Financial future built one payment at a time
7/24/2011The first credit card James Starks, 24, of Toledo, opened was a store card at Express, a mall retailer that caters to teens and young adults. He was 22 and knew he needed to start building a credit report.
"I figured that since I needed to build credit and shop there all the time, I might as well apply for one," he said.
For two years he used only that card to make small purchases and then pay them off. Just a few weeks ago, he applied for his first Visa card in his name. These baby steps have helped him work toward a goal most young adults don’t often think about: good credit, something that’s essential for anyone making the transition into adulthood.
"I did have a few instances where I was denied for a card because I didn’t have any previous credit," Mr. Starks said. "But I think young adults should be careful of store credit cards. It’s really easy to run your bill on clothes."
Emily Friess, 21 of Berkey, has been building her credit history since she was 18.
"I realized I was 18 and if I didn’t start building credit, I could never rent an apartment or really do anything financially," Ms. Friess said. "I don’t know what my credit score is and I’m scared to find out. I pay my bills on time and I’m sure it’s good, but I don’t want to check it yet because of all the loans I have for school."
Young adults without credit or any knowledge of their credit history are in danger of ruining their scores and damaging their financial futures, said Kathy Virgallito, the regional director of partnerships at Apprisen Financial Advocates in Columbus, locally known as Consumer Credit Counseling Services.
"People see a number for their credit score and they aren’t sure what it means," Ms. Virgallito said. "Students and young adults need to spend time learning what it is and how their behaviors affect that score."
Buying on credit can be dangerous if you don’t stay on top of your payments, but without establishing a good financial track record, there’s not much you can do when it comes to finances and living an independent life.
What is a credit score?
A credit score is a number between 300 and 850 that helps lenders determine whether an individual will repay a loan, Ms. Virgallito said.
Three credit reporting agencies — Equifax, Experian, and TransUnion — use an algorithm to determine the potential risk of lending someone money. The most commonly used score is called a FICO score, Ms. Virgallito said, and uses five main factors to determine risk.
Leslie McFadden, a credit columnist for Bankrate.com, broke down the factors and their weights by percent:
● 35 percent is payment history—making payments on time, the total amount past due (delinquent payments, time passed since the payment was due, etc.), and any legal action taken against you in relation to money, such as bankruptcy or garnishments.
● 30 percent is the amounts owed—the number of credit accounts with balances, the amount you owe, the amount of credit still available for you to use, and the number of accounts you have maxed out.
● 15 percent is credit history—how long it has been since you opened an account and how long since it has had any activity.
● 10 percent is new credit accounts—how many new accounts you have opened and how many recent credit inquiries you have received.
● 10 percent is the type of credit used — whether it be retail accounts, credit cards, mortgage, or installment loans. This factor demonstrates how you manage payments.
A good score is considered anywhere in the 700s and above, Ms. Virgallito said, and people with the best scores get the lowest interest rates. The best way to maintain a good score and get the best rates is to make regular payments, she said.
"Good credit is about making your payments, keeping your balance low, and staying on top of your due dates," Ms. Virgallito said.
"You can always repair a damaged score. Eventually negative information does fall off your report and if you stay on top of your bills, many people are able to work their way back."
Getting started
The catch with credit is it’s important to build a good report, but lenders and even government policy make it difficult for young adults to get started. Part of the trouble is that lenders are being more restrictive, Ms. McFadden said, which was largely influenced by the state of the economy. Also, one provision of the CARD Act of 2009, in effect since February of 2010, makes it more difficult for young adults to obtain credit cards, she said. "The goal was to keep young consumers from getting into debt."
Many young adults also aren’t able to open credit cards because they don’t have a fixed income.
So if you’re told build credit, but can’t get your foot in the door, what do you do?
Ms. Virgallito said useful resources for young adults are department store or retail credit cards. For those with little to no credit history, the cards come with low limits and require monthly payments.
"The key is, of course, control," Ms. Virgallito said. "If they can control what they buy with the card and consistently keep the balance low or pay it off all together, it can build a decent credit report over time."
Some stores, like Express, offer student plans designed for people with no credit history.
Another option is to open a credit card with a parent or guardian as a co-signer. When a lender sees the young adult is backed by someone with an established credit history, it is more likely the card will be issued, Ms. Virgallito said.
Ms. Friess said she began building credit through her bank.
"I saw that my bank offered a credit program, so I applied online and within about 30 seconds was told I was approved," she said. "It was a good start because it was just like handling my debit card. When I checked my online statements, it was just a matter of moving money from my checking account to pay off the balance on my credit card."
Traps to avoid
With every card comes a catch. It’s tempting to make just partial payments, but high interest rates on the balance can multiply the original cost of the item you bought.
Another trap is the ever-seductive rewards program. Rewards for every dollar you spend, cashback, and other perks are designed to make you spend more. This is especially seen with retail credit cards.
Signing up for a retail card often gives access to early sales and deals. As always, the remedy to these traps is staying in control, always paying your balance in full, and looking past the sale deals to the actual price.
Frequently opening and closing cards can also damage your credit report. Only open or close cards when you absolutely need to, Ms. McFadden said.
"Every time you apply for credit, a credit inquiry is generated," she said. "Too many of these make it look like you’re constantly trying to [borrow money]. When you close a card with a zero balance, it lowers your available credit. By closing those accounts... that would increase your overall credit utilization ratio [the debt-to-credit ratio]. You want that utilization to be as low as possible. So the higher it is, the more it makes you look like you maxed out your accounts."
Have a plan
Mr. Starks said consistently paying his bills on time has helped him earn a credit score of just over 700.
Ms. Virgallito reccommended young adults use myfico.com to learn about their credit score and annualcreditreport.com to get a free copy of their credit report every 12 months.
"Young adults need a plan," she said. "They need to have an idea of what exactly they are going to do with their income and to stay organized."
Contact Ashley Sepanski at: asepanski@theblade.com