Financial Tips for Teens, Part 2 of 3

Published on May 17th, 2016

To briefly recap the last article, I discussed the importance of shopping around to find a financial institution and account that fits your teen’s needs. I discussed the importance of keeping their checking account in good standing and the costs and ramifications that come when a checking account gets closed and the account holder is reported to Chex Systems. Hand in hand with keeping the account in good standing is to control expenses and to work within a budget so that their checking account doesn’t get overdrawn.

In this month’s installment, I’ll break down the components of what make up a credit bureau score. I’ll finish up the series next time by discussing the costs of a poor credit file and how to build a credit file when you’re just starting to get credit.

The exact makeup of credit scores vary amongst the three main credit bureaus (Transunion, Equifax, and Experian). Each bureau additionally has different models that will score the components a little differently. This will result in the different models having different score ranges. The credit score range that we work with at the credit union has a low score of 300 and a high score of 850. Another model ranges from 501 to 990. Therefore, when you get a score from a service off the internet, the score that you have may not mean the same as the score your potential borrower is using.

The main components that make up a credit score are: how long a credit file is open, the mix of credit (types of loans), repayment history, balances vs. credit limit, and recent inquiries.

How Long a Credit File is Open
The longer someone has been “on file,” the better it is. A credit score for someone that has a credit file that’s well established is going to hold more weight than a credit score for someone that’s only had credit for a couple of years. A more established credit file is going to get the benefit of doubt more often than a thin credit file will if the lending decision is in question.

The Mix of Credit
The mix of credit is important because certain types of credit are considered better than others. Auto loans and mortgages are “better” debt than department store charge cards and loans from finance companies. Collateralized loans are safer and show that a borrower has assets. Finance company loans and store charge cards are much easier to qualify for and may have a slightly negative appeal when looking at a credit file. This is particularly the case with finance company trade lines because they are typically considered a lender of last resort.

Repayment History
Repayment history speaks for itself. Each trade line will indicate for each month that you’ve had a loan outstanding whether the loan is paid current, over 30 days late, over 60 days late, or 90 days or more late. Anytime that you have a trade line that shows up in the 30 days or more late, your credit score will decrease. If you fall further behind and fall into the 60 or 90 plus categories, your score will decrease further. When a loan officer is reviewing a credit report and they see late payments, they will most likely want to know the circumstances of what caused the late payments prior to approving any new loan requests.

Balances vs. Credit
The next component is capacity, or as I named it earlier, balances vs. credit limits. The credit bureaus look at the ratio of balances in revolving type trade lines (credit card, charge card, personal lines of credit) to the overall credit limit a person has in those types of accounts. The lower the ratio is, the lower the perceived risk. For example, if you have one credit card and you owe $2,500 and your credit limit is $3,000, you look like a higher risk than if you had two credit cards, owed a combined $5,000 on a combined credit limit of $10,000. In the first example, you only have 16% of your overall credit limit left available to you in the event you need it. In the second example, you still have 50% of your overall credit limit left to borrow from. As a result, even though your debt is greater in the second scenario, the capacity component of your credit score will be higher in scenario two.

Recent Inquiries
The last main component is credit inquiries. There seems to be a common misconception that a single credit pull is going to have a significant negative effect on your credit score. A single credit inquiry is not a negative event. However, if there are multiple or many multiple credit inquiries, that will have a negative effect on your score. Multiple inquires make it appear as if you’re actively shopping for credit. It’s an indicator of someone that could be in financial trouble. This is especially the case if the inquiries are coming from credit card companies, finance companies, and/or pay day lenders. The exception to this is when a consumer is auto shopping. Multiple credit pulls from banks, credit unions, or auto financing companies are expected when someone is car shopping, therefore the bureaus treat multiple credit pulls to these types of lenders over the course of a couple of days as one pull.

My series of “Tips to Teach Your Teens” has wandered a little off course in this month’s edition to an area of general interest for everyone, not just for teens. It’s still great information for teens so that they can be smart when they’re establishing their credit profile. I’m always happy to answer any questions anyone may have on this topic or any past columns. I can be reached at david.lukas@leydencu.org.


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