PETE: Welcome back to How Not to Move Back In With Your Parents here on the IU MoneySmarts Radio Network. I’m Pete the Planner. That is Alex.
PETE: Phil Schuman, director of the Office of Financial Literacy, joins us, as he often does. Hello, Phil Schuman.
PHIL: Hello again.
PETE: My goal this entire episode of How Not to Move Back In With Your Parents, is to call you Phil Schuman every time I address you.
ALEX: That’s impressive. Can I call me Phil Schuman too?
PETE: If you like Phil Schuman.
ALEX: Phil Schuman loves it.
PETE: All right. So if you need any more information on what we do and how this works, please go to moneysmarts.iu.edu. This week, Alex, we tackle a topic of which a lot of people need tackled. And it is how to build and establish credit.
ALEX: This one will be a learning experience for me, because I currently—other than student loans, that’s the only thing I have in regards to credit.
PETE: But here’s the interesting thing: because you’ve not started repayment, you still have no credit.
PETE: And so there’s a big difference between no credit and bad credit. So let’s start with the differences. Phil, bad credit. Phil Schuman. Bad credit is when you’ve already had access to credit. You’ve had credit history, and you haven’t done such a great job.
PETE: 35% of your credit score is simply calculated on making payments on time. And so a lot of people that have bad credit or damaged credit, it’s because they really struggled making those payments every 30 days. And that 35%, it actually is the majority factor in your credit score. It’s just paying your bills on time. So, let’s just start here. Not really a suggestion to pay your bills on time—it’s more or less a requirement. Phil, when you’ve never paid bills before, it’s actually a challenge.
PHIL: It is. It’s something you gotta start prioritizing. If you feel like you’re responsible enough to take out whatever that loan is, you’ve gotta make sure that you’re prioritizing that you have to pay it back.
PETE: Alex, when you look—and I’m sure you don’t talk about credit a lot with your friends, mainly because you’re not horrifically boring. But if you did, do you think more people have no credit or damaged credit already?
ALEX: In my age, I would say no credit. I don’t know too many people with credit cards that are actually to them. It will be parents’ credit cards if they have them, but mostly no credit.
PETE: Here is the crazy thing about this. I think we may do an episode on the damaging things parents can actually do for your financial eyes. Sometimes parents and retirees even use credit so irresponsibly. Even upper middle class and high income earners. That if you’re a co-borrower or if you’re an authorized user on their credit card account, it can actually damage your credit because they don’t have the best habits. And so think about that. If your parent loses their job or something and they can’t make a payment, and all of a sudden, since you’re a co-borrower cause they’re trying to establish credit for you, it hurts you. That would be bad. So let’s start with people that have no established credit, or also known as no credit. There is a responsible way to build credit, and it’s a little bit of a trick. So we’re gonna take you through it. It’s called a secured credit card. Now, Alex, you know me pretty well, the financial advice that I give, and I think you realize that I don’t like credit cards.
PETE: Whatsoever. But I will tell you, and Phil, I’ll tell you, the best way to actually establish credit is to get a secured credit card. A secured credit card is a card where you make a deposit to a financial institution for 200 bucks or so. And that $200 deposit becomes your credit line. It becomes your credit limit. So it’s not like, “hey, we’ll give you a $200 credit line, and you’ve never secured it.” There’s nothing holding you accountable to that. You actually are making a deposit. It’s almost like a gift card, like a gift certificate.
PHIL: Can you spend over that $200?
PETE: No. Absolutely not. And in fact, that’s a great question, because I don’t even want you to spend 50% of it. I want to make sure your balance on that card is never above—if it’s a $200 line, above $100. Because if your credit utilization ratio, as it’s called, is above 50%, then that hinders your credit establishment. So you wanna make sure whatever your credit line is, that the balance is always below 50% of the available line.
PHIL: Okay. So this gives me two questions for you then.
PETE: Let’s do it.
PHIL: The first one, are these secured cards different from regular credit cards in the fact that, are they available through the same institutions? So you can get Visa, MasterCard, American Express. Is that the same in those regards?
PETE: They’re slightly different. It’s Wisa and Wastercard. Nah, I’m just kidding. No, it actually isn’t Visa and MasterCard. They are the same institutions. There’s different websites you can go to. You can actually go to your bank, your financial institution, and instead of asking for a credit card application or to talk to them about a credit card, just make sure you say the word secured. I’m looking into a secured credit card to help me build credit. Now there’s a lot of things going on here. To actually establish reasonable credit, you’re going to need to use this secured credit card for about 12 months. 12 months or so, and it will start to establish credit. And here’s some best practices. But did you have another question related to that?
