Credit Scores: The Financial Alchemy in the American Economy | 24

Host Chey, also known as the WitchyBookkeeper, shares her insights on the history and evolution of credit reporting, from its origins in the 1800s to the modern FICO scoring system.

Chey discusses the five key components that make up a credit score: payment history, amounts owed, length of credit history, new credit, and credit mix. She emphasizes the importance of paying bills on time and maintaining a low credit utilization rate to maintain a healthy credit score.

The episode also addresses the inherent racism in the credit scoring system, highlighting how millions of Americans, particularly those from black, Hispanic, and low-income communities, are "credit invisible" due to a lack of credit history. Chey argues that the current system perpetuates a cycle that prevents these individuals from accessing the credit they need to get ahead in life.

Throughout the episode, Chey offers practical tips for building and improving credit scores, such as becoming an authorized user on someone else's credit card or using secured credit cards. She encourages listeners to be patient, as building credit takes time.

This informative episode of "Money & Magic" combines the mystical with the practical, providing listeners with a deeper understanding of credit scores and their impact on personal finances in the United States.

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Transcript

0:03

Welcome to money and magic, the podcast that combines the mystical with the practical to help you navigate money in the Muggle world. I'm your host, shy remote bookkeeper, and judgment free money coach. I hope this podcast helps you create a harmonious relationship with your finances that empowers you to lead your truly magical life. Let's get started. Hey, magical humans. Welcome back to another episode of money and Magic. Today we are talking all about credit scores. Now, I know this might sound super boring, and honestly, it is a little boring, but it's also something that we have to deal with in the american economy. And on this podcast, I like to combine the mystical with the practical. So this is going to be all about credit scores. And credit scores are actually a very strange piece of financial alchemy. So let's go ahead and just dig right on in. So, a lot of you might know that it wasn't until 1974 that women were allowed to apply for credit cards and loans I their own, without having a male cosigner. So you might be thinking, well, credit scores probably haven't been around a lot longer than that, right? You would be wrong, actually. So I want to give you just kind of a little bit of background of where in the heck credit scores even came from and how we got to where we are today. So we are going all the way back to 1841. So before we had credit reporting or credit scoring, there was commercial credit reporting. And when it came to commercial credit reporting, this was pretty much to allow lenders to collect information about the businesses that they were going to loan money to. This was a very common practice because they needed to know that that business would be able to pay them back. So in 1841, the mercantile agency was founded, and that was one of the first known commercial credit reporting agencies. And pretty much what they would do is they had people that worked for them called correspondents, and they would actually physically go out and collect information from these borrowers to give to the lenders wherever the mercantile agency was located. So in a way, this kind of worked like our modern day credit reporting agency. However, the biggest thing that they would collect information on were marital status, ethnic background, their credit history, their age. And so at that point, that was all entered into one centralized ledger, which happened to be based in New York City. One issue with this is this type of credit reporting really relied heavily on subjective methods, such as their racial background, their gender, and even their moral character. When you have a human that is able to judge another human based on their perception, you can see how that might skew the credit reporting system. And when I was doing research for this, I found some very interesting information that talked about during the Jim Crow times. White business owners were legally allowed to turn away black consumers. So what would happen is these black people were not able to shop anywhere other than black businesses. So you had black people that were working for white people, they were earning the money, and then they were spending those dollars with the black businesses. So in turn, those black business owners were able to start building wealth. Well, as soon as the black people started being able to build wealth, the white people had to say, whoa, whoa, whoa. Wait a second. You can't do that. There were what was called redlined neighborhoods where mainly black people lived. And the houses that looked the exact same in the white people neighborhood were valued as lesser because they were in those redlined neighborhoods. So when all of this is happening, these black people are trying to buy land, they're trying to build their homes. They have the money for it, but they had to fit into the system. They were forced to go to the bank and get a mortgage. So what would happen is they would show up to the lender to get this money, even though they had the cash for it. And then they would be turned away because they were black or because they didn't like something about the way they lived or who knows what. It was all subjective. So this is when the credit score actually started. Now, it wasn't until the late 19th century when department stores and mass retailers really started to hit the american markets. A lot of these retailers were what we think of nowadays, kind of like a buy here, pay here. So they would sell furniture or drugs or the things that a lot of Americans needed, and they would offer it to these customers on installment loans. So it was a way that they could attract the customers in. They would offer a loan, but they needed to be able to make sure that the consumer would be able to pay that loan back. So that is where they would collect the information, and then they would send it back to the local credit bureau. In the middle 1960s, the credit reporting industry became computerized. So before that, it was files and paper and people, and there was so much human pieces to it that it really wasn't as effective as a lot of people would have liked. So once it became consolidated and computerized, then they were able to start moving forward. But at that time, there were over 2000 different credit bureaus, and you can see how that would be very difficult based on where you live, where you're trying to get funding, all of that. So over time, over the next 20 years or so, as things changed and, you know, people fell off the radar and all of that, it narrowed down to about five major