Secured vs. Unsecured Debt: What Are the Pros and Cons? – Credit Countdown

Secured Debt vs. Unsecured Debt - PinterestSecured credit and unsecured credit are types of credit that are very different in terms of risk to consumers and lenders.

In a Credit Countdown video on our YouTube channel, credit expert John Ulzheimer explains the benefits and drawbacks of each type of credit and how different types of credit can affect your credit score. Read what he has to say below and watch the video on our channel!

What Is Secured Credit?

Secured credit is a form of credit that is backed by some sort of physical asset as collateral. If the borrower defaults on a secured loan, the lender can take the asset in order to recoup the loss.

Examples of Secured Credit

When you take out an auto loan, the loan is secured by your vehicle. Technically, the lender is the owner of the car until you finish paying off the debt. If you fail to repay the loan as agreed, the lender can take back the car using the process of repossession.

Similarly, when you take out a mortgage, that loan is secured by your home, and the bank still “owns” the home until you pay it off. In this case, not paying your mortgage can lead to the bank foreclosing on your home, meaning that they evict you from the home and then can sell it to someone else.

Pawn shop loans and title loans are also examples of secured loans.

While most credit cards are typically unsecured, secured credit cards do exist for consumers who may not be able to qualify for unsecured credit cards due to bad credit or a lack of credit history. With a secured credit card, you make a security deposit that counts toward your credit limit that the lender can keep in the event that you are not able to make the required payments on your credit card.

Mortgage loans are secured by your home.

Mortgage loans are secured by your home.

What Is Unsecured Credit?

Unsecured credit is credit that does not have a physical asset as collateral, so the lender cannot take back an asset if you default on the debt.

Examples of Unsecured Credit

A student loan is an example of an unsecured loan because there is no material asset that can be taken away if you do not pay your student loans. Student loans are used to pay for an education, and obviously, the lender cannot “take back” the education you have already received.

Credit cards are generally extensions of unsecured credit, except in the case of secured credit cards, as we described above.

Secured Credit
Unsecured Credit

Auto loans
Unsecured credit cards

Mortgage loans
Student loans

Home equity lines of credit
Unsecured personal loans

Secured credit cards
Unsecured lines of credit

Motorcycle loans

Boat loans

Pawn shop loans

Title loans

The Impact of Secured and Unsecured Debt on Your Credit Score

Secured and unsecured accounts are treated equally by credit scoring models, according to John. You are not penalized or rewarded by credit scores based on your accounts being unsecured or secured.

Different types of accounts are still treated differently by credit scores due to other factors (e.g. credit cards are treated differently than installment loans), but this particular factor does not play a role.

Secured Credit Cards: Use Them Carefully

Secured credit card accounts are commonly used by consumers to establish credit or rebuild their credit after having bad credit. This is a valuable credit-building strategy, but you should be cautious about how much you spend on your secured credit card.

Why? Because secured credit cards often have very low credit limits. That means you can quickly get to a high utilization ratio on the account even from modest spending. For example, if your secured credit card has a credit limit of $500 and you spend $250, you already have a utilization ratio on that account of 50%.

Having heavily utilized credit card accounts can have a significant negative impact on your credit score, so if you’re trying to keep your credit score as high as possible, you’ll want to keep an eye on the balance of your secured credit card and not let it creep too high relative to your credit limit.

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How to Use Credit Cards Responsibly Without Going Into Debt – Credit Countdown With John Ulzheimer

How to Use Credit Cards Responsibly Without Going Into Debt - Pinterest

Credit cards are often vilified for their high interest rates, which can be very costly to consumers who carry a balance from month to month rather than paying off the full balance that was accrued. Credit expert John Ulzheimer believes that credit cards do not deserve the bad reputation they have earned.

In a Credit Countdown video on our YouTube channel, John explained why credit cards are not necessarily as bad as they are made out to be and how to use them responsibly without going into credit card debt.

Keep reading to learn more on this topic and watch the video below!

Credit Card APRs

It’s true that credit cards do have high interest rates compared to other forms of credit, even if you have a good credit score. For this reason, once you get into credit card debt, it can be a very deep hole to climb out of, because the interest charges keep adding to your total amount of debt. 

However, as John points out in the video, no one forces you to open a credit card or go into credit card debt, so in his opinion, it seems unfair to blame the credit cards with high interest rates for actions that consumers choose to take.

If you choose instead to pay off your balance every month, then you do not have to pay interest on your purchase, so the APR of the card is irrelevant. Therefore, if you are going to use credit cards responsibly, then there is no need to choose a credit card based on its APR.

Always Pay Off Your Credit Cards in Full

The most important rule when it comes to using credit cards correctly is this:

Only charge as much as you can pay off in full every single month. 

When you pay your bill in full each month, since you are not paying interest, it is essentially free to use credit cards. The exception to this is if your credit card has an annual fee, but for some consumers, the annual fee on some credit cards may be worth paying in order to reap the rewards offered by the card.

If you want to be a responsible user of credit cards, it is essential to pay off your balance in full every month rather than carrying a balance and paying interest.

If you want to be a responsible user of credit cards, it is essential to pay off your balance in full every month rather than carrying a balance and paying interest.

Maintain a Low Balance-to-Limit Ratio

If you want to have a good credit score, it’s important to keep a low balance-to-limit ratio (also commonly called the credit utilization ratio). The closer your balance is to your credit limit, the fewer points you can earn toward your credit score.

This goes for both FICO credit scores and VantageScore credit scoring models.

Don’t take this to mean that you cannot use your credit card often or make large purchases with it. Just be aware that since a higher balance-to-limit ratio means a lower credit score, you may want to avoid doing anything to substantially increase your balance before you apply for a loan, especially a large loan, like a mortgage loan or an auto loan. Otherwise, you could end up with a higher interest rate that could cost you thousands of dollars in additional interest over the course of the loan.