PHIL: It is a little bit simple. This is just to clarify, basically, you put that in as a security deposit. It is not the same as a debit account, you put it in and the money you spend using that card is taken out. That’s just in case you miss a payment or something, is that what that security deposit is for?
PETE: Yeah, exactly. Described very well, sir.
PHIL: Thank you.
PETE: So there’s a couple things to consider, some best practices. Number one, you probably do wanna start with 200 bucks, and the reality is, if you’re a college student, it’s kinda hard to rub a couple hundred bucks together anyway. So that’s what you would wanna start with and I probably would not start this practice until your senior year. I think if you do it in your junior year, you’re pushing the envelope a little bit. I think there’s other things you need to focus on, and Alex, you and I have talked about this extensively. We only have so much energy and focus to put towards our financial lives, and we should not waste it and spread it out on a bunch of different stuff. So I think senior year is a good year to use a secured credit card. Junior year, you got other things in mind. The reality is you’re thinking about spring break most of the time.
PHIL: Right. It sounds like senior year, as it becomes more of a transition period into being a real person, in air quotes, then that will be a good time to kind of get that in your mind.
PETE: Phil, I think another important factor in this, a lot of times when people see their parents use credit cards, they do pick up some bad habits. So what we like people to do—and I’ll let you choose here—I like people to put one category of spending, one category of spending on the card and that’s what it’s used for. So Phil, how much is is your haircut? When you get your hair, what do you pay for that sucker?
PHIL: I pay ten bucks. We’ll say fifteen after tip.
PETE: Okay Alex, he’s overpaying.
ALEX: I was going to say. He’s overpaying for a haircut?
PETE: Yeah, but look at his hair.
ALEX: I was going to say, where can I find a haircut cheaper than that?
PETE: That’s a pretty good rate for a haircut. Like I’m paying 20 and I’ve got a lot of hair falling out. So my point is this, put that on your secured credit card. Don’t put food, gas, gifts, shopping, don’t do more than one category. Because you’re creating a new habit, and you gotta keep it under control. Think of it this way. If one category is okay, then you know your limit. But as soon as two categories seem okay, then three seems all right. And if three, then four, then all of a sudden, everything’s on the credit card and you’ve got a problem.
ALEX: So here’s a question, in choosing that category that you’re going to use for that credit card, should you take into account how often you are going to be doing a transaction for that? Say, you get your haircut once a month is 12 transactions per year. Is that something that there could be limits on the credit card through the company giving it to you?
PETE: Yeah, you need to be making a monthly payment, a credit card payment. So you need to have an expense once a month or so, at least once a month. And again, you don’t want it popping over the 50% of what’s available. The other thing you can do as you get deeper into the process, and this is maybe a better tip upon graduation from college, is to make another deposit on the secured lines so you raise your credit limit from 200 to maybe 500. And so, eventually what you’re gonna do here is you’re gonna build a credit score, and you’re gonna show that you have the ability to pay bills on time, that you’ve kept your credit utilization ratio in line. But most importantly to all of this, the longer you’ve had credit, the easier it is to get credit for things you actually do need later on in life. So let’s say you’re 27, 28, and you go to buy your first house. The fact that you established credit when you were 21 or 20 matters a lot. It matters a lot. So the length of credit, your credit history, not your payment history, your credit history matters and that can help you certainly move on with your financial goals. Before we move off this topic altogether, what questions do you guys have?
PHIL: I have one question for you. So you just said you can add money to increase the limit here. Now does the credit card ever become unsecured or what happens when you close it? Because obviously your credit score gets affected by how much credit you have available.
PETE: Sure, there’s a couple of things and there is a couple techniques at the end. Number one, you can transition it to an unsecured card, so it just becomes a normal credit card. And what I would actually recommend there, once you’ve established a certain credit score, is you can transition to an unsecured card. Keep it open, if you like, for emergencies as you’re building your emergency fund, but I would no longer use it. I would no longer use it for monthly purchases. Once you’ve established your credit, stop using it. Because again, you’re establishing history, not ongoing payment. So stop using it. The other thing is when you do switch it over from secured to unsecured, then they will pay you that deposit right back. They’ll send you a check for it. Anything else for you, Alex?
ALEX: No, sounds good.
PETE: Secured credit card. Secured credit card is one of the best ways to establish credit when you have none. For more tips like this, go to moneysmarts.iu.edu. Thank you for listening How Not To Move Back in With Your Parents, here on the IU MoneySmarts Radio.