Category Archives: Building & Rebuilding Credit

Using 401k funds to rebuild credit?

By Barry Paperno

Dear Speaking of Credit,
We have a financial planner person and a 401k person that we are meeting with. They are not credit people, though, so we needed input like yours as well.

My husband and I have just had our Chapter 13 discharged.  We both have student loans that stem from additional college later in life.  Mine is about $14000 and my husband’s  $40000. We can pay off mine with 401k monies and avoid the 6.8% interest that’s been accruing in favor of a lower interest rate on a 401k loan.

My questions:

  1. Is it better for rebuilding our credit to pay off the one loan or should we make payments, basically for the rest of our lives?  I’m 48 and he’s 47.  We have no other debt.
  1. What is this business about FICO score and how important it is vs. the credit bureau scores? Is FICO just the culmination of all three credit bureau ratings?
  1. We also have been receiving sales materials telling us that we have to take action (i.e. take a loan with us) now that the bankruptcy is discharged to get back on the credit bureaus’ radar again and get our scores going up or our scores will stay in the tanker (even though the BK has been discharged). What is that about?

Thank you — Mickey

Dear Mickey,
Seeing as how you’re talking about tapping into retirement funds to rebuild credit, I’m really glad to hear you’re working with a financial planner and someone familiar with 401k’s. Otherwise, I would not want to even begin recommending or discouraging any particular credit-rebuilding action, no matter how good for your credit, that touches retirement funds. My answers to your 3 questions follow:

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Accelerate FICO score rebuilding in 3 easy steps

This post originally appeared June 25, 2015 on CreditCards.com as “3 quick, easy, inexpensive credit score rebuilding tools”

By Barry Paperno

Dear Speaking of Credit,
My credit used to be 621 a year or so ago. I never had established credit or credit cards. I’ve always wanted to start and establish credit to build my credit but always got turned down for cards. Now I own a house that my fiance and I paid for in full, so there are no mortgage payments. And I wanted to get a new truck, but I checked my credit and my score is 556 and I now have debt. We plan on getting a big chunk of money coming in soon and are planning to pay off all debt that we both owe in the next couple months. So my question is if I pay off all my debt at once like we plan, will that help bump up my credit score right off the bat or will I still have to try and establish credit to build it back up? — Chad

Dear Chad,
While you say you never established credit or had credit cards and don’t have a new mortgage, but you do have a credit score, if it’s a FICO score, then your credit report must contain at least one non-collection or public record credit account that was opened at least six months ago and at least one undisputed account reported to the credit bureau within the past six months. These requirements can be met by one or two different accounts.

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Secured or unsecured card? To the score it doesn’t matter.

This post originally appeared April 16, 2015 on CreditCards.com as “Your low-limit secured card strategy: Pay the bill early, often

By Barry Paperno

Dear Speaking of Credit,
I just opened a secured credit card. I get $200 credit a month. I just used $87.23. I paid it back within three days. So now I am back at $200. My question is: Should I wait until I get my statement to start using my card again? Will it affect my credit score if I pay off my credit balance that fast? Or should I wait until I get my statement to pay off my balance? Thank you. — Larisa

Dear Larisa,
You’re clearly on the right track toward meeting the ongoing challenge of maintaining low credit utilization (card balance/credit limit, expressed as a percentage) on that low-credit limit “rebuilder” card. Whether paying frequently during the month or waiting until you receive your billing statement before making a single monthly payment, I see no reason why you can’t grow your credit score over time to where you’ll easily qualify for unsecured cards having much higher credit limits, rewards programs and other amenities.

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How student loans can be a better credit builder than credit cards

This post originally appeared February 5, 2015, on CreditCards.com as “How to build credit with a student loan

By Barry Paperno

Dear Speaking of Credit,
How long do government-insured student loans get reported to the credit bureaus? If you are current, do they show up and help your credit score or only get reported when they are delinquent?  — Ron

Dear Ron,
To answer your questions:

  1. All student loans will appear on your credit report from the time the loan originates — even when initially deferred — until about seven to 10 years after being paid in full, regardless of how many years that might take.
  2. All student loans are reported to the credit bureaus monthly whether current or delinquent, with late payments remaining for seven years.

This subject of how student loans appear on credit reports got me thinking about how there are not a lot of good things being said about student loans these days, perhaps rightfully so. While federal student loans provide for some repayment flexibility for borrowers in financial straits, once in default, garnishment of wages, tax refunds and even Social Security payments are often the consequences. And other than in rare cases, student loans cannot be discharged in bankruptcy, giving them the distinction of being one of the very few debts a distressed borrower can never climb out from under.

