A Lifetime of Leverage - Understanding Credit

Knowledge and Tools onThe Keys to the Financial Kingdom

Nick Wolff, Region VI Staff

Overview

• How banks evaluate you for credit• Credit score elements• Credit monitoring• Building credit• How you should use credit• Money making ideas

Why Should I Care?

• Your financial limit is determined by credit• Costs of borrowing (Car, Home, etc.) can be

substantially highero Example: Score of 650 could be $250/month

more than one with 750• Other non-debt expenses (i.e. Insurance rates) can

be greater• Employers look at your credit score when hiring • Your financial flexibility is impacted

LEVERAGE

Leverage

• Lever allows you to amplify the impact of your efforts

• You can use it to either make you poorer or richer much more quickly

• If you are seeking to become wealthy, you need to learn to use leverage

5 C’s of Credit

• Character – History of making your payments; Personal Reputation

• Capacity – Cash flow shows you can pay• Capital – Net Worth; Sell to pay debt• Collateral – Securitize the debt• Conditions – Environment

What is your Credit Score

• 3 Digit Number that helps lenders determine the probability you won’t pay your bills/debts

• They probably don’t know you personally• 350 to 850• 3 Providers – Credit Reports

o Transuniono Experiano Equifax

• Fair Issac (FICO) – Agency that creates Credit Score

Approximate Score Ranges

Category Score % Default• Very Low Risk 720+ <1%• Low Risk 680 to 720 1 to 2%• Moderate Risk 600 to 680 2 to 5%• High Risk 500 to 600 5 to 15%• Very High Risk Under 500 15%

Who Reports

• Credit cards• Banks – Lines of credit or auto loans• Student loan lenders• Some utility companies• Anyone else you owe money to CAN

report. Most only do so if you do not pay• Some only report to one bureau

Components of Credit Score

• Payment History (about 40 to 45%)• Utilization (about 30 to 35%)• Age of Credit Lines (about 15%)• Recent attempts to obtain credit –

inquiries (about 10%)

Payment History

• Your record of keeping your promises• Greatest impact is usually the past 2

years• Most items are removed from report within

7 to 10 years• Bankruptcy is 10 years• Keep bad items old

Utilization

• Types of credit – Banks like to see diversityo Revolvingo Installment – (Student Loans, Auto)o Securitized or Mortgage

• Utilization – Outstanding Balance / Limit• Primarily based on revolving balances• Credit Score drops beyond 50% and drops more

severely beyond 90%• Student loans & health care bills have relatively

low impact

Age of Credit Lines

• Lenders like to see a track record• Only comes with time• Don’t close the oldest accounts unless

you’re paying to keep them open• Use each card every 6 months

Seeking more credit

• Lenders assume if you are seeking more credit you are having financial problems

• If you seek more credit, do so in chunks (all in one day)

• Inquiries stay on record for 2 years

Credit Scores

• 3 Scores based on the 3 credit reports• Credit cards and installment loans lend on the

high score• Mortgages lend on the middle score• www.annualcreditreport.com

o Free report annually• www.myfico.com

o Buy credit scores – about $45 to $50

Get to know your banker!

Questions?

Credit Monitoring

• Consider using a credit monitoring service• Monthly fee: $10 to $20/month• Free access to all 3 credit reports• Estimates of FICO score (FAKO) daily• Notifies you of changes immediately• Allow you to freeze report if you suspect identity

theft• Provide tools & recommendations on how to

improve your score• Identity theft insurance

True Credit Report

True Credit Report

Every service uses a different algorithm

Another service gives me scores of 730, 780 and 781, respectively.

(FAKO)

Applying for New Credit

• Know the answer before you asko Review your credit report & scoreso Don’t be unrealistic in what you ask for

• Correct errors on your report. Approximately ¼ of all Americans have at least 1 error on their credit reports.

