Credit 101, with Jenny Hoff & Barry Paperno

This podcast originally appeared April 26, 2017 on CreditCards.com as “‘Charged up! podcast. Credit 101

Barry Paperno, a credit industry veteran and columnist for CreditCards.com, is an expert in the credit scoring game. In less than 30 minutes, Paperno educates us on Credit 101: What matters most, how to raise your score quickly, what makes a perfect credit score and the biggest mistake people make when it comes to their credit. Since credit affects our lives in a myriad of ways – from buying a home to getting a job and even renting an apartment, knowing the ins and outs of how the system works can save you a lot of money and a lot of anxiety down the line. Whether you have faced bankruptcy in the past or are new to the credit arena, this podcast will teach you what you need to know to master the credit game.

Get Charged Up! about graduating from Credit 101!

Transcript: 

{Duration 00:27:59]

Jenny Hoff: Barry, thank you so much for joining us today.

Barry Paperno: My pleasure.

Hoff: So, let’s start with your own background. You’ve been in the credit rating world for a while. Tell us about that and the important lessons that you learned.

Paperno: I started in 1973 with Bank of America, then fast-forward a couple of decades to Experian, one of the three national credit bureaus, and 17 years at Fair Isaac Corporation, which is known to most folks as FICO, the credit scoring folks. In the over 40 years that I’ve been in the credit business, what it’s taught me is that if nothing else all of this can be boiled down to the fact that credit can be both your best friend and your worst enemy, and as with best friends and worst enemies they tend to occur at the worst possible time. It can happen to anybody. It can happen to people with lots of money, with little money and for all kinds of reasons.

Hoff: Yes, it’s a universal issue that we all must deal with, and you’re right as it really doesn’t matter as we’ve seen with celebrities who make tons of money and then go bankrupt afterward because they didn’t manage it right. Your credit, your money management skills and all that can affect you really at whatever level. One thing I really wanted to talk to you about mainly because you are an expert, you write a column for CreditCards.com, you give really great advice to people on what they need to be doing absolutely right now to start bettering their credit or get out of a credit situation that they are in. Let’s start first with the basics: the importance of good credit. For those looking to buy a house or a car, why credit is important may be more obvious. You want to secure a low interest rate, or you want to get approved for a loan. But for those not shopping for big-ticket items, why is knowing your credit score, building your credit score, and monitoring your credit report really important?

Paperno: Well, credit isn’t difficult, particularly to achieve good or bad credit. It does take time, and time is a huge factor in a credit rating. So that means to have the kind of credit that will get you qualified for a loan whether it’s tomorrow or five-to-10 years from now, you need to think ahead. It’s not something that you can just turn around on a dime, it’s more of a big battleship that you are having to steer. What you want to be able to do is when you find that home you want to buy or when you need a car or when you’re renting an apartment or even getting a job, you want to have as good of credit as you can possibly have, and it’s not something you can just think about the day before.  You have to work at it, you have to cultivate it, you have to take good care of it because it will again be your best friend, it can get you into a house that you can afford. Or it can get you turned down for a secured credit card and everything in between. So, it’s important to think ahead when it comes to credit whether you are just starting out or are trying to rebuild or just trying to stretch that already high credit score into an even higher one.

Hoff: And when it comes to monitoring your credit report, why is that important and what should people be looking for? And with your credit card statements, if you do find something that you say well I didn’t pull out that card or I didn’t make that purchase how do you dispute it? How do you get credit report errors taken off your record?

Paperno: Well, first you should be checking your credit at least once a year. If there are no problems that’s good enough, and if there are then you have some work to do. What you want to check first always is for accuracy. You want to make sure that what’s on there is yours. You want to make sure that the balances and credit limits and the payment histories are all accurate and if they are not then you have some work to do.

If they are the type of problems that are for example: You paid off a loan and it’s not showing paid off or if you had a credit limit increase a few months ago and it is not showing up, you want to go to the source first of all of that information which are going to be the creditors that report that information to the credit bureaus because that’s where the credit bureaus get their information. So, in those cases you want to go to the lender or the card companies and see what they show and see what the problem is and get them to resolve it. You may have to provide them with some documentation, and then they will submit the corrections to the credit bureau.

