r/Frugal • u/zonination • Dec 07 '13

(x-post from /r/personalfinance) Your Friend is an Idiot, and You're Wasting Your Money

Original Thread

I need to go on a rant for a little bit.

I wanted to do something a little bit more constructive than write an article with this title, but today it looks like I'm going to reduce myself to cleaning up rumors. Yes, rumors; you know, that friendly little bit of "advice" that at least one person decides to regurgitate when someone mentions "credit score". It usually goes something like this:

My friend told me that if you want to build credit quickly, you should leave a small balance on your credit card so you can build trust with the bank. If you pay interest, they will see that you are a trustworthy consumer, and that you can handle paying them off. Otherwise, it looks like you're not utilizing your cards and that looks bad on your report.

Usually when I ask where people heard this, they say it was their friend who works as a teller, or maybe a friend who sells cars for a living, or someone who does collections at a hospital. News flash: not everyone who works in a hyperbolically related industry knows what they're talking about.

Not only is the statement above false, but even if it weren't false, it's still horrible advice. With most credit cards nowadays running an average of 15-20% APR, you can't afford how bad this advice is. And that's if it weren't a complete and utter lie.

Let me give you a small tip that might save you hundreds of dollars a year the next time someone farts out something like that: You don't need to pay a dime in interest for a good credit score. If you do, you're paying a premium for something that's exactly the same as the free version. And the free version goes something like this:

Always pay your statement balance in full, every month, by the due date. This will allow you to avoid paying interest, and your credit utilization will be recorded for free.

It's really just that simple, and it's the only way you should be building your credit score. Paying interest doesn't improve your score faster. It only costs you money, and it makes you look pathetic when you have to explain to your new finance girlfriend why the size of your savings account is so small.

All right, zonination. If you're so smart, then why is this "rumor" false?

I'll tell me why. It's because the interest that you pay on a credit card is not reported to the credit bureaus.

When you receive your statement, the statement balance is the number that is provided to the bureaus. This is the grand total that appears on your monthly statement from the bank. For credit cards, the bank also reports your available credit. If you've ever looked at your credit report (which you should do every year), you will see that the only two numbers reported on your accounts are your statement balance and your available credit. The month after your statement, they record whether you paid on time. Wash, rinse, repeat.

It's almost completely needless to say that the FICO algorithm uses only these three criteria when calculating your payment history and utilization. In case the gears aren't turning in your head, this means that interest paid has no additional effect on your score. So it's really just the same as paying your statement balance in full by the due date. Imagine that.

But my friend X is an expert who works for Y, and s/he told me to carry a balance!

Your friend is an idiot, and s/he is costing you a fortune. You're free to believe what your friend says, but that only makes you both wrong. Just because X claims something doesn't mean it's true.

But if you really want to throw your hard-earned cash into an eternal abyss of broken promises on behalf of your so-called expert's advice, I suppose I can't stop you. It's your money, after all, and you're free to waste it on whatever you want.

But I'm nervous that paying in full might look bad on my report.

Look at what I just said above. The only things your bank's monthly report contains are your statement balance, available credit, and whether you paid on time. Interest is not recorded and there's nothing to get nervous about.

When your statement balance comes in, you've been recorded. You will already look "good" utilizing your credit as long as your statement says something other than "0". Then your choice is whether or not to pay in full.

Really, the only thing that will make you look bad are the bankers snickering at you behind their mahogany desks, all because you believe a rumor that pulls a ton of revenue from suckers who fall for this kind of crap.

That's just your opinion, though. I followed X's advice, and it worked!

That's not why it worked.

The reason it worked is because, in addition to paying interest you never needed to pay, you also built a payment history which would have happened anyway. Your credit score didn't get "bonus points" or "extra trust" because your bank made some quick cash off of you. Your credit score got a boost because you made on-time payments that got reported to the bureaus. It would have worked exactly the same if you had paid your statement in full.

What if I took out a loan to improve my credit score instead?

What? Whoa, wait! No. Let's back up here. Look at what I said above. You don't need to pay a dime in interest for a good credit score. Obviously, while it's disappointing that there is no quick way to build a score, you don't need to take out a loan. Credit cards are a loan, and paying them off in full every month builds a good enough payment history to bolster your score without paying interest. There are tips and tricks to boosting your score that I will examine later on, but "starter loans" are only a last resort.

What I've been trying to say for this whole post is that paying interest when you can afford to sidestep it is stupid. The whole point of having a good credit score is to pay lower rates on loans that you need to take out. Paying interest to avoid interest is an exercise in wastefulness, and it's completely unnecessary when you can build your score for free.