Yet there’s a brighter side. A student loan can be the financial difference between achieving and not achieving a college degree for students who would not otherwise be able to afford college and who either don’t have a credit score or don’t have a “good” credit score. For these young people, there is another positive side to student loans: They can build or rebuild a credit score.

Building credit means creating a solid FICO credit score, which only requires that a credit report show one credit account (collections and public records don’t qualify) that was opened at least six months ago and one account last reported to the credit bureau within the past six months. This minimum scoring requirement can be met by a single account or two accounts, with each meeting at least one of the two criteria.

When the subject of building or rebuilding credit arises, I often recommend secured and authorized user credit cards, as they are easy to qualify for and when managed properly are all that’s needed to establish a good credit score. But often overlooked in these discussions is the credit building that takes place for millions of young people through their student loans.

For establishing credit on your own, without Mom’s or Dad’s help, federal student loans and secured credit cards are about the only credit products available to people with no prior credit history. Although when it comes to their impacts on credit scores, these two kinds of credit are at the same time very similar and vastly different in their potential impacts to a credit score.

The similarities mostly lie within the scoring calculations that evaluate payment history and the length of time credit has been established. For example, a late payment will have about the same effect on your score whether it’s for a student loan, auto loan or credit card (secured or unsecured). A student loan will contribute as positively to length of credit history calculations, such as “average age of accounts,” as a mortgage of the same age.

Where a huge difference occurs between student loans and secured cards is within the credit scoring category that considers how much you owe. Here, a high credit card balance in relation to the card’s credit limit (credit utilization) can do much more damage to your score than a student loan balance many times higher.

For consumers with student loans being repaid on time each month or still in deferment, this should be welcome news, especially for those who prefer debit cards, prepaid cards or good old-fashioned cash to credit cards. With a student loan on your credit report, there’s no need to carry a credit card solely for the purpose of establishing credit.

Still, I would not recommend taking out anything more than a small student loan solely for the purpose of building or rebuilding credit, as the interest expense over many years could be steep and the lack of flexibility should you experience financial difficulty could make matters worse. Instead, using and paying off a secured card each month or being added as an authorized user to a family member’s or friend’s credit card in good standing makes much better sense.

Have a question or comment?  Let’s hear it!

Avoid over-managing credit utilization when in a debt management plan

This post originally appeared January 15, 2015 on CreditCards.com as “When building credit, focus first on on-time payments

By Barry Paperno

Dear Speaking of Credit,
I have two questions so I hope you can help me.

1) I am in a Debt Management Program. I still owe $12,000 and plan to have it paid off in two years. In February 2014, I was approved for a Capital One Quicksilver and used it responsibly always on time and kept credit utilization way below 30 percent. I am establishing new credit while paying down old debt on closed accounts, so that when the DMP is finished I have already established new credit and I will be ahead of the game. Do you think this will work if I use the new credit card responsibly?

2) I charge something small and affordable each month, but I make sure to pay it off shortly before the payment due date. I have done this for the past six months, but I always see a small balance due on my statement, which was reported to my credit report. The only month $0 was reported was when I paid the bill as early as possible. Do you think it is to my benefit and would it increase my credit score maybe down the road? Thanks — Mr. Harvey

Dear Mr. Harvey,
You are very clearly on top of what it takes to rebuild and establish new credit. By entering into a Debt Management Plan (DMP) to pay off existing debt, while adding additional positive credit via your new card, you’re laying a solid foundation for that good credit score “down the road.”

My only concern is that you may be over-managing one aspect of your credit score, the credit utilization (card balance/limit percentage) calculations that evaluate how much of your available credit is being used. What you’re doing is paying at just the right time during the monthly billing cycle so that only a small balance shows on your statement. While timing your payments in this manner is a very effective and increasingly popular way to maximize your score by minimizing your utilization, I’m going to tell you why it just may not be necessary at this stage of your credit rebuilding process.

To understand the multiple ways in which credit utilization impacts your credit score, there are some important factors to be aware of:

  • Utilization is considered on an individual account basis.
  • Utilization is considered on a combined account basis.
  • Whether individual or combined, only the current month’s utilization is considered.

I bring up the first two points to emphasize that, whereas a low balance on the Quicksilver card will lead to low — probably in the single digits — utilization for that card individually, when combined with your other card(s) carrying the $12,000 debt being paid off through the DMP, your combined utilization is not likely to be nearly so low. I bring up that last point as a way of assuring you that, as long as your focus remains on the road ahead, your current credit utilization doesn’t mean all that much anyway. Here’s why.