If they are the type of problems that are strictly credit bureau report items such as somebody else’s information is on your credit report or all of your information is not showing up, that’s not a problem typically with your credit companies, it’s the credit bureaus and their filing system. So, there you want to dispute with the credit bureaus with the instructions that any credit report will have. It may be an issue where if you are a junior and your father is a senior maybe your credit files are being mixed, or if you had credit at one address for a short time and then didn’t report it with your Social Security number it may not be showing up on your credit report but it may there in the credit bureau database anyway.

So, you basically want to check for accuracy, and if things are not accurate either go to the credit reporting agency, the credit bureau, or the company reporting it or in many cases both. For example, if you get them to update a balance you may also want to dispute it with the credit bureau. You always want to go to the source whenever possible.

Hoff: And does disputing something that you find on your credit report, so I did this not too long ago and if you find something you feel that you don’t recognize – it might have been from years ago so you may actually be wrong. I feel like in some cases it can be a little confusing when you look at your credit report. You may not remember if you had pulled out that card at one point or if you had taken out a card like that but let’s say you look at it, there’s some stuff you don’t recognize and you dispute it. Will that hurt your credit score in the short run while they are going over that dispute?

Paperno: No. The way the credit scores work is that they will exclude most information from any item on your credit report that is showing up as being in dispute. So once you dispute it, a flag goes on the item on your credit report and the credit scores will ignore things like the amount you owe or how you paid and that type of thing. It will continue to include your length of credit history so if it’s an old card that you had it will continue to give you credit for having had that a long time and so forth but no it will not hurt your score.

Hoff: And if you find that somebody fraudulently used your information say somebody took out a bunch of cards in your name or took out a loan in your name? Some people feel like “Well I shouldn’t have to do much here, this is illegal. I should be able to call the police or let the credit bureau know and it’s taken off.” But it’s not that easy, is it?

Paperno: No, of course none of this is terribly easy. But if you suspect fraud, you want to contact that company or creditor and the credit bureau. You’re going to want to dispute it, and you’re going to want to get a police report.  Fortunately, you won’t ultimately be responsible for the amount, and it won’t, of course, affect your credit score at least once it’s in dispute like we were just talking about.

So yes, you do have some work to do.  Fortunately, through, things such as credit freezes and fraud alerts make it pretty easy to flag the account and restrict it from certain access and so it’s much easier than it used to be.

Hoff: Yes, I’ve heard horror stories from people about that. Sometimes they’ve spent hundreds of hours on the phone trying to rectify basically a stolen identity, and it really just drives home that point that you need to be monitoring you credit report as often as possible because if this is something that is 10 years old it’s going to be a lot harder to rectify quickly than if it’s something that happened in the last few months.

Paperno: Yes, because you know if you are contacting your bank 10 years later, chances are they’re not going to have the records handy. It might not even be with the same bank for all we know. It’s one of those things where anytime there is an error on your credit report catching it soon is good.

Hoff: So, let’s now get into the nitty-gritty of credit scores. I feel like a lot of people are confused how their credit score is actually determined. It can go up, it can go down, it changes, they don’t know what really hurts it, they don’t know what counts the most, or what counts the least. So, let’s talk about the basics. What are the factors that go into determining your credit score, what’s the most important, what’s the least important, and what can you change pretty quickly if you need too?

Paperno: The score looks at how you’ve paid, how much you owe, how long you’ve been using credit, the extent to which you’ve taken out new credit and the different types of credit experiences you’ve had. So, that works out to five FICO categories.

The first one is payment history, and this is the most important by far, as you might imagine. If you are going to rate someone’s credit you want to know do if they pay on time or don’t they. That’s 35 percent of your score right there, and specifically there are three areas that the score covers with regard to how you pay.

First of all, if you pay your minimum payment on time each month that’s as good as it gets. So if it’s a credit card and you have a minimum $30 payment each month, as long as you make that $30 payment by the due date you’re great.

If you have a mortgage, as long as you pay that you don’t have to pay extra, you don’t have to pay it early, just pay it on time and you’re doing everything that the score wants to see you do.

Hoff: So even just paying the minimum every month on your credit card will keep your score higher than if you pay it all off at once every single month? It doesn’t make that big of a difference?

Paperno: For this category of the score, for purposes of do you pay on time, or don’t you? That’s all that matters. When we get to the next category we’re going to talk about how much you owe, so that’s where paying more will help you. But in terms of assessing your payment history, just making the minimum is all you have to do.