• Some people say the maximum credit you can be extended is 5 times your annual income

Applying for Credit Cards

• Look at credit score• “No-doc” or “stated” income

o Will verify with your profession• Sometimes auto loans too• Want to see 2 years of continuous

employment

Applying for Mortgages

• Look at Credit Score – Middle Score• “Full Doc”

o 2 months of paycheck stubso 2 years tax returnso Savings account statementso 2 years of W-2’so 2 years of addresses

Couples

• Know both of your scores• You can apply for credit as a couple

o Combined incomeo Use the lower of the scoreso Use the credit reports of both

• It might be cheaper to just be held by one person

Questions?

How Do I Raise My Score?

How to Raise Your Score

• Payment History – Pay your bills on time!o Pay your bills the day you receive them. o Auto deduct your minimum paymento Open more credit accounts to lessen impact of

bad accountso Call lenders and ask them to take bad items off

How to Raise Your Score

• Utilizationo Work the numerator

Pay off revolving credit lines Convert revolving credit lines to installment loans

o Work the denominator – “App Spree” Get more credit Do not get yourself into trouble

o Carry credit at providers that do not reporto Carry credit in a business entity. (Don’t report on your

credit and don’t care about utilization)

How to Raise Your Score

• Age of credit lineso Do not close your old accountso Open accounts as a joint account holder of

another’s credit accounts (NOT authorized user)

o Patience – It’ll come in time

How to Raise Your Score

• Seeking more credit (Inquiries)o Don’t apply for credit ofteno Inquiries

Soft – Do not impact your score Hard – Lower score Some say 3 points per inquiry

Less impact if inquiries are within a day or twoo Bumping

• This is smallest component

Questions?

Financial Management

• Credit cards – Minimum 1 to 2 percent of balance (20 year amortization)

• Auto Loan – Based upon amortizationo (2 to 5 (6) years)

• Student Loans – Based upon amortization• Mortgage – Based upon amortization• HELOC – May be interest only

Building Credit

You can build credit

Be Sure You Want To Do This• Keep high credit scores• Demonstrate responsibility with ever growing

credit lines• Charge up to ½ the limit, pay off in 3 months• Ask for increases – Every 6 months• Some say cap at about 5 times annual income

App SpreeBe sure this is right for you!!!

What if I Get Into Trouble?

• NEVER miss a mortgage payment• If you stop paying a car loan, they can take your car• All credit cards report – but no security• Some utilities report – but can turn power off• Student loan lenders report, but can help you with

other programs (forbearance or change payment plans)

• Call your lenders. They want to work with you.• Keep lines of communication open. • Don’t ignore problems. They don’t go away.

What if I am REAL trouble?

• Have lenders put you on a payment plan• Get a credit counselor or financial advisor• Increase your income – Get another job• Sell your stuff• Last resort – Bankruptcy (10 years)

How You Should Use Credit

• Credit is a tool o Buy today and pay tomorrow o Easy accesso Financial safety blanket

• Don’t buy junk with credit cards.• If you do, don’t maintain a balance

How You Should Use Credit

• Use them for convenience• Use them for rewards• Use them to build a credit history• Use them for leverage• Use them to make money

Credit Arbitrage

• Pull out big bucks from credit line at 0%• Put money in money market savings

accounts• Make payments from savings account

when needed• Pay off credit line at end of incentive• Keep interest • 2 to 4% free money – Infinite ROI

How I Use Credit

Private Lending – Be the Bank!• Borrow $25,000 on credit card

o (incentive 2% for 12 months)• Total Cost: Bank fee $75 • Lend it at 12%• Interest rate spread: 10%• Net interest earned: $2,500• Rate of return: 3,333%

My Credit Profile

• High Score: 767• Middle Score: 747• Total Available Credit

o Personal: 175,350o Business: 118,800

• Utilizationo Personal: 46%o Business: 36%

• Net income from credit lines: $670.50 / month• Active Seeker of Credit and “Bumper”

Summary

• Good credit is the key to the financial kingdom

• Credit is an excellent tool if used well• You can make borrowing cheap

o (and profitable if you want to)• You have tools to increase your credit

score

Thank you for your ongoing service to Alpha Phi Omega!