09.26.23 Professor Clark: Credit Scores 101 / Smart Borrowing For Small Business

It's my pleasure to welcome you to the Clark Howard Show where our mission is to serve you and empower you to make better financial decisions in your life. I'm putting on my Professor Clark Hat today and doing a 101 refresher about credit scores because, man, are we getting a lot of questions, both here for the podcast and at our Team Clark Consumer Action Center, where people call for free one-on-one advice and guidance. And you know, you may think you don't need to worry about your credit score because you don't need to borrow any money, but let me tell you, there are really important reasons. Even people who are not borrowing money need to pay attention to their scores and understand how they work. And later, small business owners are in a structural marketplace squeeze play right now when you try to borrow money. And I want to tell you what's going on behind the scenes and what you need to be wary and aware of as a small business owner with cash flow needs. Credit scores. There are so many different credit scores each of us have that it's crazy. You know, if you take your blood pressure with a blood pressure monitoring device and you could take a time after time with that same device, your blood pressure score moves around. But also, each blood pressure device will come up with different numbers and many aren't very accurate. So think of credit scores as all of that mixed together. There are certain elements that make up a credit score. Two thirds roughly of what makes up a credit score, only two things. One, that you pay every bill every month on time. One late pay for someone who's had a great credit score will blow your credit score apart for a lengthy period of time. Two, how much of your available credit you're using both as an overall and per card. Those two things, paying on time and how much of your available credit you're using is roughly again, depending on the scoring model, two thirds of the action. The other factors are not nearly as significant. Age of your credit, variety of your credit, all that. I mean, to have a perfect score on the most common scoring model, which is FICO, and the score is an 850 is a perfect score, requires that you jump through a bunch of hoops, but having an 850 never necessary. And a percent of people have an 850, I think it's somewhere around 1%. It may feel great, but it makes no difference in your life. As a general rule with the most important accepted scoring model in the country, the FICO score, having a score of 760 or above should get you most any loan on the most favorable terms you could ever expect. Small number of lenders may have that cut off at 780. But let's say you don't have a 780 or 760. If you're in the 700s, you're still going to qualify for most great loan products available at very favorable terms. Here's the thing though, your score on the FICO system can be different from all three credit bureaus based on what data about you they're collecting and reporting. The same time, none of us have 8 credit score, because then there are different credit scoring models. There's a mortgage scoring model, a car loan scoring model, a breathing scoring model. You name it. So what you're looking for is a direction with your scores, not a precise one. There is a credit model scoring model that is owned by the cartel of Equifax Trans Union and Experian, the three major credit bureaus, it's called the vantage score, not used by a lot of lenders, in spite of years of effort trying to push lenders by the major credit bureaus to use vantage instead of FICO. And the vantage scores tend to be more volatile based on how the scoring models work. But even if your vantage score is in a general good range, you're likely when somebody pulls a specialized credit report on you, most of the time you're going to be just fine. And looking for where you are, the temperature, basically, that you got a good temperature. The greatest risk to people like me who have no need to borrow money is not what our score means for credit. It's what it means for things like insurance, homeowners, auto, your credit standing overall, not necessarily a score, matters to a lot of employers. There are a variety of circumstances where the credit report or the credit score or the combination of the two affects you in ways that have nothing to do with credit. People will go to apply for a car loan, let's say, and that is a form of credit. And you go to apply for it and you're told, well, your credit scores, blah, blah, blah. You say, wait a minute, right here on my phone, it says it's blah, blah, blah, again, as long as it's in the good range or is in a great range of 760 or above, you're fine. It doesn't matter if it's 10, 15, 20 points difference. There will be anomalies, though, where somebody will have a credit score for a specialized purpose. There will be a lot lower than you've been seeing with the models. And it may be something on the particular credit report that that score was based on. And truth be told, there are also times that people are told who aren't monitoring their scores generally, that their score is lower than it actually is to try to sell you an inferior loan rate or loan product. This is an area of what you don't know can hurt you. So don't fixate on having a particular perfect score. And don't be freaked that you thought your score was this, and somebody tells you this amount lower if it's in a small range. If it's a big number difference, you need to do your homework. And I have a credit karma dashboard, which gives me a facsimile