Lesson 1: Understand The System

Summary:

Learn how the system works, then make it work for you
Your credit report shows a history (correct or incorrect) of your debt repayment for the past 7 years (possibly longer)
Lenders use your credit report to predict how likely you are to repay a loan they make to you
Lenders use credit reports to determine how risky your loan is and assign a risk premium to your interest rate
The less risky your loan, the lower your interest rate
The higher risk your loan, the higher your interest rate (if your loan is even approved)
You want to show lenders that you repay your loans; therefore, your loan is less risky
Mortgage lenders look at your credit report to determine your likelihood of falling behind on your mortgage
Landlords look at your credit report to determine your likelihood of falling behind on your rent
Automobile lenders look at your credit report to determine your likelihood of falling behind on your car loan
In some States, insurance companies look at your credit report to determine your insurance premiums
Build a good credit history (as we discuss in Lesson 4) to reduce the amount you pay for everyday expenses and make your money go further
Life is less expensive when you have good credit
Learning good credit is like learning to ride a bike, learn it once and benefit for life

Wise Credit Management is a free Bible-based class that teaches how credit really works by showing factual information directly from the Credit Bureaus and FICO, and simplifies the subject to show everyone how to build good credit or handle bad credit. The class is fairly comprehensive and focused on getting good credit to qualify for a good mortgage rate and terms. WiseCreditManagement.com is a free community for members to take the class, join local groups (online or in person) for mutual support, and to find local professionals who volunteer to use their skills to assist members to success.

I am not a lawyer or Credit Repair Organization.

Home ownership is the way most Americans build wealth and a lack of education about credit is a huge contributor to the growing “Wealth Gap” in our country. Wise Credit Management is focused on teaching how to get good credit and qualify for a good mortgage rate and terms.

My work is protected by the “fair use” section of U.S. Copyright Act.

Proverbs 13:16 ~ Every prudent man acts with knowledge, but a fool lays open his folly. ~

The System

Consumer credit reports give lenders a way to know an applicant’s past credit history, the current status of existing loans and a statistical way to predict the likelihood of future repayment of debt.

In simple terms, credit reports give lenders a way to determine how risky your loan will be.

A lender will then determine if the loan will be approved. If the loan application is approved, the lender will use the risk analysis to determine how high the interest rate should be to compensate for the risk. Think of risk premium as an additional fee that lenders charge to compensate for the risk of you not repaying your loan. The higher your credit score (and lower risk), the lower your risk premium you’ll pay, resulting in a lower interest rate.

I want to emphasize that race/ethnicity is not a factor in your score. However, I do recognize that there is a significant difference in the average credit score among different races. That is a socioeconomic problem and not a problem with the algorithm itself.

For Example:

A consumer with a credit rating suggesting there is a 99% probability of successful repayment with likely have a risk premium of 1% added to the loan interest rate. However, if the credit rating suggests there is only a 90% probability of repayment, the risk premium will be over 10%.

When you are preparing to apply for a loan your goal should be to have a credit report that shows you are in the 99% and therefore qualify for the lowest rate.

If you have bad credit or no credit history at all, the lender has nothing to evaluate you with and usually either denies the loan or gives you the highest interest rate.

Mortgage lenders evaluate risk differently because there is an asset (your home) to sell if you default on the loan. It is also much easier to see exactly how the risk premium works if we discuss possible examples that could happen in the real world.

Housing

The mortgage calculator on myFico.com (https://www.myfico.com/credit-education/calculators/loan-savings-calculator/) shows that you would likely pay a 1.5% higher interest rate on a loan with a low credit score than if you had the highest credit score (demonstrating the concept of risk premium). That may not sound like much, but it is about $100 per month higher per $100,000 borrowed, or about $300 per month more for a $300,000 loan. If you can get approved for a home loan with bad credit or no credit, you will likely have to pay about $300 more per month for the same home.

Have you ever tried to rent a home with bad credit? Your options are severely limited because landlords typically require a 600 credit score.

Transportation

Did you know that some auto insurance companies in some States use your credit report to help determine the insurance premium you pay on your car or truck? (https://www.experian.com/blogs/ask-experian/how-much-does-credit-score-affect-auto-insurance-rates/) If you have a loan on that vehicle, the interest rate was almost certainly influenced by your credit.

When you start to add up an increase in housing payment and transportation costs alone, you may wind up paying over $500 per month for the same things.

Everyday Things

Obviously, your credit affects your ability to get many other things like credit cards. With bad credit, you might face sky-high interest rates and miss out on rewards programs. If you have bad credit or no credit history you may not be able to get a bank account, which makes cashing your paycheck and paying bills more expensive.

“A fine is a tax for doing something wrong. A tax is a fine for doing something right.”

– Anonymous (Maybe Mark Twain)

How much you pay for many other things you need besides housing and transportation are influenced by your credit score. The higher amount you pay is like a “fine” for not having the best credit possible. By building a good credit score, you can unlock better rates, lower fees, and more financial freedom.

Luke 16:10 ~ He who is faithful in what is least is also faithful in much…~

Starting Tips

Building good credit or recovering from a setback is a process and a journey to be taken one step at a time. Do the small things you can do today to work toward a better tomorrow.

Good credit reports usually have a minimum of 2 Term Loans and 3 Credit Cards. Begin by going to CreditStrong.com for a no-qualification term loan. Next, go to Self.inc for another no-qualification term loan which eventually leads to a secured credit card. More companies that will help you start (with bad credit or no credit history) are detailed in Lesson 4: How To Build Good Credit.

Challenge: Add how much you are paying in “Fines” for having bad credit or no credit history? Calculate how much you are essentially “paying” in extra interest rates, fees, and limited access to better financial products due to bad or no credit history. What could you do with the extra money? Pay down debt? Increase your savings or investments? Anything better than paying a higher risk premium on your debt?

Next: Complete the Lesson 1 Quiz (first make sure you completed the Essentials of Wise Credit Management Quiz)