If you have any late payments, there are three ways that it looks at it and that is: how recently the late payment occurred is the most important,  second of all is how late the payment went (did it go one month, two months, three months),  and third, how many accounts on your credit report have late payments? But again, the most important is how recent. So, for example a 30-day late from last month can be more damaging to your score than a bankruptcy from seven years ago, believe it or not.

Hoff: Oh, wow.

Paperno: Yes, so that recency is important. If you’re taking notes and you write nothing else, write recency. And that’s good news for some people, because if you do have any problems it means that just the passage of time alone, as long as you’ve caught up on any late payments, will go a long way toward restoring your score.

The second big category is how much you owe or amounts owed. That’s 30 percent of your score, and this is where you get into credit utilization and that is how much of your available credit on credit cards that you’re using. That accounts for 30 percent of your score.

The next, at 15 percent, is your length of credit history, and that just looks at how long you’ve been using credit. It will look at your average age of accounts, and it will look at the age of your newest and your oldest accounts.

The last two categories are new accounts, which accounts for 10 percent of your score, and that’s where inquiries come in. Inquiries are anytime someone has looked at your credit report, it becomes an inquiry and there are two different kinds, there are soft and hard inquiries. The hard ones are the ones that count. Those are the ones that are typically associated with applying for credit. They show up on your credit reports for two years, and the score only looks at them for the first year.

Soft inquiries are the types like promotional things that put you on a mail list, that typically occurs when you get a credit offer, something like that.

The last category is types of credit. The idea here is that the more experience you have with such things as loans and credit cards, the less risk you will be down the road and you will be familiar with how to manage those two different types of credit.

Hoff: So, this is your credit mix. This is saying that OK, so you have a bunch of credit cards, you’re paying them all off on time and you don’t carry high balances, that’s all great. It’s even better if you also happen to have a mortgage or a car loan and you’re making regular payments every month on that because you are showing you can handle different types of credit, not just credit cards but also these so-called installment loans, correct?

Paperno: Absolutely, and that’s where it can get interesting because this gets into one of those areas that are sort of nonintuitive about scoring, such as, you pay off your car loan and your score goes down you think “why would it do that?” Well, maybe it’s because you no longer have an open loan to go with those credit cards and so forth. I don’t mean to scare anybody, but that’s one of the little oddities of scoring that can occur, and when it does, it’s because of that mix of credit category.

Hoff: And I know a lot of people are confused as to whether it hurts their credit to pay off their credit card balance in full every month or if they should always leave a little bit on the account to keep their credit. Can you describe that: If you pay it off down to zero every month, does that hurt your credit or does it help your credit?

Paperno: Well, keep in mind that you start with zero points and you accumulate points to your score. So, it’s more a matter of not achieving as many points in some cases as others. So, you’re not really losing.

When it comes to paying off credit cards, it’s always good to reduce your utilization. Your utilization is the percentage of your credit available to you that you are using. Another way to put it is your balance is divided by your credit limits. Any time you reduce that percentage you’re helping your score. Always the lower you go the better. Until you reach zero sometimes, and what happens is one of the things the score looks for, just like it looks for you know different kinds of credit experience, and the longer the better that you have been using credit and all of that.

One of the things it looks for is are you actively using credit currently or did you cut up your credit cards years ago and haven’t used them? In which case, you are great as far as not owing any money, but how well will you manage credit when you do take it out if you haven’t been using if for some time. So, one of the things that the credit score looks for is activity, and unfortunately the only way it can measure that or the way that it chooses to measure it is whether there is at least a balance on at least one credit card.

If it is all zeros, the score assumes that you’re not using credit even if you used it last month, even if you pay your cards off every single month, it doesn’t want to see zeros there. So ideally, pay your cards down to single-digit percentages, so the place you want to be is in the 1 to 9 percent range and obviously lower is always better.

If you are maxed out and you can get them down to 75 percent you’re helping your score, even down to 50 percent. So, lower is always better, but when the decision is should I pay them down to zero or leave something on at least on one of your cards, leave a little something. Leave just 1 percent, leave a cup of coffee or something on there. And either way, your score is going to be high. Even if you pay them all off to zero and everything else is in order you’re going to have a great score, you’re going to get that mortgage or that 0-percent car loan or whatever.