Do Not Skip a Payment

Credit card issuers sometimes offer “skip a payment” programs that allow you to “skip” a payment for one month, especially around the holidays, when consumers may rely more on their credit cards.

John recommends never signing up for these programs because by skipping a payment, you are obviously opting not to pay in full that month. Since you are carrying the balance to the next month, you will be charged interest on the debt and you will have even more debt to pay back the next month.

Instead of skipping a payment, the more responsible thing to do is to go ahead and pay the statement in balance in full just as you normally would.

Conclusions

While credit cards may be risky in the wrong hands, responsible consumers do not need to forgo using them altogether. It is possible to benefit from using credit cards as a financial tool without going into debt or paying interest.

To that end, make sure you always pay your balance in full and maintain a low balance-to-limit ratio, and never skip a payment.

To hear from John directly, check out the video below. Follow our YouTube channel to see more of our Credit Countdown videos!

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Secured vs. Unsecured Debt: What Are the Pros and Cons? – Credit Countdown With John Ulzheimer

Secured Debt vs. Unsecured Debt - PinterestSecured credit and unsecured credit are types of credit that are very different in terms of risk to consumers and lenders.

In a Credit Countdown video on our YouTube channel, credit expert John Ulzheimer explains the benefits and drawbacks of each type of credit and how different types of credit can affect your credit score. Read what he has to say below and watch the video on our channel!

What Is Secured Credit?

Secured credit is a form of credit that is backed by some sort of physical asset as collateral. If the borrower defaults on a secured loan, the lender can take the asset in order to recoup the loss.

Examples of Secured Credit

When you take out an auto loan, the loan is secured by your vehicle. Technically, the lender is the owner of the car until you finish paying off the debt. If you fail to repay the loan as agreed, the lender can take back the car using the process of repossession.

Similarly, when you take out a mortgage, that loan is secured by your home, and the bank still “owns” the home until you pay it off. In this case, not paying your mortgage can lead to the bank foreclosing on your home, meaning that they evict you from the home and then can sell it to someone else.

Pawn shop loans and title loans are also examples of secured loans.

While most credit cards are typically unsecured, secured credit cards do exist for consumers who may not be able to qualify for unsecured credit cards due to bad credit or a lack of credit history. With a secured credit card, you make a security deposit that counts toward your credit limit that the lender can keep in the event that you are not able to make the required payments on your credit card.

Mortgage loans are secured by your home.

Mortgage loans are secured by your home.

What Is Unsecured Credit?

Unsecured credit is credit that does not have a physical asset as collateral, so the lender cannot take back an asset if you default on the debt.

Examples of Unsecured Credit

A student loan is an example of an unsecured loan because there is no material asset that can be taken away if you do not pay your student loans. Student loans are used to pay for an education, and obviously, the lender cannot “take back” the education you have already received.

Credit cards are generally extensions of unsecured credit, except in the case of secured credit cards, as we described above.

Secured Credit
Unsecured Credit

Auto loans
Unsecured credit cards

Mortgage loans
Student loans

Home equity lines of credit
Unsecured personal loans

Secured credit cards
Unsecured lines of credit

Motorcycle loans

Boat loans

Pawn shop loans

Title loans

The Impact of Secured and Unsecured Debt on Your Credit Score

Secured and unsecured accounts are treated equally by credit scoring models, according to John. You are not penalized or rewarded by credit scores based on your accounts being unsecured or secured.

Different types of accounts are still treated differently by credit scores due to other factors (e.g. credit cards are treated differently than installment loans), but this particular factor does not play a role.

Secured Credit Cards: Use Them Carefully

Secured credit card accounts are commonly used by consumers to establish credit or rebuild their credit after having bad credit. This is a valuable credit-building strategy, but you should be cautious about how much you spend on your secured credit card.

Why? Because secured credit cards often have very low credit limits. That means you can quickly get to a high utilization ratio on the account even from modest spending. For example, if your secured credit card has a credit limit of $500 and you spend $250, you already have a utilization ratio on that account of 50%.

Having heavily utilized credit card accounts can have a significant negative impact on your credit score, so if you’re trying to keep your credit score as high as possible, you’ll want to keep an eye on the balance of your secured credit card and not let it creep too high relative to your credit limit.

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Ask an Expert: How Do I Build Good Credit From Scratch?

The NFCC often receives readers questions asking us what they should do in their money situation. We pick some to share that others could be asking themselves and hope to help many in sharing these answers. If you have a question, please submit it on our Ask an Expert page here.

This week’s question: I need some advice in regards to my credit report and good ways that I can begin to build up my credit. I have no credit at all. Eventually within five years once I’m out of school I want to buy a house.

Building credit from scratch will take some time and effort, just like getting a job after graduating from school. You can think about good credit as a means to an end: you need good credit to finance big purchases and get the best interest rates and repayment terms on loans and mortgages. So, getting your credit ready is an excellent start to buying a home in the near future.

What is on Your Credit Report? 

Your credit is a record of your monthly financial credit transactions. Your creditors report your activity to the three credit bureaus, Equifax, Experian, and TransUnion, and they use that data to generate a credit score. Your credit report also includes your personally identifying information such as your name, addresses, social security, and some public records such as bankruptcies and judgments and tax liens, if you have any. To start generating data for your credit report, you need to get a credit line. The easiest way to do that is to get a secured credit card. Many banking institutions issue secured credit cards, and they work pretty much like a regular credit card. The main difference is that these cards are backed by a cash deposit, which usually corresponds to the card’s credit limit.

Be Strategic

Learning how to use your credit card strategically is equally as important as getting that credit line. Your credit score takes into consideration several factors. The factor that influences your score the most is whether you pay your accounts on time and as agreed. Late or insufficient payments are very detrimental to your credit history. So, you should plan to pay in full and before your due date. Another important factor is your utilization ratio, which is how much you owe compared to your available credit. To have a balanced ratio, experts recommend that you use only 30% or less of your available credit in every billing cycle. For instance, if you have a $500 credit limit, you should be using less than $150.

