How to Build Your Credit
Do you know your credit score? Do you know how your credit score can affect your everyday life? In the journey to building your credit, not only do you need to understand the basics of your credit score, you need to understand how it is affected simply by the kind of loan you might decide to use.
In this series we are going to explore the basics of what a credit score is, reasons why having a good credit score is important, and tips for building a good score and avoiding mistakes that can harm your score.
Build Your Credit: Finance Company Loans Transcript
Part 2: How to Build Your Credit: Finance Company LoansVideo
Idaho Assistive Technology Project (IATP)
In the journey to building your credit, not only do you need to understand the basics of your credit score, you need to understand how it is affected simply by the kind of loan you might decide to use.
In the previous presentation, you learned about some of the myths surrounding credit, credit scores and how they are calculated, and finally, why credit is important.
In this presentation we will talk about different types of finance company loans and how they may impact your credit.
Let’s take a look at what a finance company loan would do for your credit. First, finance company loans are extremely easy to get, even without any credit history! That’s the key marketing point for payday lenders, check cashiers, rent-to-own businesses, and other similar places. No credit? No problem. Unfortunately, all of this quick and easy money comes with a catch!
First, these loans are considered “high risk” loans, and are extremely expensive. The costs of payday loans average around 600% APR. That means that the cost to borrow $500 over a year’s time is, get ready, $3,500! That’s seven times the original amount borrowed. This is what we call a really crummy deal, and if you think the bad news ends there, think again. Aside from the outrageous upfront costs of a finance company loan, these loans also cost you because of the effect on your credit score. Finance companies will not help you build positive credit history. In fact, they only build negative credit history. And here’s why.
Remember the five factors that make up your credit score? This is how a finance company loan affects each factor.
First, simply having a finance company loan is automatically considered to be a negative thing in the “Types of Credit Used” section of your credit score. This is because finance company loans are considered high risk loans. In other words, when choosing this type of loan you’re basically saying that you consider yourself to be a high risk for credit. Whether you truly are or not, doesn’t matter. The moment you open up a finance company loan, you have placed a negative piece of information on your credit for at least seven years. This is because all loan information stays on your credit report for seven years from the time of the last activity.
And our bad luck doesn’t end there. Most finance company loans have very short pay-off periods, usually two weeks or so. So there is a tendency of users of these loans to continue to pay off rapidly closing accounts and open new accounts in order to carry a loan balance for long periods of time. “New Credit,” which makes up 10% of your score, is negatively affected every time a new account is opened.
All this opening and closing of accounts significantly hurts the “New Credit” section of your credit report. Also, 15% of your score which measures the “Length of Credit” history, takes a hit with each of these new loans, because it significantly outweighs any mature, or old accounts that you may have in your history.
“Payment History,” which makes up 35% of your score, simply indicates whether or not you make your payments on time.
Simply getting a finance company loan does not automatically damage this factor in your score, as it does with the other four factors we’ve already talked about, but, because many customers often underestimate the costs of these loans and their short payment periods, missed payments are much more common with these types of loans than with others. It only takes two or three missed payments to significantly drop a credit score.
Finally, the “Amounts Owed” factor makes up 30% of your credit score. This means that your current balance is compared to your beginning balance. Finance company loans are very short activity periods and have costly interest rates and fees. This means that they usually show high debt ratios. This can hurt the “Amounts Owed” factor of your credit score.
Slide 9: (Interactive)
Now let’s take a moment to see what you’ve learned.
- Finance company loans are easy to get.
- Finance company loans help build good credit.
- Finance company loans are cheap loans.
Click each letter below to see the answers.
[Letter A.] TRUE: Finance company loans ARE easy to get.
[Letter B.] FALSE: Finance company loans DO NOT help build good credit.
[Letter C.] FALSE: Finance company loans are NOT cheap loans.
In short, finance company loans can negatively automatically impact four factors of your score, and there is a very high likelihood of a negative impact on the fifth factor. That means that finance company loans are never a good place to start building credit. In fact, it’s probably best to stay away from these types of loans all together. They are expensive and have very little capacity to positively impact your credit score, yet they have a high likelihood of dropping your credit score significantly.
Great job learning about finance company loans. Finance company loans turned out to be a bad deal for you and your credit score. In the following modules we will look at other types of loans as a possible way to build your credit.
Thank you for watching this webinar. A special thanks to the UI Extension office for their content expertise.