’d be are highly guarded, I think chasing credit scores is a fool’s errand.
Besides, cash on hand and lots of income trumps credit score every time. I have a mediocre credit score and a $530,000 mortgage at 3.875%.
loading....
“cash on hand” and “lots of income” are exactly what a lot of people don’t have.
Your friend is a great example of an outlier. $175K income is uncommon. Having $700K cash in the bank is *really* uncommon.
That’s a perfect illustration of the scenario where a credit score really is irrelevant.
But for the majority of people who earn less than 30% of that and have maybe $25K for a down payment, this scenario doesn’t translate. It doesn’t even translate for *me* – DH and I have household income around $150K but that’s only been within the past 5 years. It would take us 23 years to save up $700K in cash given our current expenses.
loading....
I have to second Tyler on this one. When buying a house (or refinancing) – equity is the name of the game. Banks are wary of everyone including people with really high scores and good incomes – they’ve a least learned that nothing is gauranteed in this world – that great income can disappear – and the person may walk away in pursuit of another job and they are left holding the bag with whatever equity is in it. From someone on the other side – with a great score, high income – but little equity in an eroded market.
And I think this is how it should be – cash in hand is a great indicator of a person’s ability to save and live beneath their means to afford a house of their own. A great thing to encourage in today’s day and age.
loading....
Oh, I agree – I think the housing market would be much more rational if people HAD to put down at least 50% in cash to buy. And people would have much greater financial security if they waited to do that. (That’s what we are trying to do – which is one reason we are 46 and 52 and still not homeowners.)
But I also think that committing all your cash to a non-liquid purchase is a financially risky move. Even Tyler’s rich friend didn’t do that. He could have paid cash, but he got financing.
loading....
“I think the housing market would be much more rational if people HAD to put down at least 50% in cash to buy”
Boy you hit the nail on the head there! I think we’re going through a time of significant change in the US – the choice to buy or rent is not so obvious – and a reset is occuring for an average age of homeownership – and average equity pre-purchase. Yea, it kinda suck for people who were raised to believe that homeownership was a god given right, especially homeownership in a high cost of living area. I hope that what comes out of the housing crash is a higher respect for the requirements of homeownership, that people recognize that it is a non-liquid asset – not a savings account to take money out of at any time to finance whatever.
loading....
The key is not committing all of your savings to your home if you buy. In my view, you should only buy when you’re certain you want to stay in one house for a long time as long as the rent ratio justifies it. And you should not buy so much house that you won’t have funds to fund investments. But it can serve as one way to hedge against inflation and rent hikes in the long run.
Some people say buying a home is great because it forces savings, and the sad fact is that many Americans need something like a house to impose savings discipline. But most people here are smart enough to save in other ways and do not need a house to serve that purpose.
loading....
Nobody who has replied to me is wrong. I acknowledge that my friend is not the common case. I think it’s funny though, that no one bats an eye when (for example) Matt above me expresses desire to buy a house in cash or mostly cash, but when I talk about someone who actually did it, *that’s* when the “but that’s really hard!” comments start showing up.
I concede, it’s hard, but I’d still rather work toward that rather than hoping the magic credit score fairies decide to bless me with a good score.
The main reason my friend had so much cash available is from selling stock options he got working at a growing tech company. Most people don’t have that, even when they have the high salary.
loading....
I was expecting to get attacked for that comment! Looks like you took the bullet for me. And I completely agree by the way. Bottom line: if a bank could make a profit from you (rather, statistically, from someone like you), they would be more than happy to give you a loan. If you don’t qualify, there’s a reason. The bank is in the business of making money off you, not of making sure you get a mortgage.
loading....
Tyler, I replied to you instead of Matt because a) you had a real-life scenario to present and b) your comment as a whole was the more interesting.
loading....
Ouch!
loading....
I think the idea that ‘cash on hand’ is the most relevant factor (e.g. always trumps) is incorrect.
While it can be a point in your favor, if you ONLY had a pile of cash (e.g. no income) that isn’t likely to convince them. Unless you agree to legally tie it up in some kind of collateral account, having enough to pay the mortgage several times over doesn’t mean that much. You could always just blow it all in Vegas and the bank is left holding the bag.
loading....
I’m not a big fan of credit cards and I think the credit score system is flawed even though we have top scores. But they can be a necessary evil for homebuyers who don’t have high-income jobs as in Tyler’s example of someone plunking down $300k in cash in his early 30s.
If you have a credit card, you have to be disciplined. I have four credit cards, only one of which I use, with the other three mothballed but still active to satisfy the credit score formulas.
We never carry a balance nor pay annual fees. We zero out our balance at the end of each week through electronic payment to ensure that we feel the consequences of our spending reasonably close to when we charge something. In doing so, the credit card essentially becomes a debit card with points benefits. The problem occurs when people spend differently than they would without a card or when they let their balance get out of hand.
loading....