Some credit scoring factors are based on historical as well as current information, with the most notable examples being those within the “payment history” credit scoring category that accounts for 35 percent of your score. Here, not just the present, but past payment performance going back seven years and more can be included in your current score.

Then there are other factors that don’t look at historical along with current information, such as those within the “amounts owed” category, making up 30 percent of your score. Credit utilization accounts for a large part of this category, with only currently reported balances and credit limits having any impact on a score calculated today.

For this reason, and because you’re looking long term, instead of focusing on current utilization as you’ve been doing, I’m going to suggest three simple-but-important guidelines to follow over the next two years until your DMP is completed:

  1. Make all payments on time each month without fail.
  2. Don’t take on any new debt.
  3. Avoid paying finance charges.

This means that, for the time being, you don’t have to concern yourself with establishing additional new credit or worry at all about your current credit score, as long as you follow these guidelines. But what happens if there are times when you can’t? Things happen, so if you need to max out that Quicksilver card because of some car repairs or there’s a large medical bill one month, don’t worry, as long as you can pay it off by the next due date. Or, if you can’t manage that, stretch it out over the next few months if you have to. Just know that two years from now, when your DMP has been successfully completed, your score won’t care about any past utilization.

I hope I have addressed your questions, but to be sure I’ll summarize what I’ve said. There’s absolutely nothing wrong with managing your credit utilization as you’ve been doing. In fact, it’s exactly the right strategy for keeping that utilization percentage as low as possible. All I’m saying is that, given the DMP and your rebuilding timetable, you can make life a little easier by saving that strategy for two years from now when that large debt is history. Then, if you follow my suggestions, you will not only be debt-free with at least one good open card and at least two years of perfect payment history, you’ll also have that good — if not very good — credit score to tend to.

Have a question or comment?  Let’s hear it!

Retail cards: build your credit score and save 10 percent

This post originally appeared October 16, 2014, on CreditCards.com as “Retail cards, the Rodney Dangerfields of credit, deserve respect

By Barry Paperno

Dear Speaking of Credit,
I’m wondering if closing an unused department store line of credit would be beneficial or not? Let me give the details. The line has been open since January and has not been used. I have two active accounts on my credit; the oldest one is one year. The department store card’s credit line is for a minimal amount, but since I don’t use it, would this ding my credit if I were to close it? What would you recommend? — Charles

Dear Charles,
I’m glad you brought up the topic of department store cards, which, to me, are the Rodney Dangerfields of the card world: They get no respect.

Department store cards have come under much criticism in recent years for being harmful to credit scores. Especially during the holiday season, credit experts warn about the damage that can come to your credit from accepting an offer to open a new credit account with a department store in exchange for discounts on purchases.

They’ll point out that in addition to your score dropping immediately upon opening one of these cards (due to the hard pull on your credit), the low limit — typical of department store and other retail cards — combined with the new balance can raise your individual and total card credit utilization ratio. That’s the ratio of how much you have borrowed versus how much you could borrow. It counts for about 30 percent of your credit score, and the lower that ratio is, the better.

They also like to stress that store cards’ high interest rates will most likely wipe out any cost savings from the discounts.

While are valid arguments when applied in some situations, I would like to add a slightly different perspective, focusing on how department store cards can work to your advantage.

It’s true that opening a new department store card can lower your score, yet this is not unique to department store cards. Opening any new account can temporarily lower your credit score, as newly opened accounts of any kind indicate higher credit risk and make up about 10 percent of your score. But to single out department store cards for this reason can be misleading, since there is little difference in impact between a department store card, general credit card, mortgage, auto loan or any other type of credit line.

Whereas it’s easy to see how the benefits that go along with a mortgage or auto loan can far outweigh the short-term loss of a few points to your credit score, for someone watching every penny and not intending to buy a home or car in the near future, saving 10 percent on a $500 appliance can also be worth the temporary loss of a few points from a credit score.

Let’s take this example a step further. If, for example, the limit on the account used to buy that $500 appliance is only $600, high utilization and a further drop in score is likely to occur — but there’s a way to avoid that extra credit score hit. You could pay the balance before the statement due date. Paying early prevents the charges from impacting the credit score through high utilization and keeps the finance charges from wiping out that 10 percent savings.

