If I was to give a standing ovation to an industry for successfully using the art of human behaviour and psychology to make money, it’d be the banking industry. 

A few weeks ago, I received a message from my bank:

Too many expenses to carry? Enjoy financial freedom and live life to the fullest by converting your credit card outstanding bill of $1,543  into easy instalments of $40. 

The message was followed by a big red ‘Convert Now’ button to ensure that I didn’t miss the ‘opportunity.’

They wanted me to convert my $1,543 balance owed from maximum payment to minimum payment.  

Credit card conversion is a facility offered by the bank that allows you to change your payment method from maximum to minimum payment. I talked about the difference between the two in my previous article. 

By using the buzzwords ‘financial freedom’ and ‘live life to the fullest’, they for sure got me hooked to reading the full message and thinking about clicking the button. A lot of people must have fallen for the trick. Converting your bill to minimum payment simply means signing up for interest charges. 

Well, since we don’t talk about money, don’t read the terms & conditions and we’re also mindless, passive decision-makers, credit card companies take advantage of us.

Our choices largely depend on how our problems and ideas are presented to us.  They’ve learnt the art of presenting the minimum payment to us as relief of our financial worries as they continue to bank over 18% in interest rates.

But The Wealth Tribe community is smarter than that so of course, I simply smiled at that marketing brilliance and made a note to tell you guys about it in this article. Stay woke!

“If you don’t take good care of your credit, then your credit won’t take good care of you.”― Tyler Gregory

 

Debt payoff planner and debt payment calculator

 

Click here to download an easy to use debt payoff planner and debt payment calculator.

What is a credit score?

 

The first thing that financial institutions think about when you walk into their offices or call them to ask for a loan, is your ability to pay back. Your ability to pay back on time. It’s bad business for them if you can’t pay back because this simply means they’ll lose their money.

To determine your ability to pay back, they use the credit score system.

A credit score is a number used by financial institutions to decide whether you qualify for a loan (credit). It’s a number that ranges from 300 to 850 (for some countries it’s between 200 and 1000). The higher your score, the higher your likelihood of getting your loan approved. 

Kinda sucks that we still have to worry about scores years after we leave school , right?

If you’re thinking… 

I’m still young, I don’t see why I should care about my credit score.

Or

I don’t have plans to take a loan now or in the near future.

Or

I pay everything in cash, have savings & investments, and I’m pretty good at managing my finances. Banks would be impressed.

Or the very common one…

My relationship with loans is like water and oil, we don’t mix (simply put, you’re one of those who’s scared of debt and swore that you’ll never apply for a loan)

Your reasons are valid. 

But I have a spoiler alert…drum rolls please… Welcome to adulthood! Your credit score matters in the same extent your immune system matters in this COVID-19 period. 

And you have to borrow to build your credit score.

I’m sorry to be the bearer of this unpleasant news, but I’m also here to help you understand why your credit score matters and also help you learn how to use debt facility to your advantage.

Building a good credit score is an important part of adulthood. 

You never know when you’ll need a huge amount of money either for business, school, medical emergency, mortgage down payment etc. You shouldn’t wait for the moment of need to start thinking about your credit score.

 

How credit cards build credit

Credit bureaus create your credit reports based on data they receive from financial institutions. Financial institutions such as banks, credit unions, Saccos etc send your financial data to these bureaus. 

 

Factors that determine your creditworthiness 

 

1. Your current amount of debt

How much of your available credit are you using? This is commonly referred to as the utilization rate. The institutions want to see you using a small amount, ideally 30% of your available credit. This is the rule that I use for my credit card.

This is why you’ll often be advised to get a credit card even if you don’t think you need it. But remember to learn how it works before you do as you risk burying yourself in debt.

Just because you have a huge amount of available credit, doesn’t mean you should be out there applying for loans. 

2. Debt payment history

Have you been paying your other loans on time?This is one of the greatest factors because it shows your ability and how disciplined you are towards meeting your financial obligations.

3. Your debt payment history

The longer your credit history, the lower the risk for the bank. This is because it gives them enough data to work with to determine your creditworthiness.

4. Time

How long you’ve had credit?

Financial institutions also track your frequency of loan applications. If they realize that you are looking to apply for too many loans within a short period of time, the system interprets that as risky behaviour.

5. Type of credit

Different types of loans (student loans, mortgage, credit card, auto loan etc) are judged using different parameters. A credit card loan is not treated the same as a mortgage.

Financial institutions want to see a mix of different kinds of credit from your data as it shows how responsible you are in settling different kinds of debt. 

I always roll my eyes on this one because trust me I’m not about to go shopping for debt just to tick this box. I currently have a student loan (Higher Education Loans Board) and 1 credit card. 

6. Timely payment of bills

Yup, this also determines your creditworthiness. 

7. How often you check your credit score

In Kenya, you’re entitled to one free credit report per year. 

If you keep requesting for more reports, the system thinks that you are shopping for more loans and getting rejected which lowers your credit score.

There are many other factors that credit bureaus use to calculate credit scores, it varies from country to country. 

I must, however, remind you that most mobile money loans are unregulated and therefore don’t respect your privacy. You have to give them access to your text messages, call logs, location…basically, they have access to almost everything on your phone. I wrote about it here.

 

Why your credit score matters

 

1. You get higher interest rates if you have poor credit

It’s common for a financial institution to charge you a higher interest rate if you have a bad credit score. This how they protect themselves against the risk that you might not pay back, or you might not pay back on time. 

So yes, building your credit score should be a priority.

2. It determines the initial deposit amount when applying for a mortgage

For loans that require a down payment, your credit score is used to determine how much an institution can give you. The higher your score, the higher the amount.

This is also applicable when renting an apartment in places such as the UK, USA or Dubai.

