What is Credit?

The real definition of credit

It’s not what you think it is. Tune in to find out what credit’s all about—and how you have only the good kind.

Podcast transcript

JASMIN: MoneySmarts U is brought to you by IU MoneySmarts.

PHIL: Arguably, the most important years of your financial life are your college years. The decisions you make in college can make or break your first few years in the workforce. This is exactly why you need to be money smart. Enter MoneySmarts, Indiana University’s financial literacy program for students. To begin, it’s free! Now that makes financial sense. At moneysmarts.iu.edu, you can learn how to budget, how to deal with your credit, living expenses, and student loans. You can learn how to leverage summer earnings to help you reduce your student loans. Indiana University MoneySmarts, creating a financially smart culture one student at a time. Visit us online at moneysmarts.iu.edu to learn great ways to maximize your money and wreck your debt.

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ALEX: Welcome back to another week of MoneySmarts U on the IU MoneySmarts Network. We’ve got an interesting one this week, Pete. We’re going to change it up a little bit. We’ve been having some interviews with current college students, figuring out their specific situation, helping them thorough it. Hopefully you listeners are taking some of that information and applying it to your own life. But this week, there’s a topic that at my time in school always came up constantly and it still comes up today. We dove in a little bit with Phil when he was here on the podcast, but we’re going to dive into it deeper, and that is credit.

PETE: Yeah, credit scores and how to build credit. You and I get a lot of questions via email and the speaking stuff we do. And one of the number one questions is, how do you build credit as a college student? Because there is so much emphasis on the importance of good credit so we are Full Disclosure Tuesday. I don’t even know if it’s Tuesday. Who knows when anyone’s listening? And by the the way as we’re recording this, it’s not a Tuesday. So it’s Full Disclosure Tuesday slash Wednesday, Thursday, Friday here on Money Smarts U. We’re going to talk about what our credit scores are, how they were established. And we’re gonna throw all the BS away. There’s no misinformation like you hear so much with credit.

ALEX: Yeah it’s gonna get real. And I guess the first place to start for college students would be, hopefully at your institution there is some financial literacy right? As a baseline we would hope so. At a lot of places where there isn’t much in the realm of financial literacy, the one thing you will maybe hear about is credit. Or you’ll have people at events showing up from credit card companies trying to get you to sign up for a credit card and all that. And that’s kind of where it starts, at a lot of points.

PETE: Yeah, so on the baseline, establishing credit is about the practice of showing people that you’re good at borrowing. So on thought, it’s you have to borrow, even when you don’t need to borrow, to prove that you should be able to borrow when you need to borrow.

ALEX: Totally, and I honestly think, that one specific point, in the beginning, which is the baseline of what credit is, is still grossly misunderstood and not told to college students. It’s something that I know, but still kind of needs to be hammered in every once in a while. And that’s a place I think we should stop, is credit is only about being good at borrowing money. It is not good financially, it is being good at borrowing.

PETE: And to be fair, I was out in California speaking to some pre-retirees, people in their 60s. And a guy came up to me after the presentation and said, I have an 800 credit score. And I was like, cool man, all right. Cuz even people in their 60s feel as though that means something like-

ALEX: Status. Yeah.

PETE: Here’s the reality, it’s not like he can go to a bank and say, hey, I have an 800 credit score, can I borrow my retirement? Because he’s done borrowing, so it doesn’t matter, it doesn’t matter. Now, here’s the thing, we want people to have good credit habits. We don’t want you to cater to your score, because a lot of the things you have to do to get your score to go up, are a, unnecessary, and b, completely dangerous. And Alex, you’re a perfect example of that in a good way.

ALEX: Yeah, and we’re gonna definitely dive into that a little bit. Real quick though, since you specifically mentioned that, can you explain these specific difference between good credit habits and then those credit score habits?

PETE: So my bank, when I had a mortgage at one point, and I refinanced the mortgage, meaning I went with a different lender at a different rate, cuz rates had dropped. That process is called refinancing, and so when I did so, they run your credit, and I had at the time a 790. Okay, and by the way, this is generally on a 850 scale.

ALEX: Right, so it’s very, very good.