Yet another factor is the age of your credit history. The older your credit history, the more history and data you’ll have to establish a solid credit history. Achieving this will just require time and your continued effort. The other two factors to keep in mind are the mix of credit you have (credit cards and loans) and how often you ask for new credit. Too many new credit inquiries reflect negatively on your score, so it’s important that you only apply for new credit sporadically. In your case, you should keep your secured credit card for at least a year before applying for a regular credit card. In some cases, your creditor may even upgrade your secured credit card to a regular one and return your cash deposit.

It’s never too soon to start building your credit. And once you learn healthy credit management habits, it will be very easy for you to manage your credit and use your credit cards responsibly on a daily basis. If you feel you need additional guidance or personalized help to get you started, you can always reach out to an NFCC Certified Financial Counselor. They are ready to help over the phone, online, and in-person if it’s available in your state. Good luck!

The post Ask an Expert: How Do I Build Good Credit From Scratch? appeared first on NFCC.

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Things Everyone Should Know About Credit Cards

Things Everyone Should Know About Credit Cards - Pinterest graphicCredit cards are not only a useful payment method for making purchases but also an essential component of a solid credit-building strategy

After all, credit cards are the most common form of revolving credit, which is given more importance than installment credit (e.g. auto loans, student loans, mortgages, etc.) when it comes to calculating your credit score.

Unfortunately, credit cards often get a bad rap because it’s easy to rack up excessive amounts of debt and destroy your credit score if you do not know how to use credit cards properly.

However, when you have the knowledge and ability to use credit cards to your advantage rather than to your detriment, they can be an extremely powerful financial tool to have in your arsenal.

If you’re unsure if using credit cards is the right choice for you or confused about how they work, then keep reading to learn the basics of credit cards that everyone should know.

What Is a Credit Card?

A credit card is a card issued by a lender that allows a consumer to borrow money from the lender in order to pay for purchases.

The consumer must later pay back the funds in addition to any applicable interest charges or other fees.

They can choose to either pay back the full amount borrowed by the due date, in which case no interest will be charged, or they can pay off the debt over a longer period of time, in which case interest will generally accrue on the unpaid balance.

Each credit card has an account number, a security code, and an expiration date, as well as a magnetic stripe, a signature panel, and a hologram. Most credit cards also now have a chip to be inserted into a chip reader rather than swiping the card at the point of sale. In addition, some credit cards offer contactless payment capability.

Credit cards allow consumers to pay for goods and services with funds borrowed from the credit card issuer.

Credit cards allow consumers to pay for goods and services with funds borrowed from the credit card issuer.

How Do Credit Cards Work?

Although using credit cards may feel like using “fake money” or spending someone else’s money, it’s important to understand that the money you borrow when you pay with a credit card is very much real money that you now owe to the lender.

Credit Cards Are Unsecured Revolving Debt

With most credit cards, the funds you borrow are considered to be unsecured debt because you are borrowing the money without any collateral. That means the credit card issuer is taking on additional risk by giving you a credit card, since there is no collateral that they can take from you if you fail to pay back the debt, unlike with secured debt, such as a mortgage or a car loan.

Furthermore, the lender allows you to decide when and how much you want to pay back the funds instead of requiring you to pay the full balance on each due date. You can choose to only pay the minimum payment and “revolve” the remaining balance from month to month, which extends the amount of time during which you owe money to the credit card company.

Most credit cards now come with a chip in addition to a magnetic stripe.

Most credit cards now come with a chip in addition to a magnetic stripe.

For the above reasons, credit card interest rates are typically significantly higher than the interest rates for installment loans.

However, credit cards are also the only form of credit where paying interest is optional—there is a “grace period” of at least 21 days before the interest rate for new purchases takes effect, and you only get charged interest if you do not pay back your full statement balance by the due date.

(Keep in mind that the grace period usually only applies to new purchases, as stated by The Balance. This does not include balance transfers or cash advances, which typically begin accruing interest immediately.)

Understanding Credit Card Interest Rates

To reiterate, the interest rate of a credit card technically only applies when you carry a balance instead of paying off your full statement balance each month. However, most people will likely end up carrying a balance on one or more credit cards at some point, so it is still a good idea to be aware of what your interest rates are.

APR and ADPR

The interest rate of a credit card is usually expressed as an annual percentage rate (APR). This is the percentage that you would pay in interest over a year, which can be confusing because interest on credit card purchases is charged on a daily basis when you carry a balance from month to month.

You can find your average daily periodic rate (ADPR), which is the interest rate that you are being charged each day, by dividing the APR of your card by 365.

Average Credit Card Interest Rates
The interest rate of a credit card, expressed as the APR, is important to know if you ever carry a balance on the card.

The interest rate of a credit card, expressed as the APR, is important to know if you ever carry a balance on the card.

As of October 2020, the average credit card interest rate as reported by The Balance is 20.23%. However, credit card issuers are allowed to set their APRs as high as 29.99%. It is not uncommon to see APRs upwards of 20%, even for consumers who have good credit.

The highest interest rates are generally seen on credit cards for bad credit or penalty rates that credit card issuers can implement when you are 30 or more days late to make a payment. You may also get penalized with a higher interest rate if you go over your credit limit or default on a different account with the same bank, according to ValuePenguin.

Ask for a Lower Interest Rate

In our article on easy credit hacks that actually work, we suggest trying the simple tactic of calling your credit card issuer’s customer service department and asking for a lower APR. Surveys have shown that a majority of consumers who do this are successful in obtaining a lower interest rate.

Important Dates to Know

Many consumers assume that the payment due date of your credit card is the only important date you need to worry about. While it’s true that the due date is the most important date to be aware of, there are several other dates that are useful to pay attention to as well.