of a score based on the vantage scoring model. Again, not the preferred industry version of FICO, but I'm able to have a real sense of direction and how I'm doing. As for those two things I talked about, I told you upfront, you got to have a system whether it's manual or it's calendar based, electronic or whatever, what you never forget to make a payment. You'd be amazed how many people foul up their credit score for months or years because they just forgot to pay a bill. That's a better problem to have than people who can't afford to pay a bill. But you don't want to have the forgot, because the forgot will eat you up just as if you didn't have the money. Make sure you have good financial habits so that the bills get paid. And if you know you're really flaky, set up automatic payments for those cards so that you at least are always going to be reported as current. Second thing, on the amount of your available credit you're using, never higher than 30% is you move up from 30% your score goes down, down, down, down, down, down. That is, the scoring models show clearly that people that are using above 30% of their available credit are much more likely to default or bankrupt out on the debt owed. Huge danger sign for the banks and credit issuers. If you really want to have a great score, use less than 10% of your available credit. Yeah, I know. I give you a credit line of whatever and you think that is your permission to spend. So if you have a $5,000 limit on card, yeah, so I'll spend up to the $5,000. In the case of a $5,000 credit limit, you never want to have charged up more than $1,500. And I've talked strategies before for people who want to push their score up from where it is. And this moment is not about that. This is about just good financial habits and good financial health, Christa. This question's from Kathy in Pennsylvania. I know there are many credit scores for a person. How can I access those other scores such as those that a car dealer might look at when we purchase a car or a realtor would access when we bought a home? I think mortgage lender. I can access my other scores through my credit car my account, but I would like to access these scores. Thank you. As best I know, there's no easy way for you to see the auto lender scoring models. But if a lender tells you, let's say you make the mistake that 80% of people do, and you make the terrible error of financing a vehicle at a car dealer saying, well, that's horrible thing to do. Anyway, the finance person at the car dealer may say, oh, well, I don't know why I mean, you might be able to get your finance here, but I'm really worried about this credit report of yours is going to be terrible. And you say, well, you know, I'm looking right now at my current bike go score, and it's blah, blah, blah. And then they may fold because they may be trying to fib on you, or there could be something on a particular report that shows that auto loan score being lower. So you need to be armed with your own knowledge and remembering that a lot of the people you do business with on their apps, give you a current to that moment credit score, and you'll have to see there is a fight go or vantage, but either will give you that indicator. Why do you never finance at a car dealer, at least not upfront, because car dealer loans are marked up so, so much versus even a regular bank loan, but so much more than a credit union issued vehicle loan. I mean, the interest rate on credit union vehicle loan could be half the interest of what a car dealer is going to try to sell you. Now, if there's a special factory subsidized loan, and you can get a better deal with the car dealer, you'd already know, because they say, well, we've got this special deal. And you know what the credit union said, then you could make the call to go with the financing from the dealer, but otherwise that credit union loans the best. This one is from Susan in Washington. I just took advantage of a 0% interest loan for 24 months for a $9,000 tempera paedic mattress. Are you okay? No. Okay, I hope that is the greatest night's sleep ever, $9,000. I mean, you do spend a third of your life sleeping, right? What in the world does this mattress do? Okay. So let me get to her question. My credit karma score tanked 47 points. I went from 823 to 776 out. Will this stay with me the entire 24 months or just mildly recover as I pay $400 a month over the next two years to have a zero balance before the promo expires. Okay. I'm sorry. That was really not classy of me, Susan, to say something about how much you spent on a mattress as a personal choice, personal decision. I mean, my mattress has always come from warehouse clubs. And I roll them out of the store myself on the rolling pallets. So the credit score will recover step by step as you pay down the balance because it's reported right now that you have a $9,000 limit on that financing with a $9,000 balance. So it's like 100% utilization on that card. And that's what attacked your overall, if it's a credit karma vantage score, and that will heal steadily gradually. John in California says guru Clark, I previously asked if I should close my Apple master card because as an Android user, I couldn't really access the card info as Apple only really let you easily see statements through an iPhone. And I could only make payments if I linked my bank account, which I was unwilling to do. It also really bothered me that they wouldn't give me a paper statement nor let me pay via my bank bill pair. Someone from your help center kindly responded, encouraging me not to close it, but to find a way to occasionally