Money is probably one of the biggest obstacles for a person’s taking a leap of faith in terms of stepping out of their comfort zones to do something they feel God’s calling them to do. I bring this up now because interest rates are in the process of rising, and they’ll likely rise several more times over the coming year to help start getting a handle on inflation. To help try to make that obstacle a little easier to overcome, I’d like to spend some time today talking about how to pay less for stuff by getting better interest rates, which in turn, means you’re using the resources God’s provided you with wisely and can do more with those resources in your charge.
Ideally if you want to buy something, you’d pay it in full right then and there at the site of the transaction. Cash used to be the dominant way to do this, but it’s not nearly as common anymore. There are times, however, when you don’t have enough cash available (either in your wallet or in your bank account) to make a large purchase. You’ll likely need to borrow money from a bank or credit institution to cover the cost of a house or vehicle, for example. Those institutions, in turn, will charge you money for the service of borrowing their money. (You’ll make payments to them, but the total amount you hand over will be way more than the original amount you borrowed.)
Credit cards are a similar thing, but at the same time they’re a different animal. Debit cards are nice in the sense that they’re sort of the electronic version of cash. You purchase something with a debit card, and it takes the money right out of your account. Just like cash…if you don’t have enough for the purchase, you don’t get to walk away with the thing you’re trying to buy. A credit card, on the other hand, doesn’t require you to have enough money available to pay for whatever you’re buying. In fact, credit card companies would prefer that you not pay off your credit card bill in full, because it gives them the opportunity to charge you large amounts of money for the privilege of using the credit they’ve extended to you. Don’t get lured in by earning reward points. I’d recommend that if you’d like, you can use credit cards to purchase things you were going to buy anyway, but try not to use them for impulse buys. When making a purchase, if you don’t have the money to pay for it right then and there, consider whether or not it’s worth going into debt for.
Okay, so…let’s pretend you’re a lending company…either a credit card company, somewhere that gives out car loans, or a mortgage company. Someone you’ve never met applies to your company for some credit. Each time you lend money to someone, you’re making an investment in them that involves some amount of risk. What do you use in making your decision about whether or not to extend credit to them?
It turns out these organizations use something called a credit score. Every person’s track record of the way they’ve handled credit or debt in the past plays some role in their credit score. If the lending institution sees an applicant who has a very good credit score, they’ll view that applicant as a safer investment than someone with a low credit score. Those with a high score are more likely to be able to secure larger amounts of credit at cheaper rates.
If an applicant has a low (or worse, no) credit score, they’re seen as a risky bet. They may be approved for credit, but it will likely be in smaller amounts, and will almost surely pay higher interest rates. A higher risk means there’s a greater chance that they won’t reliably pay back the full amount of money owed. To offset this risk, institutions will grant the credit at higher interest rates. (Even if the applicant defaults, the money gained from the high interest rate helps recover some of the money they’ve initially laid out.) A bank’s favorite scenario? When a person with a high interest rate pays off the full balance, but does it as slowly as possible. The bank not only recovers its initial outlay, but also gets to pocket all that high interest as profit.
Now let’s look at it from the other side. If you’re applying for credit, you want to get money for the lowest possible interest rate. Your best bet is to build up your credit score before you even apply for credit. Credit scores run from a low of 300 to a highest possible 850. In general, a “good” score is 700 and up. An “excellent” score is anything above 800. Most people have a score that falls somewhere between 600 and 750.
What factors determine a credit score?
As it turns out, demonstrating good credit habits will naturally build your credit score. As you may expect, the biggest chunk comes from your track record of payments. Thirty-five percent of your credit score comes from your payment history. If you pay all your bills in full each month (including housing, installment loans, and credit cards), that’s 35% in your favor. It demonstrates reliability.
The next-largest chunk of your credit score (30%) comes from your credit usage. If you don’t pay off the balance in full each month, how big a balance do you carry over? What percentage of your available credit are you using? Carrying a balance on one or more credit card isn’t the end of the world, but if you want to raise your credit score, you definitely need to use no more than 30% of your credit line per account, and it would be even better to get those balances down to zero each month. Just because you have credit available doesn’t mean you should use it. Showing restraint works in your favor. Additionally, getting an account balance down to zero is a great thing, but if you close the account after doing so, it decreases the total credit available to you. If you’re still carrying hefty balances on other accounts, closing an account will mathematically increase the percentage of remaining credit you’re using, which could drop your score. It’s better to pay off the balance and then simply avoid adding any new debt to that account. If you really want to close the account you should wait until you’ve paid down more of your total debt.
Those two items, making payments on time and showing restraint in your credit usage, account for nearly two thirds of your credit score. If you want to improve your score, start there. The remaining 35% is broken up into smaller categories that will be less impactful in the immediate term, but play a significant role over a longer period of time.
Another 15% of your credit score comes from the length of credit history. How old are your oldest and newest accounts? What’s the average age of all accounts combined? There are a few other considerations in this category, but for the most part, you just have to have time on your side for this one. Keep reliably making those payments.
Ten percent of your credit score comes from your credit mix. There are fixed obligations (rent/mortgage, student loan payments, the cable bill, etc.), variable obligations (credit cards), and some that are sort of in between (the electric or water bill). Showing you can manage more than just one type shows you can handle the responsibility of credit. At only 10%, this isn’t a huge factor, but it still plays a part if you’re in the gray area between “poor” and “fair” or “fair” and “good.”
The final 10% comes from “new credit.” Don’t open lots of new accounts in a short period of time. Lenders will see a lot of new accounts and wonder why the credit you’ve already got isn’t enough. Is it due to mismanagement? Are you in some kind of financial trouble? It just adds a perception of risk to the mix.
A handful of items go into a basic credit score, but by demonstrating that you can handle various lines of credit, you also make yourself more likely to get the best rates. Access to better rates means you free up resources you can use in your pursuit of furthering God’s kingdom, however you’ve been called to do it.