In terms of not getting the respect they deserve, department store cards are rarely recognized for their positive contributions to credit scores. For instance, in the scoring calculations that consider payment history and length of credit history — together accounting for 50 percent of your score — department store cards can do as much for your score as any other form of credit.

To answer your initial question, I recommend leaving that department store card open for the simple reason that closing it will do nothing to help your score and, in some situations, could actually do damage.

High utilization not only results from charging a large amount on an account with a low limit and not paying immediately. Closing an unused card removes its credit line from the overall credit utilization calculations, which can result in higher overall utilization.

Although you don’t owe on your department store card, if you have high utilization on your other cards, closing the department store card could hurt your score.

The other way in which closing a card can hurt your score takes place in the future — typically about 10 years later — when the closed account is removed from your credit report and can no longer contribute to your score. Since the department store card will be one of your oldest accounts in 10 years, the loss of it from your credit report could cause your score to drop slightly.

The good thing about credit scoring continues to be that as long as you pay all of your bills on time each month, keep your card balances low and only open new accounts when needed, other actions, such as closing or leaving an account open, won’t have much impact.

I hope you find this information is helpful. Thanks for writing!

Have a question or comment?  Let’s hear it!

Rebuilding credit is like gardening.

This post originally appeared July 14, 2014, on CreditCards.com as “Rebuilding fiancee’s credit one small monthly charge at a time

By Barry Paperno

Dear Speaking of Credit,
I want to help my fiancee rebuild her credit. If we were to get a joint credit card account, and put one small monthly charge on it and pay off the balance in full each month, would that help rebuild her credit? — Matt

Hello Matt,
I can’t think of a better way to begin establishing a good financial foundation for your future than by helping your fiancee rebuild her credit. This will not only save money and eliminate stress for you both, it’s something you can work on together — sort of like gardening, but with an even better crop of greens.

Since you said “rebuilding” and not “building,” I take it your fiancee has had some past financial difficulties reflected on her credit report and in her credit score. Whether she is rebuilding or has not used credit in the past and wants to establish a credit rating for the first time, the plan of action should be the same: Develop a consistently on-time track record, starting with one or two positive accounts reported monthly to the credit bureaus, and increasing the number of good accounts as time goes on.

So, yes, your plan to get a joint credit card, make small monthly charges and pay off the balance monthly is a good one. Credit scorers like to see regular activity, small balances and, above all, on-time monthly payments, since this demonstrates the ability to manage credit in such a way that if extended additional credit, she’ll be able to handle it.

My only concern with your plan is that if she’s truly rebuilding and has some negative items on her credit report, applying jointly for a card where her credit history along with yours will be considered for approval may result in the application being denied.

Instead, since you appear to be the one with good credit, you may want to apply for a new card individually and then add your fiance as an authorized user once it’s been approved. Or simply add her as an authorized user to one of your existing cards. Or do both.

Why an authorized user?

First, what is an authorized user? Traditionally, this has been someone granted access to the account by the primary account holder, with a common example being a child provided with a card on the parents’ account, but not held legally responsible for the debt. Another, and perhaps the most common example of an authorized user is where a spouse is given a card on which the other spouse is the primary cardholder.

As to the why, when adding an authorized user, not only does the card’s entire history appear on the primary account holder’s credit report, but it also appears on the authorized user’s report and, most importantly, for building or rebuilding purposes, is included in the authorized user’s credit score.

This means that when your fiancee is added to one of your accounts as an authorized user, the history of that card is now blended with her own credit, and assuming the history of the authorized user card is positive (otherwise, don’t add the authorized user to it), the addition of your positive credit should begin to establish or raise your fiancee’s score, starting from the moment it appears on her credit report.

Another way to build or rebuild credit is via a secured credit card. This is a card that can be established despite bad or nonexistent prior credit, and where a security deposit in the amount of the credit limit is required from the user to protect the lender in case of default.

A secured credit card can be used just like unsecured cards, and it will appear on a credit report and be treated just like an unsecured card by most credit-scoring models. The only potential downside to these cards is that the credit limit is likely to be lower than for an unsecured card on which she’s an authorized user, which could limit her ability to charge major purchases, such as airline tickets and major car repairs. But if the main purpose here is to build or rebuild credit, charging large amounts may make it harder to repay on time, which could jeopardize her rebuilding efforts.

So, whether building credit for the first time or rebuilding following a financial setback, either going the authorized user route on a new or existing card, obtaining a secured card, or all of the above can contribute positively to rebuilding your fiancee’s credit.

Hope this helps! Best of luck to you both!

Have a question, comment, topic idea, random thought? I’d love to hear from you!