That is a great idea! I would like to hear more about that and other ways to make using a credit card feel more like cash.
loading....
I *think* that you’re not actually accomplishing anything by doing that.
For a long time I did the same thing – paying off any purchase on my card as soon as I made it. What that does is keep your credit utilization rate at 0%, i.e. irrelevant.
When I set up my credit card to carry a balance each month, but pay it off automatically well before the due date, I saw my credit score shoot up after about a year.
Obviously I can’t say for sure whether the two are connected, but I suspect they are.
loading....
I think imelda hit the nail right on the head. The 2nd biggest factor in the credit score is the Amounts Owed or the Debt Usage. This is the percentage of the outstanding debt over your total credit limit. Though it is advisable to keep this ratio as low as possible, a 0% credit usage, month over month, actually signifies that you AREN’T using any credit. Which can bring down your score.
As with a few other things in life, credit score is a necessary ‘evil’. As long as it exists in the current form, and we know it does, I cannot fathom why people don’t pay more attention to it and try to boost it using every opportunity. True cash is king, but credit worthiness is right up there. To say that “I’ll only pay in cash” and implying credit scores are for lesser mortals is a little foolhardy. Why not use all the available resources for your own benefit?
loading....
I will say that depending on the week, a balance will almost always show up on my statement because I use the card so frequently for bills and routine expenses there is always a weekly accumulation at some level when the bill triggers. It’s not the biggest balance in the world because I make frequent payments, but it’s a balance nonetheless.
I don’t think it’s accurate to say that having zero balance serves no function. As I understand it, credit utilization is a percentage of debt to credit limit. I’ve left open three cards with high limits just to drive down my utilization rate. At the same time, because length of credit history is a factor, having three cards that have been open for several years aids in that part of the formula as well, even if I never charge a dime there.
As for accomplishing something, I’d say that we are accomplishing plenty. Because we have high scores, I use credit cards for convenience and points. The credit card companies are happy to provide those benefits because enough people pay interest and late fees to make it worth their while. So the best way for me to avoid that is to make full payments as often as I can.
loading....
There is an error in this article. In the U.S., it is a violation of ECOA (Equal Credit Opportunity Act) for a lender to consider age when determining if they will approve a loan. As long as you are 18 years old, you cannot be discriminated against because of your age, sex, race, marital status, or whether or not you have children.
http://www.ftc.gov/bcp/edu/pubs/consumer/credit/cre15.shtm
They will ask for your date of birth because they have to gather personally identifying information about you (aka CIP), such as your name, DOB, SSN, and physical address. They will look at age if they suspect fraud, but they can’t deny credit, offer a better or worse APR, or discourage you from applying for a loan due to your age.
Manual underwriting does exist. Most major lenders use an automated decisioning system based on a computer model, but sometimes there are applications that fall within thresholds that don’t fit the model, but also don’t necessarily warrant a decline. These applications are manually underwritten by a human being who follows a set of pre-determined underwriting guidelines, plus their knowledge and experience in underwriting to make a decision. It’s cheaper for high volume lenders to use an automated scoring model for applications, so the number of applications that are manually underwritten is pretty low in comparision to automated. Also, manual underwriting does present a higher risk because people make mistakes or use poor judgement from time to time. There is a lot of regulatory scrutiny these days so most apps are underwritten by a computer.
I’m a technical writer for a major lender in the U.S.
loading....
I suspect that a big reason to use computer generated underwriting is to avoid being liable for a class action suit because a bunch of individual employees personal beliefs (most likely unintentionally) skewed the amount of money they loaned based on age, race, gender etc…
loading....
Jennifer,
while it may be illegal to discriminate openly, lenders have found sensible ways to reduce risk factors. I’ve had numerous married friends in their 20s who applied jointly be told that only one of their incomes will be counted for repayment purposes as they are in prime childbearing age and if that happens either someone will stay home with the baby after its born or daycare expenses will consume a significant portion of the second income. This makes a lot of sense in my opinion from a banks perspective, but whether that strictly legal is yet to be determined.
loading....
I’m not an expert on credit, but I have worked selling credit cards over the phone. My understanding is that a secured credit card isn’t very good at all for building credit. It’s not a loan, it’s more like a prepaid credit card. By giving them $500, you are able to spend $500. That doesn’t sound like a loan at all.
When I was 22-23ish, I applied for a credit card with my bank that I’d had a checking account with for several years. (at least 2) My bank saw that my account always had a balance of at least a couple thousand dollars. (No overdraft fees, etc.) They took a chance and gave me a $500 unsecured credit card. While that isn’t very much, over the years I have obtained student loans, a car loan & several credit cards, (some way higher than I need) and great credit history my credit score is ~720.