3. Negotiating for interest rates

If you have a good score, you can negotiate with the institution to reduce your interest rate, increase your loan limit, consolidate your credit card debt and more.

4. It determines your credit card limit and interest rate

Financial institutions will use your score to determine how high they should set your credit card limit or how much interest rate they should charge you for the same.

Getting reported as a defaulter significantly lowers your credit score. It makes you a risky customer to financial institutions.

 

How to improve your credit score

 

1. Pay your bills on time

This includes utility bills, all loans and credit cards. 

Manage your finances in a way that you prioritize bills that impact your credit score. If you have to decide between upgrading your wardrobe vs paying your credit card, start with credit card. 

Automate your payments for as many bills as possible. For example, my banking app has a feature that allows me to schedule monthly payments. Since I know that I receive my internet bill on the 30th of every month, I can automate this payment so that I don’t have to worry about missing my payment which negatively affects my score.

2. Acquire loans only when needed

Don’t open unnecessary lines of credit especially if you know that you won’t be in position to service them. 

Improving your credit score takes time. You should make your first credit score inquiry as soon as now then make a plan on improving it. 

 

Benefits of using a credit card

 

1. It helps you build your credit score!

When you want to buy a home, start a business, buy a car, or anything that you’d want to acquire a loan against, the financial institution will use your credit score to determine the amount and interest rate to give you.

It’s literally your borrowing power! 

2. You’re literally borrowing money for free

This is if, and only if, you make maximum payments every month. Otherwise, it’s the most abused, misused and misunderstood form of debt. 

3. You get reward points

The most common forms of reward are air miles, cash back (1 to 2% of the transaction), free vacations, hotel stays,  and access to airport lounges.

But reward points should not be the motivation to get a credit card. Banks keep reminding you about the reward points because it’s an incentive to make you spend money. The more you swipe your card, the more the points. The 1 to 2% rewards are too small to warrant unnecessary spending.

Shop around and decide which of the rewards offered suit your lifestyle. 

4. Fraud protection

Since you’re using other people’s money when you pay using a credit card, you’re not responsible for unauthorised purchases. With so many fraudulent crimes while buying stuff online, you want to protect yourslef from losing your money. 

Your credit card is not linked to your account so there’s less risk of losing your monies.

5. If your card is stolen, just call the bank to block it

Unlike cash which you’re unlikely to recover.

6. In case of fraud, you get your money back

Banks are very swift to help you solve fraud cases because well, it’s their money. You don’t get the same protection when you use your debit card.

7. Convenience

Faster as compared to cash. I also realized that some hotels don’t accept cash or debit cards for reservations.

8. It can sort you out when you have an emergency

If you have an emergency such as a hospital bill, you can use your credit card to pay for it then use the 1 month grace period to figure out how to pay for it. 

A credit card is not a substitute for an emergency fund.

 

Disadvantages of credit cards

 

1. Interest rates are extremely high

They charge an Annual Percentage Rate of 20 to 30%. This is ridiculous because you can’t find an investment with such a high rate of return! The way to escape losing that much money is paying your card in full every month.

2. The fees and penalties

If you miss a payment, you’re charged.If you make a purchase in a different currency, you get charged conversion fees. 

There are very many hidden fees that your banker will never tell you about unless you ask. I wrote a list of questions to ask your banker before you get one.

To avoid these fees, do your research, read your bank statements and call your bank in case there’s a charge you don’t understand. And make maximum payments.

3. It can lead to excess spending if not controlled

As much as I’m quite good with money, credit cards  incentivize me towards spending more. 

Everything is just a swipe away so you don’t really feel the pain, until you’re hit with the bill. 

Sometimes I’ve had to leave my card at home to avoid the temptation.

You have to exercise discipline and self-control while using them. Well, isn’t this whole thing called adulting about discipline and self-control?

 

Travelling with credit cards

A lot of people don’t know that when you make a purchase in a different currency, you be charged conversion fees. This costs the bank nothing but oh well, they have to make money.

You need to call your bank or read their document to be sure how much they charge before you’re hit with a fat bill after your vacation.

You also need to have enough money in your checking account so that you don’t miss a payment when you’re out of the country.

 

Which credit cards are the best?

Deciding which credit card to go for can be a daunting task, especially if you live in a country that has different types of credit cards on offer.

Should you go for one with cash back? 

Credit cards with zero interest or no annual fees?

Should you pick ones with airport Lounge access? golf lessons? or luxury hotels? 

As much as picking credit cards with the best rewards might be an attractive approach, remember that you actually have to spend loads of money to get those rewards. 

The best approach is to choose depending on your lifestyle. A credit card should be a supplement to your lifestyle and should offer you options. This wealth building journey is all about having options.

If you travel often, pick a card that focuses on air miles as a reward. A credit card should be supplement your other options as opposed to something that leads to more unplanned spending.

Get something that serves your interests…not the bank’s.

How many credit cards should you have?

How many credit cards is too many?

I’ll leave you to decide on this one. I have only one which I think is sufficient for now.

The financial institutions advertise the rewards and convenience to make you take up as many as possible. As much as these rewards sound sweet, they don’t beat the interest rates and fees.

As always, educating yourself should precede any financial decision.

Good debt vs bad debt.

For somebody who’s terrified of debt, I can’t believe I’m about to say this.

Credit cards are a form of good debt. 

Yes, being good with money as an adult also means accepting debt as a tool to grow yourself as opposed to something that you fear and avoid. 

It’s about fully educating yourself about it and being hands on about your finances as opposed to taking a back seat which most people who end up deep in debt do.

Take charge through learning, talking about money, auditing your finances regularly and reading your statements so that you can change tactics in case you’re on the wrong path. 

 

Was this helpful? Do you have more questions about credit cards? Leave a comment and I’ll write an article just for you 😉