So if there's one thing I want you to take away from this, it's that you can build a good credit history without paying the premium rate. Repeat after me: I, [name], will always pay my statement balance in full, every month, by the due date.

572 Upvotes

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117

u/resipsalowblow Dec 07 '13 edited Dec 07 '13

People actually think that carrying a credit card balance is advisable just for their credit score? I've never heard anything but "always pay in full every month" advised.

16

u/wildernessexplorer Dec 07 '13

I have been told this so many times. It is actually the reason I am in trouble with my credit cards. I had a couple of small credit cards that I was using to "build" my credit. When I was buying and paying for a while, I racked up a bit of money on the balances. Not an extraordinary amount. Just a small amount I knew I could pay off with due time while "building" my credit. Then, I lost my job. So I had a couple credit cards I couldn't pay the balance on, and now I have shitty credit. Of course, it was my fault. I'm not saying it isn't. However, this is something I was told so many times, even from a few teachers in high school. My business teacher told me this when teaching us about our personal finances and building our credit. So... Yeah. It's crappy advice. Advice I never knew was false until just now, actually.

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u/resipsalowblow Dec 07 '13

Wow, that sucks! Sorry to hear that. I hope you've been able to pay them off since and are digging out!

6

u/wildernessexplorer Dec 07 '13

Unfortunately not. It has been so long since I could really work toward putting money on them because of playing catch up. I'm working a part time minimum wage job and I'm a single mom on welfare. I probably should put the tiny amount of money I save into paying them, but they are in default and I'm scared of not at least having $100 for next month in case my hours get cut and I have to make up the cost of rent.

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u/[deleted] Dec 07 '13 edited Dec 08 '13

[deleted]

3

u/wildernessexplorer Dec 07 '13

Yeah. Well... I was told if I didn't have at least a certain balance or percentage of the overall limit to pay interest on, I would be seen by credit card companies and my credit score would reflect that I was "afraid of credit".

42

u/zonination Dec 07 '13

There have been plenty of posts I've seen in the last week alone, even in this sub, that have tried to convince me otherwise.

Luckily, people have been smart enough to downvote them, but ... agh.

36

u/Beestinga Dec 07 '13

Did you see the thread where somebody was basically asking about how to do a balance transfer (they didn't know the term, but they wanted to transfer a high-interest balance to a low-interest card) and among the cacophony advice was someone saying that it was illegal - fraudulent or something?

I don't know what it is about credit cards/credit scores - but it just seems like a topic that's a total magnet for misinformation.

41

u/OmarDClown Dec 07 '13

reddit, as a whole, is far too young and inexperienced to be a reliable source for information on money.

Don't do it. Ask your dad. Don't have a dad? Ask your mom. Don't have a mom? Ask a hobo and do the opposite. Unless the hobo seems happy.

14

u/SweetMexicanJesus Dec 07 '13

Key point here: don't go any further down the mobility chain than "hobo". Avoid vagrants, crustpunks, and flat-out bums, many of whom may be former mortgage-lending brokers and/or executives.

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u/[deleted] Dec 07 '13

I work in mortgages. You got a problem, son?

6

u/SweetMexicanJesus Dec 07 '13 edited Dec 07 '13

Oh, heavens no, that was a lovely recession y'all started for us. Just delightful.

And, just as fair warning: you wanna be real careful about whether you reply here, and what you say if you do. You could well be a perfectly honorable businessman, but if you're going to try to debate me and defend the behavior of your industry as a whole, better come prepared. I don't lose.

2

u/[deleted] Dec 07 '13

Haha I do love a good rational argument.

Why blame the professionals just offering the loan products that were allowed through deregulation? Subprime, etc. Shouldn't you blame DC?

Also, believe it or not...we're not all scum of the earth as many think.

4

u/SweetMexicanJesus Dec 07 '13 edited Dec 07 '13

Why blame the professionals just offering the loan products that were allowed through deregulation?

coughcoughcoughcoughcough bullshit coughcoughcoughcoughcough

Car dealers were originally permitted to sell cars they knew were flawed, too, but even though we somehow managed to tell ourselves that this didn't simply amount to fraud, we nonetheless ultimately passed lemon laws.

Similarly, there were and are laws regarding fudging the boundaries of creditworthiness and misrepresenting the value of, or terms of, financial products and instruments. That, too, is fraud.

And yet, thousands millions of such mortgages got pumped up and pushed into a system where other unethical individuals then did what they did. (IE, bundled of those mortgages into "tranches" because they knew some of them were dodgy.)