You can try to get a secured credit card, but an unsecured credit card of $250 or $500 will get you started on a path to good credit 10X faster than any secured credit card.
loading....
My wife has a secured card. There’s no way to tell by looking at the report that it is secured. I would be very, very surprised if FICO excluded it.
loading....
Zero score is fine. She just needs to use a small community bank to write her loan. Credit scores need to be high or zero. On time rent payments and a good down payment will get her a mortgage if she wants one.
Like Dave Ramsey says “FICO is a I Love debt score” not an indicator that you are good with money. “
loading....
This is a great post that shows two different–neither “wrong”–viewpoints on credit. I think you put it best when you said, “As with all things personal finance, you have to do what works for you, just as Gwynn does what works for her.”
I’ve never had any loans, just credit cards, and just a few cards at that. But they’re helping me build my credit. I know I’ll need the interest rate benefits in the future, so I’m being cautious to use my cards responsibly until then.
loading....
I purchased a condo about 2 years ago and was able to secure a 4.275% mortgage rate on a 15 year loan. As a “fellow 20-something” year old, this was only possible because I opened several credit cards during my college years and used them responsibly, establishing a solid credit history. I was also able to secure a car loan on a used car which is somewhat difficult for young adults. While there is certainly something to be said for people who save and only make purchases they can afford, your suggestion on opening a credit card for automatic payments and paying off the full credit card balance each month is a good one. The trick is in self monitoring and knowing your limits. For many years I went without ever having a credit card balance at the end of the month but have recently faltered. It’s easy to overspend when you know you have the “available credit”. Finance, just like many things in life, is about knowing your boundaries and playing by the rules.
Ultimately, without establishing a credit history it will be difficult to secure a Small Business Loan (SBA) down the road which plays into my dream of owning my own business. Better to start now than later.
Great post Tim!
loading....
Unless I have sufficient amount to purchase home with cash, buy a car and send kids to college I would need loan. Unfortunately I cna’t and I have to ask for loan. Having a good credit is must for getting a loan with affordable interest.
Hence, I can’t live without a score. The steps I am taking towards improving my score is paying off credit card balance in full every month, paying off car loan on autopay and not clising old lines of credits and most importantly, keeping my expenses in check to maintain better credit/debit ratio.
loading....
Two or three years ago I ordered my credit report and was surprised (or maybe not) to find that my score was zero. The last debt I had was for a few thousand bucks a looong time ago. Since then I’ve never had a car loan, a mortgage or credit card.
So I signed up for a credit card and have been using it often, especially with the nice perks of 1% cashback. I paid it off every month (probably too often, like every five days lol!). Maybe two months ago I checked my credit score and it was very, very high!
loading....
Great information! I also agree with not taking cash and putting the whole bill on the card. If I do that, then I spend the cash on purple plastic fish, or some other useless junk!
loading....
You don’t build your credit score by spending more. You actually hurt your utilization portion of your score.
I don’t know why you wouldn’t take the cash and get the credit card rewards? Are you more likely to spend cash if you have it in your wallet?
loading....
I like credit cards, they keep me honest. Also! Cash doesn’t give you cash back, but credit cards can.
loading....
I liked the comment a few weeks ago about going to college, when a person was given a credit card to take to college but was only allowed to buy a bottle of Snapple on it once a month. Good way to get the kid to build up credit rating and also self control!
A few months ago I was buying something at Macys and using cash as usual. The employee serving me asked if I wanted to sign up for the store credit card and then I would get 20% off the item,get future discounts and be notified of sales etc. I admited to her that it was tempting but I try to keep to using cash only as a way of controling my spending. She told me that many people still get the credit card….get the discounts….and then just go to another teller on the way out of the store and pay the credit card bill off right there. I thought this was a very interesting way of getting your cake and eating it too…..as long as you pay it off right then.
loading....
I would venture most people would still spend more if they didn’t have the cash available.
loading....
Thank you! Awesome. 20% down and my utility bill should get me covered. Why would anyone finance a house with less than 20% down is beyond my comprehension.
loading....
What about emergencies? I got my first credit card when I went to college 3,000 miles from home. You never know if you’ll have to buy a last minute plane ticket home. (Luckily I never had too) but a credit card is a good safety net for those types of things.
loading....
When I was in college I used a credit card as that safety net, but I think an actual emergency fund is preferable.
Having said that, I see no problem with having a emergency fund that’s a little harder to get to (on online bank, for example), and using the credit card at the actual time of the emergency, then using the e-fund to pay the credit card bill in full.
loading....
i have always had a credit card for emergencies only.
i can’t remember the details (i was quite young), but we had some crazy bank error thing while on family vacation as a kid, leaving my folks with no way to fix it (across the country from the local bank) and no money, except for the one credit card my dad carried. it was all paid off as soon as we got home and they got things straightened out, but if it hadn’t been for that, we wouldn’t have had the money for gas home, even (barring a wire transfer or something similarly pricey).
i never travel without a credit card and enough cash for a wrecker =)
loading....