PETE: Anything above 720 is considered very good. Anything above 740 is considered excellent, and you’ll get the best rates. So, let’s be honest, anything above 700 is pretty darn good. And anything above that’s sort of gravy. They sent me a letter and said, hey, you have a 790. But you might want to consider diversifying your credit. Which means to them, they wanted me to take out a credit card, they wanted me to have a store credit card. They wanted me to borrow against my home on top of my mortgage and potentially take out a car loan, so I could prove to them that I’m good at borrowing. They said if I did any of those things my score would go up. But Alex, what do I care if my score goes up? Because I don’t need to borrow anymore.

ALEX: Yeah, that’s interesting to me. So were they saying they would give you a better rate if you did that?

PETE: No, no, no.

ALEX: Or is it just only [INAUDIBLE] your score?

PETE: No, they would make my score, which doesn’t matter, go up. So if I’m above 740 I’m getting the best rates.

ALEX: Right.

PETE: I was at 790 and they told me the best thing I can do was quote, unquote. I’m doing the air quotes here, buddies, diversify my credit. And so you have to, it sounds all fancy and official.

ALEX: Right.

PETE: It’s really stupid.

ALEX: Yeah, especially if it isn’t even gonna get you better rates, which is the only reason why you would do that even though it’s something you shouldn’t do. That’s the only reason why you’d do it in the first place.

PETE: So yeah, so the basic premise here with credit, just pay your bills on time no matter what they are. That’s the first thing. You have two lines of credit, Alex. Yeah okay.

ALEX: So let’s say that I dive into that specific then.

PETE: Yeah, let’s dive into yours cuz it’s the perfect example. You are removed from college by months, not a year, months.

ALEX: Yeah, man, almost six months now, I think. We’re approaching six months cuz my grace period is about ten on student loans, so we’re about five months out.

PETE: You have two types of credit lines.

ALEX: Yes, on my credit history, my report-

PETE: Yep.

ALEX: There are two different things. The first is my student loans, and the second is my credit card, which I’ve had for under a year. I got it in fall of senior year of college.

PETE: Okay, and why did you do it? Did you do it to establish credit? Or did you do it for more of a practical purpose? [BLANK_AUDIO]

ALEX: I’d have to think back. Honestly, it’s a little bit of the establishing credit, just to kind of start to build a credit history there.

PETE: Because you knew you had it. And it’s not like you were creating expenses, you knew you had major expenses coming, because you had planned a trip.

ALEX: Honestly the timing was around the trip. So I was planning a big trip to Europe, we were getting ready to book thousands of dollars worth of flights and hotels.

PETE: Which you had saved for, by the way.

ALEX: Yeah, I already had all the money. The money was there, so it was more of I chose to buy it with a credit card that I had. I got a credit card, I bought all those purchases. But I have never once carried the actual purchases to the end of the month to create a so-called balance on a credit card. I treated it like a debit card and paid it off as soon as I made the purchase.

PETE: So there’s a lot of things going on there in that one statement. Number one, you were paying it off in sometimes within minutes of making a purchase on it, you’d go and transfer money from your checking account to pay the balance of the card.

ALEX: As soon as it appeared, I paid it off.

PETE: There’s a lot of misinformation out there to tell you it’s better for you to carry over, leave a balance, a little bit of a balance, it’s better for your credit. Which is, if true, cuz it’s arguable, if true, who cares? Because you’ve never done that, you’ve paid within minutes, you have student loans which aren’t even out of their grace period, and what is your score?

ALEX: My score right now is a 724. I’m looking at it currently, 724.

PETE: Okay, so you’re 20 years old, 22 years old.

ALEX: 22 years old.

PETE: 20, jeez, what was that? Sorry, you’re 13 years old, and you have a 724, and you’ve done nothing risky or weird or stupid. You basically borrowed for tuition, okay? And you’ve begun the very active process of paying off the debt.

ALEX: Yep, been paying off thousands of dollars so far to try and get ahead on my student loans. So I mean, that’s it, other than the trip I barely ever use my credit card. I mean, I actually dislike using it because I hate having the outstanding balance there. If I make purchases, I want it to be done. I want it just, all right, it’s out of my account, I paid for it, it’s done. So, I kind of hate using it, to be honest.

PETE: There’s something unusual about the way you did it, in a good way, is that you had expenses you knew were coming, yet you had saved for.

ALEX: Right.