Billing cycle

The billing cycle of a credit card is the length of time that passes between one billing statement and the next. All of the purchases you make within one billing cycle are grouped together in the following billing statement.

This cycle is typically around 30 days long, or approximately monthly, although credit card companies can choose to use a different billing cycle system.

Statement closing date
Your credit card's statement closing date is not the same thing as your due date, so make sure you know both.

Your credit card’s statement closing date is not the same thing as your due date, so make sure you know both.

Sometimes referred to simply as the “closing date,” this is the final day of your billing cycle. Once a billing cycle closes and the statement for that cycle is generated, the balance of your account at that time is then reported to the credit bureaus.

You can look at your billing statement to find the closing date for your account. Because of the 21-day grace period, the statement closing date is usually around 21 days before your due date.

Due Date

This is the most important date to know in order to pay your bill on time every month, which is the most influential factor when it comes to building a good credit history. To make it easy for yourself to avoid accidental missed payments, you may want to set up automatic bill payments.

If your due date is inconvenient due to the timing of your income and other bills, you can try requesting a different due date with your credit card issuer.

Promotional offer dates

Many credit cards offer introductory promotions to attract new customers, such as 0% APR, bonus rewards, or no balance transfer fees. To use these offers strategically, you will need to know when the promotional period ends so you can plan accordingly.

Expiration date
All credit cards have an expiration date past which they cannot be used.

All credit cards have an expiration date past which they cannot be used.

Every credit card has an expiration date printed on it, after which you will no longer be able to use that card, although your account will still be open. You just have to get a new credit card sent to you to replace the one that is expiring.

Usually, credit card companies will automatically send you a new card before the original card expires. If this does not happen, simply call the issuer to ask for a replacement credit card.

A Common Credit Card Mistake

Some consumers think that the closing date and the due date are the same thing and therefore believe that if they pay off the full statement balance by the due date, the credit card will report as having a 0% utilization ratio. They may then be confused to find out that their credit card is still reporting a balance to the credit bureaus every month.

However, the statement closing date is usually not the same date as your due date. This is why your credit cards may report a balance every month even if you always pay your bill in full—the account balance is being recorded on your statement date before you have paid off the card.

If you do not want your credit card to report a balance to the credit bureaus, you will need to either pay off the balance early, prior to the statement closing date, or pay your statement balance on the due date as usual and then not make any more purchases with your card until the next closing date.

Credit Card Payments

With credit cards, you have several different options for payment amounts.

Minimum payment
If you make only the minimum payments on your credit cards, it will take you longer to pay off your credit card debt and you will be charged interest.

If you only pay the minimum payments on your credit cards, it will take longer to pay off your credit card debt and you will be charged interest.

This is the minimum amount that you are required to pay by your due date in order to be considered current on the account and avoid late fees. Although this may vary between different credit card issuers, typically the minimum payment is calculated as a percentage of your balance.

If you make only the minimum payment every month, it will take you a much longer time to pay off your balance and you will be paying a far greater amount in interest than if you were to pay off your statement balance in full. Check your billing statement to see how the math works out; the credit card company is required to disclose how long it will take to pay off the balance if you only make the minimum payments.

Statement balance

This is the sum of all of your charges from the preceding billing cycle in addition to whatever balance may have already been on the card before that cycle. This is the amount you need to pay if you do not want to pay interest for carrying a balance.

Current balance

This number is the total balance currently on your credit card, including charges made during the billing cycle that you are currently in, so it will be higher than your statement balance if you have made more purchases or transfers since your last closing date. You can pay this amount if you want to completely pay off your account so that it has no balance.

Other amount

You can also make a payment in the amount of your choosing, as long as it is greater than the minimum payment. This is a good option to use if you don’t have enough cash to pay the statement balance in full, but want to pay more than the minimum in order to mitigate the amount of interest you will be charged.

Credit Card Fees

Credit cards often charge various other fees in addition to interest. Here are some common fees to be aware of.

Although you may have access to a "cash advance" credit limit on your credit cards, it is generally not recommended to get a cash advance due to the high interest rates and fees you will have to pay.

Although you may have access to a “cash advance” credit limit on your credit cards, it is generally not recommended to get a cash advance due to the high interest rates and fees you will have to pay.

Late payment fees

If you do not make the required minimum payment before the due date, the credit card company will likely charge you a late fee somewhere in the range of $25 – $40 (in addition to potentially raising your APR to a penalty rate). If you usually pay on time but accidentally miss a payment for whatever reason, try calling your credit card issuer and asking if they would be willing to reverse the fee since you have been an upstanding customer overall.

Annual fees

Some credit cards charge an annual fee for keeping your account open. Many times this charge may be waived for your first year as a promotional offer to attract new customers. Cards with higher annual fees will often have additional perks and rewards, but there are also plenty of great options for rewards cards that do not charge annual fees.

Cash advance fees

Your credit cards may give you the option to borrow cash in the form of a cash advance. However, this is usually not advised because cash advance interest rates are often significantly higher than your regular interest rate for purchases. In addition, you will most likely be charged a cash advance fee when you first withdraw the money, whether a flat dollar amount of around $10 or a percentage of the amount you take out, such as 5%.

Foreign transaction fees

Some cards charge a fee to use your card to pay for things in other countries. These fees are typically around 3% of the purchase amount. However, there are many credit cards on the market that do not charge foreign transaction fees.

Be sure to check the terms of service of your credit cards for fees such as these so that you can avoid any unexpected charges.

How Credit Cards Affect Your Credit

Credit cards are one of the most impactful influences on your overall credit standing, and they play a role in multiple credit scoring factors.

Building Credit With Credit Cards

One of the major advantages of credit cards is that it allows you to start building a history of on-time payments, which is extremely important given that payment history is the biggest component of your FICO score, making up 35% of it.

All you have to do to get this benefit is use your credit card every so often and pay your bill on time every month.

Click on the infographic to see the full-sized version!

Click on the infographic to see the full-sized version!

