Wednesday, May 30, 2012

Credit Reports & Credit Ratings

What is your economic reputation worth to you?

Your credit report is a listing of all past and present obligations and the credit rating is a number that estimates how reliable you are financially.  Banks and other lending institutions look at your credit rating to determine whether to lend money to you and what price (interest) you will pay for the loan. According to Bankrate.com, a person with a poor credit rating borrowing $200,000 for a house will pay $127,000 more in interest than someone with a stellar credit rating.  This is insane.  

Image by Petr Kratochvil
Debt ends up costing you so much over your lifetime, so remember any unpaid bill lowers your score.  You can raise your credit score just by paying things like rent and utility bills on time.  The idea that you need a credit card to increase your score is silly because the credit card will encourage you to overspend. If you overspend, by definition you have spent more than you have, so you will not be able to pay the bill.  

The credit card company will happily add interest to the remaining amount and your debt grows.  This is called carrying a balance (aka: falling behind) and it lowers your credit rating while costing you more. If you are careful with a budget, you can utilize credit cards as a cashless payment system assuming you pay the bill off each month and there are no hidden fees. Read all credit contracts carefully; better yet have your parents do it.  That’s why they are there. The problem according to Robert D. Manning in his book Credit Card Nation is that paying by credit cards does not hurt as much when you buy with cash, and this leads many to overspend and get into debt.

If your parents have given you a credit card for emergencies, then save it for true emergencies.  Pizza lust is not an emergency.  If you run up your parents’ bill, they will find out when the bill comes, so get permission prior to using it.  If you can’t contact them, and in your best judgment it is an emergency then use it, but let them know immediately.  Your parents are depending on you to not screw them, honor their trust in you by thinking hard before using the card.  If you screw up in judgment, be up front about it and accept the consequences.