use it. Well, Apple ended up closing my Apple card due to lack of use. Well, the fact that they closed the card on me without warning hurt my credit score more than if I closed it myself. Apple only notified me after they closed the card. Ultimately, my credit should be fine as I fortunately have a near perfect score. Okay. So makes no difference if the accounts closed unilaterally by Apple, which was actually Goldman Sachs that operates that program for them. Although I've heard they're going to sell off that portfolio. And then or you voluntarily on your own closely account, the impact on you is identical. I'm sorry that Apple did that to you. But if you have lots of other credit cards and the available credit that the Apple card represented was a very small portion of your overall credit profile in terms of available credit, it will not impact your credit score in any meaningful way. If on the other hand, the credit available with that Apple card represented a substantial amount of your available credit, you want to take out another credit card with someone else to raise back up your available credit. The Apple card, as we talked about before, is only useful to people who are totally in the Apple orbit. iPhones in particular, most important, and you use it exactly as Apple intends, then the card can be useful and rewarding with 2% cash back. Any other circumstance, the Apple card is a waste of your time and your money is better charged on something else somewhere else, but it's really designed for tap and pay. And I should tell you a funny thing. I was reading a story recently about how terrified the banks are of Apple's ability would tap and pay to seize power from the banks. And I'm cheering for you, Apple, all the way on bringing the worst fears of the banking industry to life, coming up ahead, speaking of banking. We're going to talk about there's serious issues for small business owners who need working capital, and the marketplace is offering some ugly options. I want to make sure you're aware how to protect yourself and your business. Did you know that Discover is more than a credit card? With Discover's online savings account, you earn five times more interest than the national savings average, five times. There are no monthly fees, no minimum deposit, and no monthly balance requirements. It's FCIC insured up to the maximum amount allowed by law. Learn more at Discover.com and start saving with confidence today. Discover bank, member FDIC. If you are not to manure, you are a small business person. You're operating your own business. You are key and core to future economic growth in the United States. I mean, that's where it happens. Is companies that are successful, get so big, they become pure critic, they become lumbering giants. And as I've always said about dinosaurs, they went extinct because their brains were so small, no matter how big they were. And that seems to happen as companies grow, as their IQ steadily goes down. So the innovation, the disruption comes from small businesses. Unfortunately, changes in the banking sector have made it really hard for small business owners and entrepreneurs to get working capital. Very hard for them to borrow money because the banking sector has gotten to a point where we've got the four giant monster megas. And then we have the regionals that are too large to be close to customers. And make the kind of decisions that banks used to make. If you go back when we used to have gosh, more than 10,000 banks in the United States, now we got four that account for more than half a banking in the country. And everything is a bureaucratic, ridiculous process. So the marketplace finds a way. And today we have a lot of what are referred to as small business fentex that are these lenders that I got solicited by them. I don't know how many times a day by email, regular mail, spam text messages, saying, hey, you know, you need money for your business. We make instant decisions in most cases. And so I instantly can borrow money for my company. The problem is federal law did not keep up. And there's not required robust disclosure of fees, interest rates, and other charges you face junk fees that you face as a small business owner taking out alone. So here we've got this wide gulf that's opened up a traditional small town banking that has mostly vanished in the United States, known as community banking. And that's what was best set up and always was the connection for small businesses. So as a business owner, the time you need to establish that relationship is not when you've got to worry about how you're going to meet next week's payroll or pay some other key expenses for your business. First best thing is to go find a real local one, two, three office bank. Not when it's pretending to be local, but isn't an actual real one where you have someone you can talk with. He failing that a number of credit unions now have as part of what they do. They can take on a certain number of small business clients. If neither of those work for you and you're left with the small business fentex. Never take out one of those instant loans until you have an email confirming and writing interest rate, upfront fees and other fees that are required if you borrow from them. Do you know there are small business loans people are getting that are charging rates not at all unusual 50% or more in an interest rate. Very easy to get brutal to have. Now a lot of small businesses run their businesses on credit cards. You know, when there are certain times a year cash flow sinks and that in many cases is a preferable option to the lack