Revolving Accounts Are More Important

We have previously discussed why revolving accounts are more powerful than installment accounts when it comes to your credit score.

Revolving accounts such as credit cards can have a much greater influence on your credit than auto loans, student loans, and even a mortgage—for better or for worse. They must be managed properly because negative credit card accounts will also have a very strong impact on your credit.

Mix of Credit

Although your mix of credit only makes up 10% of your FICO score, it is still worth considering, especially if you aim to achieve a high credit score or even a perfect 850 credit score.

A good credit mix generally includes various types of accounts, including both revolving and installment accounts. You can see the different types of accounts in our credit mix infographic.

Credit cards may help with your credit mix if you have a thin file or if you primarily have installment loans on your credit report.

They also add to the number of accounts you have, which is a good thing for the average consumer. In fact, as we talked about in How to Get an 850 Credit Score, FICO has stated that those who have high FICO scores have an average of seven credit card accounts in their credit files, whether open or closed.

The Importance of Credit Utilization Ratios

Your credit utilization is the second most important piece of your credit score, which is another reason why credit cards are such a strong influence on your credit.

The basic rule of thumb with credit utilization ratios is to try to keep them as low as possible (both overall and individual utilization ratios), meaning you only use a small portion of your available credit. Ideally, it’s best to aim to stay under 20% or even 10% utilization, because the higher your utilization rate is, the more it will hurt your credit instead of help.

Conclusions on Credit Card Basics

Credit cards can be intimidating, especially when you don’t know how to use them correctly.

It is also true that not everyone wants or needs to use credit cards.

It’s not impossible to build credit without a credit card, but it is more difficult since you would be limited to primarily installment loans, which are not weighed as heavily as revolving accounts, and possibly alternative credit data.

However, for those who are able to use credit cards responsibly and follow good credit practices, they can be an incredibly useful credit-building tool as well as a way to reap some benefits and perks that other payment methods do not provide.

We hope this introductory guide to credit cards provides the knowledge base you need in order to feel confident using credit cards and to take advantage of their benefits.

If you found this article useful, please comment to let us know or share it with others who want to learn more about credit cards!

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How to Get an 850 Credit Score [Infographic]

People who are serious about improving their credit often wonder what it takes to get the highest possible credit score. For the FICO 8 credit scoring model, the perfect credit score is 850.

As of April 2019, only about 1.6% of scorable consumers in the United States have the elusive 850 credit score, which is actually an increase from 0.98% in April 2014 and 0.85% in April 2009.

There are many other credit scoring models that are used for different purposes and may have different credit scoring ranges. However, since FICO 8 is the most commonly used credit score, we will use the number 850 as the benchmark for the ideal credit score.

Check out the infographic below for some fast facts on how to get the highest credit score possible, then keep reading the article for even more tips on getting the coveted 850 credit score.

How to Get an 850 Credit Score - Infographic

Payment History — 35%
Most people who have an 850 credit score have seven years of on-time payment history with no lates.

Most people who have an 850 credit score have seven years of perfect payment history.

Your payment history is the biggest slice of the credit score pie, so even one late payment or missed payment can significantly affect your score. Negative items can stay on your credit report for up to seven years, so if you miss a payment, you may not be able to achieve a perfect 850 credit score until at least seven years have passed!

To safeguard against the possibility of forgetting to make a payment, consider setting up automatic bill pay for all of your accounts. Be sure to continue to check your accounts regularly in case of any system errors.

If you do miss a deadline once in a blue moon but have otherwise been an upstanding customer, try negotiating with your creditor to see if they will forgive the late payment and wipe it from your record.

FICO says that 96% of “high achievers,” or those with FICO scores above 785, have no missed payments on their credit report.

Essentially, to get an 850 credit score, you just need to follow one simple strategy: make all of your payments on time for a long time. We will further discuss the connection between payment history and time in the “Length of Credit History” section below.

Credit Utilization/How Much You Owe — 30%

The amount of debt you owe compared to your total credit limit is your credit utilization ratio. To get a perfect credit score, you’ll want to keep this ratio as low as possible, both overall and on each of your individual tradelines.

A study by VantageScore and MagnifyMoney found that people with the best credit scores and people with the worst credit scores actually had similar amounts of outstanding debt. However, those with the best scores had an average total credit limit of $46,700—16 times the credit limit of those with the worst scores!

Therefore, for the high scorers, that outstanding debt made up a much smaller percentage of their total available credit than those with low credit limits and poor scores, which highlights the importance of the overall utilization ratio.

This study reported that the average credit card user has an overall utilization ratio of 20%, which is generally considered to be a safe number for maintaining decent credit. To become someone who has an 850 credit score, however, you’ll need to keep it around 5% or lower. As of 2019, FICO says that the average revolving utilization for those with the “850 profile” is 4.1%.

While consumers with 850 credit scores do use credit cards, they tend to keep their utilization ratios around 5% or lower.

While consumers with 850 credit scores do use credit cards, they tend to keep their utilization ratios around 5% or lower. Photo by Ellen Johnson.

In addition, keep in mind that even if you have a low overall utilization ratio, individual cards with high utilization could still bring down your score. You can read more about this in our article on individual vs. overall credit utilization ratios.

As a hypothetical example, let’s say you have two cards: one with a $10,000 limit and a $0 balance and the other with a $1,000 limit and a $900 balance. Your total available credit is $10,000 + $1,000 = $11,000 and your total debt is $900. Therefore, your overall utilization ratio is $900 / $11,000 = 8% utilization, which is a very good number.

However, your account with the $1,000 limit has a 90% individual utilization ratio! Since you only have two accounts, that means 50% of your accounts have high utilization, and that could negatively affect your credit. According to creditcards.com, maxing out just one credit card can reduce your score by as many as 45 points.

To get around this problem, if you have any individual cards with high utilization, consider transferring the balance to other accounts to keep the utilization ratio on each account as low as possible.