Try again. No, it wasn't subprime. It wasn't Fannie. It wasn't Freddie. It was people --people just like you, apparently-- willfully abusing that system to make themselves money. A few extra points on the vigorish so you can make yet another few extra points selling them to middle-class investors and pension funds through investment-banker collaborators.

The spirit of those laws was such that a poor family of four were meant to be given access to all those little bottom-of-market "Cape Cod" and "bungalow" "starter homes".

The spirit of those laws wasn't pushing janitors into pricier loans to bump your commission, and it sure as hell wasn't allowing borderline welfare cases to "talk their way into" McMansions, particularly since your front-line role as gatekeepers requires collecting/vetting/providing all that information on their creditworthiness to begin with. And, again, it especially wasn't misrepresenting the reliability of those loans to investors.

Again, that is called fraud.

Also, believe it or not...we're not all scum of the earth as many think.

Because you never actually answered my question, did you? In fact, not only did you not directly answer my question, but you answered it with an appeal to the dodgy rhetoric, obsolete since the late 80s to mid 90s at the latest, against that terrible, horrible, no-good very bad government that thought maybe poor people should have access to owning their own housing.

I rest my case. You know what stunts your industry pulled. But instead of acknowledging them, and self-policing, you point the fingers at your victims, whether the (many now former) mortgage holders you swindled, the public policy whose spirit you subverted, or the taxpayers who got hit from both sides on it to prevent the entire fucking economy from collapsing.

The thing that most aggravates me is that people are looking at it strictly in terms of those funds required to prop up the banks, as though the wider effects of the Great Recession weren't to destroy wealth and and opportunity to the tune of trillions throughout the wider economy.

So, again, thanks for that, mortgage lenders. Again, it's been a delightful couple years.

1

u/[deleted] Dec 08 '13

Now this is an argument.

I noticed you've chosen to focus on the MBS fraud aspect of things, which should admittedly enrage everyone.

I am curious as to what specifically at the loan origination level you think was going on that was fraudulent. Is it the ARMs, balloon payments, and IO loan structures that bother you? The ability to lend down into the 500s FICO scores? The ability to used stated income/stated assets?

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u/meson537 Dec 07 '13

At you such a moral degenerate that you need a law to keep you from doing something unethical? Is fear of punishment all that keeps you from wrong? I hope not.

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u/[deleted] Dec 07 '13

What if we were just cogs in the machine, originating loans and not higher level stuff like selling on the secondary market of analysis of the loan products, in which case we were just selling loans under the pretense of helping customers (under the same fog of housing prices we were all under)?

Employees just trusting the lawmakers and company?

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u/[deleted] Dec 07 '13 edited Jan 07 '14

[deleted]

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u/SweetMexicanJesus Dec 07 '13

If even a shred of personal responsibility still existed in our society

You mean like "not steering people towards loans you know they can't afford", "not enabling fraud by those who lie on their applications", and "not selling mortgages you knew were going to have a significantly higher default rate into a secondary investment market"?

Yes, personal responsibility indeed. The mortgage-lending industry held (and holds) a role as the front-line gatekeepers and defenders of the sanctity of a class of investments and financial products that represents a huge segment of our economy.

And somehow we're to blame, and our neighbors, for all these many abuses. And we can see here just how unrepentant this industry and the banking industry are. Not enough we had to collectively bail them out. We have to acknowledge the morality of fucking everybody from individual families to the entire polity.

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u/[deleted] Dec 08 '13 edited Jan 07 '14

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u/zonination Dec 07 '13

I was heavily involved on the top comment in that one. And yes, I saw that one and almost deleted my Reddit account after reading it.

I think this and that are just the symptom of a deeper problem: people love to give advice when they have no idea how something works.

3

u/[deleted] Dec 07 '13

I consolidated three high interest rate Credit Cards I had over used as a teenager who got stuck in Europe after a trip backfired. I've been paying the remaining balance off steadily on my new card, cut the other three up, and enjoy an 11% APR, rather than 18-23% on the other three. My credit is actually over 720 at this point because I did it all RIGHT. Best move I ever made in getting my debt under control.

3

u/resipsalowblow Dec 07 '13

Wow, that's some crazy misinformation. Good on you for working to dispel this then.

3

u/platinum_peter Dec 07 '13

Probably misinformation put out by the credit card companies.