of disclosure from the small business fentex, but still inferior to having that relationship with a small local bank or a local credit union that does the small business loans. Christa. Okay, speaking of small businesses, Chris and Wisconsin says my college age son spent this summer and the previous learning landscaping from a professional company in our hometown. Now that he's back in college, he started a side hustle with some skills that he's learned. It's a small subset of hardscaping where he refreshes paper brick patios and walkways, cleaning and resetting them and replacing them when needed. He's done an amazing job spinning up a website, even trademarking his business name and logo and has begun advertising on social websites. However, he has not purchased any insurance, not even general liability. Should he and is there any risk for me as his parent if he were to ever be sued? All right, so those are great questions and Chris. I'm not a lawyer. I will tell you that if you're providing more than 50% of the financial support to your son, and there was a liability risk with something he did doing hardscape at someone's business or their home. There is the potential risk that they could pierce your assets in a lawsuit varies by state. It is possible, but again, the key trigger is that he is your dependent, not financially independent, which is generally considered to be again, if you are providing 50% plus one or 51% which is to keep it clear of the financial support to him, then yes, potentially you could be the easiest solution in this case is that your son do business as an LLC, very affordable to set up an LLC. Now online, you could operate that limited liability company. Always needs to do business as that limited liability company. And that would prevent the risk is the alternative you mentioned that's very wise is a business liability policy. But with the volume he's doing and that sort of thing at this point, having an LLC to me seems to be the better strategy, better idea. This one's from anonymous in California park car was hit by a neighbor who is also an insurance salesman. The damage was minor and I got an estimate of $325 from an independent repair person to fix. This is that cheap. Yeah, this was one third of the cost of what an auto body shop wanted. The neighbor prefers to file a claim because quote, he won't pay anything if he makes a claim. He has a particular body shop he prefers. I use where he will have the claim started. Clark, why would someone in the insurance business do this to avoid such a minor cost? Am I missing something? You're not missing anything. What is that insurance salesperson doing to himself for herself? Oh, man, they could have just given you $300 plus $325 and cash. And call it a day and they want to file a claim. I don't get it. Wow. And you didn't miss anything. They did. Brian in Texas says both my kids helped establish and build with the pedal card based on your advice. My son just informed me they're now charging an $8 monthly membership fee. Before you recommend the card again, would you please warn listeners of this new junk fee? My son is ditching his account immediately before your son ditches his account. He needs to the whole purpose of this account for him was to establish credit. He needs to make sure that's happened that he's crossed that bridge that he can get a card preferably from a credit union and have a credit union issued. These are master card pedal card has been a great product. And I guess they need to bring in some money because they've been doing some weird stuff. So your kids were randomized. Only certain people are being charged this new junk fee of $8 a month, which kills what was such a great virtue of the pedal card, which allowed used alternative methods to determine credit worthiness and a traditional credit score. And they'd issue a pedal fees a card and it would then help you build credit. It was a bridge without doing a secured card to establish good credit as long as you handled it right. Well, now again, randomized, some people are getting the $8 a month notice and other people aren't. Pedal isn't saying at all how they decide who is going to be charged the fee or not. They have another product that they've had for a while that has supposed enhancements that comes with, I think, a $60 annual fee, but they're not letting people move who are being told they now have to pay the $100 a year. They're not allowing them to move the $60. So your son is doing the right thing as long as he does it in the right order because pedal says there's no appeal. If you're the unlucky one selected for the $8 a month fee to make sure before he fails out of the $8 a month fee, the is able to establish that credit elsewhere. Otherwise, well, if you're not for right now, it's worth it till he can to keep paying the $8 a month junk fee. And I assume that they've not found the card to be profitable as they expected. And that's why they're testing doing the $8 a month fee. And of course, we will update on our review of the pedal card on Clark dot com. This information that other people need to know that you could randomly be assigned a fee on what was a fee free visa card. And thank you so much for being with us today. And in addition to Clark dot com being there for you every day of the year around the clock. Our Team Clark Consumer Action Center is there to serve you with free one on one advice 30 hours each week. You can see how to reach the Team Clark Consumer Action Center and talk with the member of our team one on one. You go to carc.com slash CAC. Have a great rest of your day.