PETE: And you could’ve very easily just paid them with your debit card, or money order for that matter, and been done with. But you chose it as an opportunity, to create a little bit of a process, to establish credit. A lot of people aren’t in that situation, hey, that haven’t saved money for boo, right? And they don’t necessarily have set expenses they know where they’re coming. They more use it for an emergency or just in case and that’s where people can get in trouble.

ALEX: Yeah, absolutely and that’s where I kind of think about the available credit line and things like that. So I have a pretty low available credit line because it’s my first credit card.

PETE: What is it?

ALEX: It’s 1500 right now and that was raised probably a month or two ago from 1,000 when I started out.

PETE: All right, so this is me hopefully giving some perspective. I don’t think that’s low, right? I think for someone who’s 22, this is where I sound like the old condescending guy, that part of the episode.

ALEX: Of course.

PETE: I don’t think that’s bad, at 22 to have a $1,500 credit limit. And by the way, you’re a guy with an emergency fund.

ALEX: Mm-hm.

PETE: And you’re a guy that’s got money saved for a car, and that will have your student loan interest, accrued interest paid off by the time your loans start or your loan payment.

ALEX: You make it sound so good.

PETE: It is good.

ALEX: I feel like I’m toiling away with student loans.

PETE: That’s why it’s good.

ALEX: [LAUGH]

PETE: So 1,500 bucks is not a little.

ALEX: For me, 1,500 bucks is still a lot of money. But I saw when I was booking my trip, there would be a point. Another reason to pay it off is I’d be booking hundreds of dollars at a time on hotels and stuff that I had money for. And that uses up that available credit, and I would take a step back and be like, I could have made those purchases without the money saved up, and you can get a pretty good chunk done for 1500 bucks. But I was paying that off right away afterwards. I could very easily feel the pit in my stomach of if I were to make that purchase without having the money to back it up.

PETE: I think the best part about this is six months removed from college. You’ve officially and this is dramatic, we should have a drama horn or something, [NOISE].

ALEX: The ham horn.

PETE: Yeah, what is that called, a ham horn?

ALEX: Yeah, I got it.

PETE: You do?

ALEX: Yeah.

PETE: We should get this working while I’m talking, you get it going and will it take you a second here?

ALEX: Yeah just a second here.

PETE: All right, we’ll filibuster here for a moment cuz we need more sound effects on the show. We should talk to Phil Schuman, executive director for the Department of Financial Literacy at IU, to get more sound effects. So drama alert.

ALEX: We’re ready, this is going to be way too loud. [SOUND]

PETE: That is way too loud. I like that, it’s called a ham horn?

ALEX: Ham horn, that’s the name of it yeah.

PETE: I’m an old guy. I don’t even remember what I was saying. No, here’s what I’m saying, you are six months removed from college. Your credit is established for life, done, done, seriously.

ALEX: So I did not realize. I’d known my credit score was there. It was at 695 for awhile, and bumped up.

PETE: When did it bump up, do you know?

ALEX: It had to have been two or three months ago at earliest, yeah. So that’s what I’m thinking is, is it because I’ve been making that ahead of time payments on my student loans? I guess the gist of it is, I got a credit card out and I was trying to, I made some extra purchases on there for my trip. Hey, it could help whatever. Essentially, it seems like that really might not have done much at all.

PETE: Yeah, first of all it takes 12 months on a new credit line for it to be considered what’s called established and to matter.

ALEX: And to actually start making a difference.

PETE: So you are about 12, you’re close to 12 months of that credit card being around. But the reality is this, you started paying on your student loans early within the grace period sooner than than you had to.

ALEX: And it shot up.

PETE: Your credit score shot up, and by the way paying on your student loans early is the smartest thing you can do, so you kill two birds with one stone. You pay off the interest so it doesn’t accrue. You start paying right away aggressively. Two, you establish credit in the process.

ALEX: And the great part is, I didn’t realize the whole 720 is one of the best, 740 is the best you can get. It’s a very nice feeling that I just accrued five minutes ago from learning this that. I don’t even have to, as long as I don’t mess up and miss a payment, which I won’t, I won’t have to worry about that at all anymore.

PETE: Yeah, so 740 is not the best, to put you in the best tier, so basically 850 is the best.

ALEX: That’s what I was saying.