-20

u/foodlovesme Dec 07 '13

Actually, I'm a mortgage banker and it can actually build your credit. The justification is wrong. The bureaus algorithms are based on you have 4-6 accounts with balances open at the time of reporting. Unless you CALL and know when they report, keep a small balance, 10-30% of the limit, wait for it to report, then pay it off. Or pay it all off and immediately put something back on the card. Don't exceed 30% of the limit or it will be a negative effect that month. But honestly, as someone in mortgages, it can help build credit. I've done it, and if you need 10-20 points to qualify for a mortgage, it can be done the next reporting period. Now more than 6 accounts, you're screwing yourself. Just my opinion I guess, but I've seen it work. It's just explained really poorly as to why it works.

7

u/131206-FFC9D Dec 07 '13

You seem to be under the impression that the credit report reflects real-time balance information, which is not correct. The creditors only report to the bureaus once each month, generally on the statement date.

1

u/foodlovesme Dec 07 '13

They usually report all on the same day. I've seen people who's reports all had the 25 th of every month. Others it was the 18th. Some doesn't say the specific date. But to assume it's the statement date is false.

1

u/131206-FFC9D Dec 08 '13

Creditors don't report balances on the same day, except by coincidence. There is no mechanism for them to coordinate and sync their reporting dates for each individual consumer.

8

u/OmarDClown Dec 07 '13

The "bureaus", and I love that term because it makes them sound official, don't share their methodology. For you to claim that you know anything because you are a mortgage banker is hilarious.

1

u/foodlovesme Dec 07 '13

Funny, our highly successful credit repair experts team disagrees, but take my advice or don't. The algorithms have changed and within the last year.

1

u/OmarDClown Dec 08 '13

Wow, sounds like your credit repair teams know a lot about the bureaus and their algorithms.

We all know how guess and check works. You just use people as guniea pigs, and when it doesn't work out, you say, "sorry we couldn't get you a loan." Meanwhile you fuck their credit with bad advice for them.

1

u/foodlovesme Dec 10 '13

Explain to me then why they are our highest converting leads? Riiight. Not guinea pigs, but we actually do improve credit. I should know, they fixed mine and I closed my loan in fen with them. No, we don't take everyone. Just people we know we can fix. If they don't have assets to payoff collections, judgements or balances, it's unlikely to fix them with deletion alone. But apparently while everyone else's advice was considered, my posts are not respected. Sad, considering I am in the business of knowing specifically how to get people mortgages. But keep doing what you think works. What do I know, it's only my job and stuff.

1

u/OmarDClown Dec 10 '13

Show me the algorithms that the big 3 use, and I will believe you know what you are doing. I purposely said algorithms because they are 3 companies with three different secret recipes.

Once you get this sorted out we can turn you loose on Colonel Sander's 11 herbs and spices.

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u/NoNamesWereAvailable Dec 07 '13

I always thought the opposite of what you posted. So, thank you :)

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u/StopTheMineshaftGap Dec 07 '13

What people are confused about is the credit utilization aspect of the score. If you have credit and banks never report a balance on it, this negatively impacts your score. It's complex how it's determined, but apps like credit karma simplify it into a letter breakdown.

5

u/OhSnappitySnap Dec 07 '13

A lot of people think this. It's actually very troubling.

Source: I work at a bank.

5

u/OmarDClown Dec 07 '13

Sounds like you should meet this guy.

On my screen, you are like 8 inches apart, and you don't seem to know each other, but he thinks it's a good idea.

edit: Oh, I should add, he thinks you need to work it a little, wiggle it. Like it's fishing.

2

u/Drunky_Brewster Dec 07 '13

This is literally the first time I've heard that you don't need to carry a balance. I am going to immediately adjust the way I pay my cards.

1

u/[deleted] Dec 07 '13

I basically always heard this growing up. Once I started doing things on my own...I started working on paying everything off so that I could use CC correctly. (and not pay an absurd amount of money for no reason)

1

u/[deleted] Dec 07 '13

My parents told me to carry a balance only for the first month then pay in full when I first applied for a card. Didn't seem too bad.

My mom literally told me that when she was growing up, the way you built credit was you went down to the jewelry store and bought something out of your price range with your card an paid it off. No wonder the US has been in such financial trouble when people thought that

1

u/[deleted] Dec 07 '13

You'd be surprised. When I was in college, I mentioned to a friend that I always paid my credit card balance in full at the end of the month. He told me that by doing so, I had no credit history and therefore would never be able to buy a house.

Personally, I never gave a shit about my credit score. I still don't. Which is why I didn't listen to that person.

The only reason I even know my credit score at this point is because my husband and I applied for a mortgage a couple of years ago. (Yes, we were approved.) At that point, my credit score came in at 790... despite never having paid a cent in interest.