credit bureaus. And now we all know of the three major ones. But in 1989, FICO, which is what we're used to today, actually started working with the national Credit bureaus so they could create a credit scoring model that would be across the board, across the entire country. Everyone would have generalized credit score. And so that was born in 1989 with the help of FICO. And the biggest thing that cemented those FICO stores scores is when the lovely Fannie Mae and Freddie Mac started requiring mortgage applicants to submit those credit scores. And that was, like, the mid 1990s. So I was born in 1991. So, for me, I've never known a life without credit scores, honestly. So it's very interesting to me to know that, really, it wasn't until the mid nineties that they were being, like, heavily relied on. And that leads me into, what the heck are credit scores even used for nowadays? So many people know that your credit score is used when you go to take out credit cards or loans or a mortgage. But what a lot of people don't know is sometimes jobs can request a credit score. There are a lot of different times that people might ask you for your credit score or want to pull a credit report on you. And so, unfortunately, it's something you kind of have to keep up on here in America. So when it comes to credit scores, FICo credit scores to be exactly. Scores range anywhere from 300 to 850. Obviously, the higher score that you have that tells the lender that there is a more likelihood that you'll pay your loan back on full and in full and on time. But there are a lot of things that do not go into building that credit score. So there are five pieces that are looked at when it comes to calculating your credit score. The first and the one that is weighted the heaviest is the payment history. So, a lot of times when I'm working with clients trying to set up a debt payoff plan, try to figure out what the best way for them to get their debt paid off is going to be. We always make sure the credit card minimums are getting paid every month, and that's because payment history is 35% of your credit score. So even if you are only able to pay the minimum each month, you are still making that payment on time. The second part of this is the amounts that you owe. So this is the total amount of credit and loans that you're currently using compared to your total credit limit. This is often called your utilization rate. So if you have a credit card that has a $1,000 limit, and of that thousand dollars, you have $500 on there, that credit card is at a 50% utilization rate. You take that across all of your debt, and that is how you determine your utilization rate. This is 30% of how your credit score is calculated. So the two biggest pieces here are 35% is your payment history, 30% is the amounts that you owe. So 65% of your credit score is made up of those two things. So if I can tell you nothing else, I want to tell you, make sure you're paying your loans and credit on time, even if it's just minimums. And be very cognizant of the amounts that you owe, and try to keep that utilization under 30% if possible. And then the last three pieces of this are the length of your credit history, and that's really not anything that you can do. So you'll hear a lot of people say, well, I don't have credit. And that goes to the fact that maybe they've never had a loan, they've never had a credit card, so they have no credit history. And while a lot of people think, yeah, that's fantastic, unfortunately, the way our capitalistic society in America works, it's very difficult to get anything on credit if you have no credit score. In my mind, that makes no sense, because if someone came to me at 30 years old and their credit was almost non existent, just because they didn't have anything over those last twelve years of their adult life, that should be a good thing. Like they haven't had to take on debt in those last twelve years, I personally think that's fantastic. However, capitalists do not, banks do not, lenders do not. So if you don't have credit history because of whatever reason, and that length of credit history is low, there's nothing you can really do about that. The next piece of that is new credit, which is opening up new loans, lines of credit, credit cards, all of that. That's about 10%. And they look at how often you apply for and open those new accounts. This one is probably my biggest struggle, because I like to use credit cards for the points and the rewards. So recently, I stopped using my discover card because I was no longer getting the double cash back that I was getting when I signed up. And I switched to a new credit card that would give me more cash back over that length of time. So that did ding my credit a little bit, because it was a new inquiry and it was like three months after I got my car. So I had an inquiry on that. And so I knew my credit would go down. I was aware of that because I understood that when you get new credit, it does ding your credit. And then the last piece of this is the credit mix. So when you look at your credit report, if you have nothing but credit cards, that's most likely going to lower your score compared to if you had a couple credit cards, a mortgage, a car payment and student loans and a line of credit. That's a very diverse credit mix. You have different creditors, you have different products. So that shows the capitalists in the world that are using this system that you can manage multiple different types of credit in an efficient manner. So those are the five things that go into calculating your credit score. Now, I will tell you, there are times like when I pay off a credit card, my credit score will go down. And to me, that's silly. That makes no sense because my utilization went down, my overall amount went down. But there's something about the way the credit people work that they don't like that. But I will say it does end up going back up. So it is a good thing. It just, for some reason, that's how the credit bureau system works. So I have a few other issues with the way credit reporting works, though, that I want to talk to you about. Something that I have never understood is that people who pay a mortgage, that mortgage does get reported to the credit agency. However, those who pay rent, it does not. And to me, most of my friends that pay rent are paying a higher amount of rent than I am for my mortgage. So why rent is not included in credit is beyond me. But also other things like paying your monthly utilities, your recurring subscriptions. I personally feel like if you're paying your gas, electric, water, you're paying those utilities on time every month, that should go on your credit. Another thing, being able to maintain a checking account or a savings account in good standing, that should also go on your credit. So there are a lot of things that I believe should go on your credit that do not, but I think we are working on that. I know like Experian does this thing called Experian boost, and