PETE: Yeah, so 740, anything above 740, you’re fine. It doesn’t even matter, right? Because on some level, credit scores are gamification, right? It’s the idea that, we want you to go higher, but the people that want you to go higher, are the people that want you to consistently borrow money.

ALEX: Yeah, they want you to give them more money over the long term.

PETE: So why your credit score is so good, is because you established student loans, taking out student loans four years ago. And then you started to make good on them, before the grace period ended. So any student that graduates with student loans and makes payments right away. Forget doing weird stuff with credit cards to establish credit or getting a car loan, or God forbid don’t get store credit cards, that’s a horrific idea.

ALEX: Please no.

PETE: Please don’t. You are gonna be fine and I think if anything, if you don’t have the money to pay for expenditures like you have with your Europe trip, a secured credit card is a great option and in fact, it’s my preferred option opposed to the way you do.

ALEX: So let’s maybe talk about this from the other side then. Because I think that’s really important for the people who say, if you’re lucky enough, this is an opportunity for people who have to take out student loans to have it kill two birds with one stone.

PETE: Yep.

ALEX: But for the people who are lucky enough and who don’t have to take out, or who have worked hard enough, right? Two sides of that coin, to not take out student loans, they might not have that established credit because of that. So if they’re like, well my credit score’s lower, now they feel the need maybe to fall into that system. So secure credit cards come up. I guess what’s the battle for not worrying about your credit score maybe not being as high?

PETE: Secured credit card basically, you put money down which secures the line of credit. So you deposit $200 to $300 cash with a banker financial institution, they extend the line of credit which is backed by that money. You make a few purchases, repay it, make a few purchases, repay it. Over a 12 month period, credit is established. So it takes 12 months, but you know what?

ALEX: And then you’re going from there. And hopefully you aren’t needing to borrow at something that would require pretty significant interest rates, right, by the time you have credit established.

PETE: I mean, let’s be honest about happens when you turn 18 and you go to college. You are asked in that moment, is the drama horn still available because this is about to go, am I really dramatic today? I feel like I’m dramatic today. [SOUND] Here’s my drama statement of the minute cuz I had one a couple of minutes ago. When you’re 18 you’re asked to make probably the most difficult financial decision in your life. I mean, you’re asked, hey what do you want to do for a living? And how much do you want to borrow when you don’t actually know what’s gonna happen to fund that education? You’re not asked to make decisions like that when you’re 22, or 23. Have you had to make any hard decisions, financially, post-college?

ALEX: Not ones that will affect me that drastically.

PETE: No, not at all, and so there’s this idea that you’ve got to warm up to make all these adult decisions when you graduate. No, not at all, you haven’t, and you won’t have to.

ALEX: Yeah, and that’s the most fascinating part of it for me is, I had no idea that was happening. And it’s just, before I started working with you and working in personal finance, I had zero idea. So my parents had taken out student loans, because that’s what was going to be required. And then they filled me in on what was going on, I was just like, okay, if that’s what needs to happen. And now, as I’ve gained more knowledge I’ve realized it. But it has taken that time to actually realize the magnitude, and of graduating you realize the magnitude of what’s actually happening.

PETE: So I guess we’ll leave people with this, maybe get a secured credit card.

ALEX: Yep.

PETE: 2 to 300 bucks max to start, establish it for 12 months. If you’re gonna go the route Alex went, where you know you have some expenses coming up, and you just get a credit card to do it that way. Only, only, only do that if you have the cash anyway. Don’t do it to fund something you can’t afford like a spring break trip or something like that.

ALEX: Blanket statement, treat a credit card like a debit card. Treat it like it’s coming right out of your balance. Make that payment right away, and that’s the easiest way to avoid any of those credit issues.

PETE: Well, there it is, look at you. [SOUND] Into this man.

ALEX: All right, so hopefully that gets rid of some of the BS you may have heard about credit. If you guys have questions about it, reach out to us. If you want to be on the show, maybe you have some credit questions that you would like to discuss. Reach out to us, go to moneysmarts.iu.edu, fill out the application, join us on the show, we’d be happy to talk through it with you. I think that’s good, I think hopefully you guys can get the dose of reality this week on MoneySmarts U about credit, thanks for stopping by. We’ll be back with more next week with more college students, thanks for checking out MoneySmarts U.

PETE: Straight drama.

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