You could also request credit line increases from your creditors, which can lower your utilization ratios and benefit your score. Try using the tips we provide in “How to Increase Your Credit Limit.”

Another way to help with overall utilization is to add low-utilization tradelines to your credit file.

Optimizing this factor also means not closing old accounts even if you don’t use them very often, because their credit limits could be helping your score. To ensure old accounts don’t get automatically closed by the banks for inactivity, try to use them every 1-2 months, perhaps for small, recurring bills.

Length of Credit History (Age) — 15%

This category takes into account age-related factors such as the average age of your accounts, the age of your oldest account, and the ratio of seasoned to non-seasoned tradelines. (A seasoned tradeline is an account that is at least two years old, which is when the account is believed to have a more positive impact on your credit.)

The more age your accounts have, the more they will help your credit score.

Age goes hand-in-hand with payment history, because the more age an account has, the more time it has had to build up a positive or negative payment history. Together, age (15%) and payment history (35%) make up 50% of your credit score, which shows how important it is to open accounts early and make every single payment on time.

This is also why we always say that focusing on age is the #1 secret to unlocking the power of tradelines.

According to FICO, the age of the oldest account of people who have 650 credit scores is only 12 years, compared to 25 years for people who have credit scores above 800. In addition, individuals with fair credit have an average age of accounts of 7 years, compared to 11 years for those with excellent credit.

Cultivating an 850 credit score takes years of maintaining a positive credit history.

Cultivating an 850 credit score takes years of maintaining a positive credit history.

FICO reports that the average age of the oldest account of consumers who have 850 credit scores is 30 years old.

We have an in-depth discussion of which age tiers are most significant in our article, “Why Age Is the Most Valuable Factor of a Tradeline,” but the bottom line for getting the best credit score is simply to get as much age as possible. Seasoned tradelines can help by extending the age of the oldest account and the average age of accounts.

Also, keep in mind that it may be impossible to achieve an 850 credit score without a certain amount of age, even if you do everything else perfectly. So if you have stellar credit habits but haven’t yet been able to join the 850 credit club, you may just need to wait patiently for your accounts to age.

Credit Mix — 10%

While the mix of credit is one of the least important factors in a credit score, to get a perfect credit score of 850, you will still need to consider this factor.

In this category, credit scores reward having a balanced mix of several different accounts, including both revolving credit and installment loans. This is because creditors want to see that you can successfully manage a variety of different types of credit.

As an example, a credit file that includes an auto loan, a mortgage, and two credit cards has a better credit mix than a credit file that has four accounts that are all credit cards.

About the “credit mix” credit score factor, FICO says, “Having credit cards and installment loans with a good credit history will raise your FICO Scores. People with no credit cards tend to be viewed as a higher risk than people who have managed credit cards responsibly.”

The total number of accounts is also considered, with more accounts generally being better, up to a certain point.

FICO also states that high score achievers have an average of seven credit card accounts in their credit files, whether open or closed.

Auto loans are common among people who have 850 credit scores.

Auto loans are common among people who have 850 credit scores.

If you are looking to improve your credit mix statistics, adding authorized user tradelines can increase the total number of accounts and help diversify one’s credit file.

850 scorers also have installment loans in their credit files. According to Experian, the average mortgage debt for consumers with exceptional credit scores (800 or above) is $208,617. In addition, people who have FICO scores of 850 have an average auto-loan debt of $17,030.

Experian says, “In every other debt category except mortgage and personal loan, people with perfect scores had more open tradelines but less debt than their counterparts with average scores—underscoring the value of being able to manage debt while having numerous credit accounts.”

For a more detailed breakdown of the credit mix factor of your credit score, see our article, “Credit Mix: Do You Need to Care About Types of Credit?

New Credit — 10%

The “new credit” category of your credit score refers to how frequently you shop for new credit. This includes opening up new credit cards and applying for loans, for example. This “new credit” activity is reflected in the number of inquiries on your credit report.

Since seeking new credit makes you look like a higher risk to creditors, each hard inquiry has the potential to drop your score by a few points. Therefore, if you are going for a perfect 850, it’s best to avoid applying for new credit for a while.

However, it is possible to score an 850 with hard inquiries on your record. FICO recently stated that around 10% of 850 scorers had one or more inquiries within the past year, and about 25% had opened at least one new credit account within the past year.

If you need to shop for an auto loan or mortgage, be sure to complete all your applications within a two-week window in order for all of the credit pulls to count as one inquiry. For credit cards, however, each inquiry will be typically be counted individually.

Fortunately, inquiries only remain on your credit report for two years, and FICO scores only consider inquiries that occurred within the past year, so it shouldn’t take long for your credit to recover if you do have new inquiries on your credit report.

Inquiries aren’t the only thing that matters when it comes to the new credit factor of your credit score, however. It also includes data points such as the number of new accounts you have, the ratio of new accounts vs. seasoned accounts, and the amount of time that has passed since opening new accounts. The main idea if you want to maximize your credit score is to not open too many new accounts at once, which can make you look riskier to lenders and bring down your score.

More Tips on How to Get an 850 Credit Score

In addition to optimizing each of the above five categories that factor into your credit score, it is also important to regularly check for errors on your credit report and dispute any inaccurate information both with the credit bureaus as well as with the lenders who furnish the data to the bureaus.

In addition, those with very high credit scores rarely have serious delinquencies or public records on their credit reports, such as bankruptcies or liens. Obviously, this will be easy to avoid if you follow all of the suggestions above, but if you have a history of bad credit in your past, it could take up to 7-10 years to recover enough to get an 850 credit score.

850 Credit Score Benefits

What are the benefits of being in the 850 credit club? In reality, you’ll be able to take advantage of the benefits of having an excellent credit score whether you have a 760 credit score or an 850 credit score. You don’t need to score a perfect 850 to get the best credit cards or the best interest rates on loans.