To rent a car, you either need a credit card or to have enough money in your checking account to pay for the car when you use your debit card. And sometimes almost everyone needs to rent a car unless they want to drive instead of fly to Europe.
loading....
We have used debit cards plenty of times in Europe. You just have to book it in advance, or have the money in your account. If you have such a low balance. why are you going on vacation?
loading....
They put a block on your checking account for the amount they want to put until you turn the car in. And if they want to jack you up on “damage” that you didn’t do, you don’t have much recourse. Just how much do YOU have in your account that it isn’t a problem for you?
loading....
Question: If Gwynn is determined to not borrow, why on earth would she care about building her credit? The FICO score is based 100% on your history and behavior with DEBT. It is not a measure of your income, net worth, or ability to manage money. The easiest evidence is that if someone were to win the $500+ million dollar lotto tonight, their credit score would not change one point. It would only be affected if they subsequently went into debt. If that winner was a person with a low FICO score, even with $500 mil in the bank they would still not qualify for a car loan under this screwed up system. They could buy a dealership for cash, but they couldn’t get a car loan!!
Yes, the FICO score can affect some job opportunities (but few), it can affect insurance rates in a small way, and yes you would have to go to a manual underwriter to get a traditional mortgage. But these are all small inconveniences to someone who truly wants to divorce themselves from debt.
loading....
NYC landlords seem to care quite a bit about credit scores. I think it’s quite common for apartment applications to be rejected for low scores. (based on anecdotal evidence, admittedly!)
loading....
Our credit reports were pulled last time we applied for a rental. I don’t think landlords often pull the *scores*, but the reports – most definitely yes.
In the L.A. market, quality rentals (throughout the metro area) average $1100 per bedroom. In our neighborhood, it’s closer to $1400/br on average. High rents = high risk for the landlord. So yeah. They check.
loading....
My landlord pulled our scores. The broker actually told me that they were concerned about my score being low at the time, but since my roommate’s was higher, they’d take us.
loading....
I was kind of hoping this article would be about…. the different ways of building your credit score?
Instead we got the normal one, ie credit cards, plus the (terrible) idea of paying interest on a personal loan from your bank.
Are there really no other ways to build your score??
Here is my concern: I have a good score, but it’s mainly based on 1) student loan payments, and 2) a credit card I’ve had for several years. But what happens if my credit card company decides to get rid of me? (I’m a “deadbeat” customer; they make no money off of me)
Since it’s the main source of my score, I’m considering getting a second credit card, to start building up more history. I’d like to buy a house in 5 years or so. But I don’t like credit cards, and would rather not get another one. Are there no better options?
loading....
The FICO (and others) are debt-utilization scores. You can’t improve them except by gaming the debt system (i.e. borrowing). And, as noted above, contracts that go unpaid (i.e. utility bills) immediately become reportable debts if you’re in arrears.
btw you aren’t a “deadbeat.”
A deadbeat is someone who doesn’t pay their debts. You are just unprofitable!
So the card issuer may opt to boot you, or may start charging you an annual fee. On the other hand, they may start offering you lavish incentives to start using the card more.
I have a very high limit card that I paid off a couple of years ago and haven’t touched since they proposed to raise my APR on new charges by nearly 9%. They are now showering me with convenience checks and transfer offers at a rate lower than it was when I stopped using it.
loading....
Thanks. I guess it makes sense that using debt is the only way to improve your score…. just not sure if I’m willing to do that.
It really pisses me off, though, that things like utilities can be used to *lower* your score, but not raise it.
(also, btw, a “deadbeat” in credit terminology is actually someone who pays their balance in full each month: http://credit.about.com/od/usingcreditcards/a/deadbeatcredit.htm )
loading....
I wonder if she’s really not profitable for the card company. After all, they do take a percentage (from the merchant) of every purchase she makes. She’s maybe just not as profitable as they’d like her to be.
loading....
Visa/MC make about 2.5% off of every transaction. They make way more money off of those that never pay off balances. But they have to have reserves for those that stop paying their bills. Thus, rates are high for everyone. All of us can survive without a credit card. I aspire to have a Zero for a credit score.
loading....
Rent and utility payments should go into your credit history.
loading....
Credit cards make the average person spend more. You can borrow $1,000 from a bank and pay it back and that is just as effective as a credit card.
loading....
I agree with you and I think that some people cannot handle how easy it is to spend when you have a credit card but for others who have the self discipline a credit card is the way to go.
loading....