you could use it to log in and kind of show, yeah, I pay my electric bill every month. I pay my Internet bill or whatever it is. And that kind of helps boost your credit score, but it's still not to where I would like to see it. And another thing about this is the people that kind of get left behind in the credit score system. So even though it is illegal to use gender, race, marriage, any of those type of things on credit reporting, credit reporting is still inherently racist. And this is why I say that when we look at credit scores in the US alone, we have about 26 million with an M million Americans that are considered to be credit invisible. And this is really just them having that lack of credit history with the biggest part of that. Most of those people are black, hispanic, or low income. And it's one of those things where in order to get ahead in life, they need the credit, but they can't get the credit because they've never had the credit to show that they can pay off the credit. And so it's just this vicious cycle of not allowing the people that truly need the credit, that not allowing them to get that. So it is absolutely still based in racism, whether we like to see that or not. It 100% is. And I would love for us to figure out a way to change this and allow an even layer across the board, because there are so 26 million Americans. That is insane to me. Absolutely insane. But anyway, I digress. So I know that was a lot. It gave you kind of a little bit of insight, kind of where we came from with credit scores, all of that. And so I just want to give you a few tips and pointers of things that I have been told, things that I have learned, and some stuff that I just kind of little nuggets of information that I would like you to take away from this. So the biggest thing that I already mentioned is to try your damnedest to pay your bills on time, like I said. Even if that means that your credit card bills are only the minimum, at least you're paying them on time. Try to keep that 30% utilization rate. Like 30% is the max. Now, I know that is very difficult and also kind of stupid, because if I have $1,000 credit card, why can I only use $300 on it? I get it. It sucks, but that's where we're at. And then the next tip that I wanted to give you is, if you are someone who's trying to build credit, but maybe you're not able to get a credit card, or maybe you just haven't really figured out exactly how you want to build that credit, a great way to do this is to become an authorized user on someone else's credit card. So a prime example is, when we were building our house, we got a Lowe's credit card. At that point, my husband had very little credit because he'd never had credit cards. He'd never needed loans. He didn't really have any credit history other than a mortgage. So I got the credit card and then I added him as an authorized user. So now the credit card is in my name, but he's an authorized user, and it goes against both of our credits. So we are both building credit with that credit card, and we only use it for household stuff anyway. So that made sense to me. So if you have someone in your life that is trustworthy and that trusts you, you might ask them to become an authorized user on your credit card. On their credit card. If you're not able to do that, you can always look into secured loans or secured credit cards. And what these are is, let's say you get a dollar 500 secured credit cardinal, you give that credit card company$500. It's kind of like prepaid. Like they hold onto that just in case. But then you use that $500 credit card just like you would use any other regular credit card. So those are some options if you are trying to build credit because you don't have any. If you have any, any other credit questions, please reach out. I would love to help you. I am by no means a credit expert, but these are just things that I have learned. The basics, kind of overall, all of that. The very last thing I want to tell you about credit scores is if you are trying to build, rebuild, start from scratch, whatever, be patient, because this is not something that happens over time or overnight. It is something that happens over time. So please have patience. Please keep that in mind, and please reach out if you have any questions. So I really want to thank you for tuning into this episode today, because I know credit scores can be a very boring topic. My hope is that you do understand a little bit more about maybe how they're made up or where they came from. Maybe you have some new views and opinions. Maybe you have some questions. I hope you got something that you can use to your advantage out of this episode. So our next episode is going to be the 25th episode of Money and Magic, and that is just wild to me. But we are going to talk about the upcoming Sabbath of Maebun, and then we will be taking a month off. So in September, there will be no Money and magic podcast episodes that are released new. I might post a couple reposts, but there will not be any new podcast episodes in the month of September. However, season two of the Money and Magic podcast will be coming back in October, and we will have more money and magic content along with some special guests for you to hear from. So my plan starting in October for season two is we are going to have guests that tell us about their money story, guests that talk about magic in their life, people who talk about money, aspects from their job, or all different kinds of things. So once we start season two in October, it's no longer going to be just me that you get to listen to. You will get to listen to all sorts of other people too. And if you are one of those people that's like, hey, I have a fantastic money story that I'd love to share. Reach out to me podcastbundancealchemy Co. Or you can go to my website and just click the contact me form and send that over to because I would love to hear from you. I would love to hear your money story. I would love to hear about maybe how you uncovered your money story while listening to my podcast. Maybe you have a hot take on some money topics or something a little out of the ordinary. I don't know. But stay tuned because we have one more episode this month taking next month off, and then starting in October, we'll be back with season two. So for now, I'll see you in the next episode. And that's a wrap for another spellbinding episode of Money and Magic. I hope you learned something that can help you navigate money in the Muggle world. If you have any questions, topics, or even your own money and magic story that you'd like to share, reach out to me on social media. I'd love to hear from you. And if you have found the show insightful, I'd truly appreciate it. If you could take a moment to subscribe, leave me a review and share money and magic with your friends and family. Think of it like casting a spell to help others on their financial journeys. As always, stand tall, shine bright, and stay grounded. I'll see you next time.