But if you really want to maximize it, leave just a little bit of a balance and that doesn’t mean pay interest on it. So, it doesn’t mean carry it over from one month to the next. It just means that you allow that month’s card statement to show a small amount that you then pay off before incurring any interest. There’s never any reason score-wise to pay interest.

Hoff: OK, so yes, so just in the hopes of getting your score up you shouldn’t be paying interest, but if you can maneuver it timing-wise it reflects that you have a little bit of a balance on your card but you’ve managed to pay it off before interest comes in, then you can up your score a little bit.

Paperno: A little bit, yes, either way it’s good you know you’re not hurting your score. It’s not like paying late or something to pay it off.  But you can squeeze a few more points out of it by leaving 1, 2, 3 percent up to 9, 10 percent on your card statement.

Hoff: And toward the end of this interview I want to ask you what a perfect credit score portfolio would look like, what would they have done right to have managed to get that perfect credit score. But first I want to go through a couple of these topics again. Credit utilization, we just went through that, is there a goal a percentage goal that we should always be aiming for? Is it the 1 to 9 percent, or is it 30 percent?

Paperno: I still read all the time experts saying you should get your utilization below 30 percent.  It used to be below 50 percent, sometimes you see below 25 percent, and while that’s true, 30 percent is better than 40 percent. There really is no particular threshold below which you will see a big jump in your score. So if you’re at 31 percent and you bring it down to 30 percent, you’re doing the right thing. But ideally, as I have said before, you want to be in the single digits. So, in the 1 to 9 percent range. Lower is better, but a little something more than zero is best.

Hoff: And that’s where credit cards can actually help. If you do happen to have many credit cards, that means you have a much bigger line of credit extended to you when you combine all those cards together. But let’s say you were going to put $2,000 on your card every month no matter what. The more credit you have available to you the lower your credit utilization is?

Paperno: That’s correct. That utilization is measured in two ways. Both on an individual account level and as a combined percentage. You want to have a low percentage across the board over all your total balances to your total limit, and you also want to prevent any individual card from having high utilizations.

Hoff: OK, so it’s not even just the overall how much credit you have extended to you and how much you use, but it’s how much you are using on each card. I want to get to know the biggest mistake you see people make regarding credit. You have your column, Speaking of Credit. I highly recommend people read this. You give such great advice, such pin-pointed advice that we can learn so much about how this crazy credit system works, but what are the biggest mistakes that you see people doing over and over and over again regarding credit?

Paperno: As people do in other areas of their life, failure to plan, wishful thinking, specifically, failing to budget. You didn’t budget for that car repair that happened unexpectedly or medical emergency. To the same extent that any other aspects in your financial world you want to prepare for emergencies, you want to do that credit-wise, too, so that’s why you don’t want to have to max out a card because your car broke down right before you’re applying for a mortgage, obviously.

The most common thing I see people doing is failing to, well, failing to monitor their credit, to check it once a year. The Consumer Financial Protection Bureau every once in a while releases a survey on how frequently people check their own credit reports, and considering how easy it is to get a credit report it’s amazingly low. I think it’s under 50 percent of people who don’t or haven’t checked their credit report in the last year or more.

So people don’t check their credit until they need it; they don’t plan for emergencies. For example, if you are planning, you know you may have to put a new roof on your house and that a year from now you’re going to want to refinance that house. So you want to plan for that roof. If you have to put it on a card, what is that going to do to your score and then plan for how you’re going to reduce that so a year later your score is going to be high enough to qualify you for that refinance.

So again, it’s planning. What makes it particularly difficult is correcting anything, as we’ve alluded to. It takes time and effort in a lot of cases. So if there is something that’s wrong on your credit report, don’t expect it to turn around in a day or even a month in most cases. You have to look at least 30 to 60 days if everything goes right with a dispute to get it corrected, and it can often be longer. So again, failure to plan, allow time if you’re going to be buying a home, check your credit at least six months before and that will give you some time to prepare for the worst.

Hoff: That’s great advice. I know people who have never checked their credit score, or they checked the credit score they get that comes free with your credit cards but they have never checked their credit report. You know they don’t even know where to go to check their credit report.

Well, as I mentioned earlier, I don’t know if we can do this on the fly, but what would be the portfolio of someone who has the perfect credit score?

Paperno: Well, I’ll take you down those five credit categories and we’ll look at how those look since that’s what makes up your score.

In terms of payment history, you have never missed a payment, simple as that.

In terms of amounts owed, kind of reviewing what we talked about, utilization percentage in the single digits.