Essentially, the main benefit of having the best possible credit score is bragging rights!

Final Thoughts on How to Get the Perfect Credit Score

While it’s probably not necessary to get an 850 credit score, it is smart to work toward the goal of having excellent credit by managing your credit wisely, which will eventually get you into the upper levels of high credit score achievers.

The most important factors of your credit score are payment history, utilization, and age. Therefore, to keep your credit in pristine condition, you’ll need to make all of your payments on time, keep your utilization as low as possible, and maximize your credit age. Beyond that, you’ll also want to maintain a balanced mix of accounts and minimize new credit inquiries.

How to Get an 850 Credit Score Pinterest graphic

Finally, take advantage of your three annual free credit reports to make sure your credit reports are free of damaging errors.

To summarize, here’s an example of what the credit profile of someone who has an 850 credit score might look like, as we illustrated in the infographic above:

No missed payments or delinquencies within the past seven years
A high total credit limit
The overall utilization ratio is 5% or lower
Individual credit cards each have low utilization, around 5% or lower
The oldest account is likely about 25-30 years old
The average age of accounts is at least 11 years
Typically has at least seven credit card accounts (whether open or closed)
Usually has an auto loan and/or a mortgage loan
May have additional installment loans
Minimal inquiries within the past year
No damaging errors on their credit report

Have you ever achieved the perfect 850 credit score? Is it a goal that you are currently working toward? Share your thoughts with us by leaving a comment below!

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#AskanExpert: Should I Apply for an Apartment or a Credit Card First?

Q. I am planning to apply for a new apartment soon and my credit score is 678 from Equifax and 608 from Transunion. What do most rental companies require to get approved? This is a low-income property.

I also want to get a new credit card for someone with low income and no annual fee. Are there any credit cards that will give me a card with my current credit scores? Also, should I wait to get a credit card after the apartment complex does their credit check or should I get a credit card first?

Dear Reader,

Each rental company will look at your credit report differently. Ultimately, they want to know if they can trust you to pay them on time every month. Because your credit score is considered fair, you may end up needing to have a bigger deposit to secure an apartment.

Having only fair credit can make it difficult to get a credit card with a decent interest rate. However, you can look for a secure credit card. These cards work like regular cards, but they are secured by a deposit you make. Secured cards provide a great way for people with no credit or with a low score the opportunity to improve their scores and their credibility.

Be sure to do your homework and compare several secured credit cards. Look for one that meets your needs–in this case, one that does not have an annual fee. Another option for improving your credit would be to check out Experian Boost. It uses your phone and utility bill payments to “boost” your score if you have been paying those regularly and on-time.

Now, whether you should wait to get your card after the apartment company reviews your credit, I think you should. Whenever you ask for new credit, even for a secured credit card, a hard inquiry is generated on your report, and it lowers your credit score. So, it’s best to have the highest possible score to get your apartment.

After that, apply for the card and use it strategically, always paying on time and only using up to 30% of your available credit or less. If you need additional guidance, feel free to contact an NFCC-certified credit counselor from a local nonprofit near you. They are ready to help and can provide more personalized recommendations for improving your credit. Good luck!

Sincerely, 

Bruce McClary, Vice President of Communications

Bruce McClary is the Vice President of Communications for the National Foundation for Credit Counseling® (NFCC®). Based in Washington, D.C., he provides marketing and media relations support for the NFCC and its member agencies serving all 50 states and Puerto Rico. Bruce is considered a subject matter expert and interfaces with the national media, serving as a primary representative for the organization. He has been a featured financial expert for the nation’s top news outlets, including USA Today, MSNBC, NBC News, The New York Times, the Wall Street Journal, CNN, MarketWatch, Fox Business, and hundreds of local media outlets from coast to coast.

The post #AskanExpert: Should I Apply for an Apartment or a Credit Card First? appeared first on NFCC.

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Credit Mix: Do You Need to Care About Types of Credit?

Mix of credit comprises 10% of a FICO score.

Mix of credit comprises 10% of a FICO score.

Credit mix, also called mix of credit, is one of the factors that your credit score takes into account. It is one of the least important factors, weighing in at 10% of a FICO score.

However, it’s still important to consider when building credit, especially if you want to get the best possible credit score.

What Is “Credit Mix” or “Mix of Credit”?

Credit mix is the diversity of types of credit accounts in your credit report. Having different types of credit accounts in good standing in your credit file demonstrates that you can use credit responsibly. Lenders ideally want to see that you have successfully managed a diverse mix of multiple types of accounts.

Types of Credit Accounts

Depending on how you define the types, there are 3-4 general categories when it comes to types of credit.

According to Experian, there are 4 types of credit:

Revolving credit is a form of credit with which you can “revolve” or carry a balance each month. You are assigned a credit limit that you can charge up to and you make a payment each month. Interests will typically be charged if you carry a balance from month to month. Credit cards and lines of credit are the most common types of revolving credit accounts.
Charge cards are similar to credit cards, except the balance must be paid in full every month.
Service credit includes accounts with your service providers, such as utilities, cell phone service, etc. These are considered credit accounts because the service is provided before you pay the bill.
Installment credit is a loan of a specific amount of money that you pay back in regular payments of the same amount over a certain period of time. Types of installment loans include car loans, mortgages, student loans, etc.

Credit Karma simplifies the categories to 3 types of credit:

Revolving credit
Open credit (includes charge cards)
Installment credit

Examples of Revolving Credit

As we touched on above, the two most common types of revolving credit are credit cards and lines of credit.

Credit cards include those issued by banks such as Capital One, Bank of America, and Chase, as well as store cards, which can typically only be used at a particular retailer. 
Lines of credit are similar to credit cards in that you have access to a set amount of money—your credit limit—that you can draw from. After you borrow money from your line of credit, the balance starts accruing interest, and when you pay it back, that credit is then available again for you to use. This is why it’s considered revolving credit: you can use it again and again as long as you keep paying it back.