In terms of length of credit history, you should have a long history. This is where if you’re new to credit you can max out on your payment history factors, right? Because even if you have only had credit for six months, as long as it’s been paid on time you’re great, and as long as your utilization is low you’re great.

But you can’t do anything about the fact that you’ve only had credit for six months and this is where for somebody new is probably going to fall a little short of that super high score. But so, somebody with a perfect score is going to have many years, in most cases decades of credit, at least in terms of their oldest accounts.  That’s where some of us old folks have a bit of an advantage. And you have to have some advantages in this life.

In terms of new accounts, you shouldn’t have opened a new account within the last year or two, that type of thing and as we talked about, you have a mix of credit so you have at least one open loan whether it’s a mortgage, auto loan, student loan, home equity loan, personal loan, anything of a loan type along with credit cards either.

A credit score looks for a certain number of things, but with most of the scores the specifics are rather secretive. You can have an ideal number of cards based on a number of other factors, or you can have too many or too few.

How many cards you have can matter, but you’re not going to have any way to know going into it, so there’s some other factors like that. Number of accounts that have balances on them, there’s an ideal, so there’s some little things, but for the most part, if you have a long history, low utilization, on-time payments, you’ve got a great score.

Hoff: What would you say are the three things somebody listening to this podcast can do right now to start taking charge of their credit?

Paperno: First of all, check your credit. If you haven’t pulled your credit report in the last six months, get your credit report. There are different websites, including CreditCards.com where you can get a free report and free score. I would say at least once a year take advantage of annualcreditreport.com, which provides the credit reports that are free once a year. They are complete credit reports, and the ones you get on websites are not always as complete. So once a year from each credit bureau get your report from annualcreditreport.com. It’s free. That’s the first thing.

The second thing you’re going to want to do is reduce your utilization, unless it’s already low in which case you’re already doing it. If it’s at 10 percent, get it down to 1 percent. Obviously, if it’s 75 percent, get it down to 50 percent. The lower the better.

Third: Plan ahead. Is there a credit card, for example maybe you just started a new job and you do a lot of traveling and you want a card that gives you miles, or you use your card a lot for your own personal business and you want cash back rewards. Well, what do you have to do to get that card? Look into it, again you can look at creditcards.com and see what credit card programs are being offered and what kind of scores you need for them. Do a little planning, and then you can not only get some cash back, but if it’s got a high limit that can help you lower your utilization. If your score isn’t where it needs to be now, well work toward getting it there, doing all the things that we’ve talked about.

Hoff: What I really wanted this podcast to show is credit scores don’t have to be that complicated. They’re not totally out of your control. You can control them by learning just a few of the secrets and/or a few of the things that go in to making your credit score and just start taking control of that, because a high credit score means you get a lot better deals when you need them.

Finally, what gets you charged up about helping people master the credit game?

Paperno: Anybody can play the game. It’s what I mentioned early on: You can have good credit no matter who you are. You can be rich or poor, you can be young or old, you can have a good history, or a bad history as long as you’ve done some things since that bad history. Anybody can have good credit.

One of the beauties I think of credit scoring is that scoring doesn’t look at how much money you make, it doesn’t look at how much you have in the bank, it doesn’t look at any other assets, it doesn’t look at your name, where you live, what you do for a living, it doesn’t look at how old you are anything like that. As a result, with one little department store credit card you can have a higher score then Warren Buffett, basically.

Thatt’s somewhat empowering. Anybody can have good credit if you do the right things, and then that leads to what it’s all for, and the other thing that I love about this, you get to see great results. When I was at FICO, I managed their My FICO forms for the first five years, and people would post pictures of the home that they just bought that they were able to buy because they raised their score using the information from our site.That’s a beautiful thing to see.

I had a friend whose husband was an immigrant, had no credit and needed a car and was being faced with some prime rates, and I mentioned, well just make him an authorized user on your credit card. She did that and he got a great rate from a credit union on a new car, and I got to take all the credit.

It’s something you can see tangible results from, and anybody can benefit from it.

Hoff: I love that it’s empowering, it’s an equal opportunity system of rating, and you know how to play the game and you know how to follow the rules and you can get your credit score up high and make life a lot easier in that case. Barry, thank you so much for joining us today this was a great conversation.

Paperno: Oh, I’ve enjoyed it, Jenny.

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