Types of Lines of Credit
A home equity line of credit (HELOC) is secured by your home.

A home equity line of credit (HELOC) is secured by your home.

Lines of credit can be either secured, which means the borrower has provided collateral to back the line of credit in case of default, or unsecured, meaning no collateral is required.

Beyond those general categories, there are three main types of lines of credit.

A home equity line of credit (HELOC) is a line of credit secured by your equity in your home, which is the difference between the value of your home and the amount you still owe on your mortgage. Since your home equity serves as collateral, if you default on a HELOC, you could risk losing your home to foreclosure.
A personal line of credit is usually unsecured, although sometimes you may be able to provide collateral in the form of savings or investments.
A business line of credit may be secured or unsecured. They are offered by financial institutions as well as many commercial vendors.

Examples of Installment Loans
An auto loan is one type of installment account.

An auto loan is one type of installment account.

Types of installment credit include:

Auto loans
Mortgages
Student loans
Personal loans
Credit-builder loans
Home equity loans (not to be confused with a HELOC, which falls under revolving credit)

The breakdown of account types outlined above is a simplified version of how credit scoring systems actually categorize different types of accounts. In reality, credit scoring models may consider as many as 75+ account types.

In addition, each type of account could have a different effect on your credit.

How Does Credit Mix Affect Your FICO Score?

As we mentioned at the top of this article, credit mix makes up about 10% of your FICO score. With VantageScore, type of credit and credit age are combined into the same category, which makes up approximately 21% of your VantageScore.

With both types of scores, credit mix is a relatively small portion of what determines a credit score, so having the perfect credit mix is not necessarily essential in order to have good credit. However, it’s still a good thing to aim for, especially if you want to get a perfect 850 credit score or somewhere close to it.

What Is a Good Credit Mix?

When it comes to your credit score, the most important thing is to demonstrate that you have managed both revolving and installment accounts. Therefore, it’s best to have at least one type of account of each type.

FICO high score achievers have an average of seven credit cards on their credit reports. Hloom on Flickr

FICO high score achievers have an average of seven credit cards on their credit reports. Photo by Hloom on Flickr.

For example, you might have a credit card (revolving) and an auto loan (installment). Or, you could have a mortgage (installment) and a HELOC (revolving). Any combination of one revolving account and one installment account is a good start for your credit mix.

FICO supports this idea, saying, “Having credit cards and installment loans with a good credit history will raise your FICO Scores.”

FICO also says that people who have managed credit cards responsibly are better off than consumers that don’t have any credit cards, who can be seen as risky because they have not demonstrated experience in using revolving credit.

Statistics show that high FICO score achievers have an average of seven credit cards on their credit reports, which includes both open and closed accounts.

People with credit scores in the 800s also typically have installment loans such as mortgages and auto loans, according to Experian.

The total number of accounts in your file may also play a role. FICO has indicated that those with high credit scores can have 20+ credit accounts in their credit reports.

How Many Credit Cards Is Too Many?
Having too many credit card accounts could hurt your credit score.

Having too many credit card accounts could hurt your credit score.

Keep in mind that it is possible to have too many accounts on your credit file. According to the FTC, having too many credit cards could have a negative effect on your credit score, as could having loans from some types of companies.

There is no hard-and-fast rule when it comes to how many credit cards is too many because the impact of any given factor on your credit score depends on what is already in your credit profile, says FICO.

However, in figure 1 in the article “How Credit Actions Impact FICO Scores,” the hypothetical consumer “Rachel,” who has 33 credit accounts, has a lower credit score than “Maria,” who has 21 accounts. This would seem to imply that at some number between 21 and 33 accounts, one’s credit score might begin to suffer. However, these two consumers have other differences in their credit profiles, so the difference in their credit scores cannot be solely attributed to the number of accounts in their files.

Can Some Account Types Hurt Your Credit?

Certain types of loans on your credit report could make you seem like a more risky consumer and therefore could end up hurting your score instead of helping.

Why? It’s all based on statistics and who the credit score algorithms have deemed to be risky borrowers. 

For example, taking out a furniture loan could actually drop your credit score. That’s because furniture loans are often reported as “consumer finance loans,” which are typically reserved for borrowers with bad credit who are statistically more likely to default on loans. Therefore, having this type of account on your credit report could be viewed as risky by lenders and credit scoring algorithms.

Alternatively, the financing arrangement may be reported as revolving debt, which will appear nearly maxed out until you make enough payments to get the balance to a lower level.

Payday and title loans, however, are typically not reported to the credit bureaus, so these types of loans won’t count toward your credit mix or credit score—unless, of course, you default on a loan and it gets sold to a collection agency, who will then report it as a collection account.

Conclusions on Credit Mix
Credit Mix - Pinterest graphic

Since credit mix makes up about 10% of your credit score, it is helpful to try to achieve a balanced mix of credit by keeping a few revolving and installment accounts in good standing. The best credit mix should ideally include a few credit cards and at least one or two installment loans, such as mortgages or auto loans.

However, it’s also important to note that credit mix is much less important than other credit score factors, such as payment history, credit utilization, and credit age. It’s probably not worth obsessing over because you won’t automatically get an excellent credit score just by having the perfect mix of accounts.

In addition, most people naturally accumulate different types of accounts over time, so it’s not necessarily the best idea to start opening new accounts left and right just to build up your credit mix. This strategy could result in lots of inquiries and new accounts bringing your score down in the short term, and having access to credit you don’t need could also encourage extra spending.

However, one way to add accounts to the mix without the risks of opening a new primary account is to purchase authorized user tradelines

As with all credit-related decisions, it’s up to you to take your overall financial goals and priorities into account before taking action. You might decide that you don’t need to worry too much about improving your credit mix, and that’s fine. On the other hand, improving your credit mix can only help your credit score, and it is something that you should pay attention to if you want to get a perfect 850 credit score.

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