Building Credit -- Keep the loan?

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Thrasymachus
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Building Credit -- Keep the loan?

Post by Thrasymachus » Tue Jul 30, 2013 9:40 pm

Hi! First post on Bogleheads.

Summary:
I'm a 24 year old that's trying to build long-term credit. I have one credit card ($500 limit) that I opened in February. I have a car loan ($5.3k at 4.79%) that I could pay off today with cash, but I'm keeping it around for credit purposes. Is this a sound strategy?

Details:
I ran into a few problems after opening my credit card. I mistakenly tried to maximize my reward benefits after opening the card by using it frequently, and I ended up with a high utilization for the first few months of use (though I paid all balances on time). When I applied for a credit limit increase in late April, I was rejected because the high utilization degraded my score and the account had not been open for very long. My credit card company performed a "hard pull" for the credit limit increase request - my score was 734 at that time. I also moved to a new apartment at the beginning of May, and I believe my apartment complex and several utility companies also checked my credit score. I received a letter from my power company in mid-May that levied a safety deposit for a low credit score - citing high utilization, recent credit requests, and recently-opened accounts. My score was 382! I was extremely shocked - and I'm still pretty concerned.

I checked my credit report, but didn't notice anything unusual or wrong. After this point, I realized that I needed to take immediate corrective action to prevent further downward spiraling of my credit score. I drastically reduced my credit card use and did not apply for anything involving my credit score. I decreased the utilization to 9%, and I plan to keep it there for the foreseeable future.

My question is about my car loan - I haven't paid it off yet because I'm told that it will help me build credit. I'm currently planning to wait several months to apply for another credit card. After I have another credit card, I plan to fully pay my car loan.

Is this a sound strategy, or should I pay the car loan immediately and wait several additional months before applying for another credit card? I don't have a near- or mid-term need for a good credit score, but I'd like to have an established credit history and an excellent credit score by the time I'm considering a mortgage. Also, I'd like to transition away from my debit card for security reasons - but there's no immediate pressure.

Also, in terms of sequencing - is it better to seek a CLI or a new credit card first?

Thanks!

---

EDIT, July 31: I've added a few additional details and answered a few questions below. http://www.bogleheads.org/forum/viewtop ... 7#p1764777
EDIT, August 3: I paid off the loan! http://www.bogleheads.org/forum/viewtop ... 9#p1767149
Last edited by Thrasymachus on Sat Aug 03, 2013 1:10 pm, edited 3 times in total.

JustBill
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Re: Building Credit -- Keep the loan?

Post by JustBill » Tue Jul 30, 2013 10:42 pm

Welcome to the boards. Part of your FICO evaluation considers the different types of credit experiences in one's history. So albeit the APR on the auto loan is somewhat high, the actual interest dollars is small, and I'd keep it in place for a while. Also, with a $500 Cl on a credit card, virtually any purchase/balance at all exceeds the commonly recommended 30% utilization rate. Most CCs report statement closing balances to the bureaus, so you could max the card multiple times during a month and make payments to maximize incentive earnings, but leave a smaller balance at the time your creditor reports to the bureaus. Also, consider visiting creditboards.com for much discussion by many credit score obsessed people on this whole FICO score matter.

FlyOverState
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Re: Building Credit -- Keep the loan?

Post by FlyOverState » Tue Jul 30, 2013 11:10 pm

Pay off the loan. Good credit is overrated. The idea that one should pay to obtain good credit by paying interest on loans when it's not necessary is crazy. Time and a solid payment history will go much farther in building credit. Not paying bills on time and getting sent to collections is a much bigger issue.

I'd rather save/invest that interest and let it grow over the next 40+ years than just hand it over to a lender.
Thanks, | John | | FlyOverState

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steelerfan
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Re: Building Credit -- Keep the loan?

Post by steelerfan » Wed Jul 31, 2013 12:26 pm

FlyOverState wrote:Pay off the loan. Good credit is overrated. The idea that one should pay to obtain good credit by paying interest on loans when it's not necessary is crazy. Time and a solid payment history will go much farther in building credit. Not paying bills on time and getting sent to collections is a much bigger issue.

I'd rather save/invest that interest and let it grow over the next 40+ years than just hand it over to a lender.
Agreed. Don't worship at the altar of almighty FICO. Do the right thing with money and your finanacial reputation will take care of itself.
"You make most of your money in a bear market, you just don't realize it at the time." - Shelby Cullom Davis

Snowjob
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Re: Building Credit -- Keep the loan?

Post by Snowjob » Wed Jul 31, 2013 12:33 pm

The balance is small and the interest rate low in absolute terms.

I would keep the loan, pay it off as scheduled and use the money to bolster the emergency fund or add to tax advantaged investment accounts -- liquidity at your age should be the first concern.

harikaried
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Re: Building Credit -- Keep the loan?

Post by harikaried » Wed Jul 31, 2013 12:43 pm

Can someone explain how keeping the loan helps build credit if one already has at least another active account, e.g., credit card?

It seems that these are some of the main factors for credit scores: utilization, payment history, history age, number of accounts.

1. Utilization only affects credit cards I believe, so paying off the auto loan doesn't change much.
2. Payment history looks at how many payments were missed, so not having an auto loan and making sure credit cards are paid makes this simpler.
3. History age is both oldest account and average account age, so if the auto loan is recent, closing it would increase the average age.
4. Number of accounts include both open and closed, so paying off the auto loan has no effect here.

harikaried
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Re: Building Credit -- Keep the loan?

Post by harikaried » Wed Jul 31, 2013 12:51 pm

I suppose another option is if you know how long you want to keep the auto loan, you should be able to pay down the principal so that the regular monthly payments pays off the loan in that desired amount of time.

So very roughly, if the $5300 loan is currently 5 years with $100/mo payments, you could pay the loan down by $4200 immediately. The remaining $1100 principal and interest would get paid off in about 1 year (still at $100/mo) where the amount of interest paid would be $50 instead of $675, so you save $625 in interest.

Spirit Rider
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Re: Building Credit -- Keep the loan?

Post by Spirit Rider » Wed Jul 31, 2013 12:55 pm

Snowjob may be correct if you don't have adequate emergency funds.

Many people are under the mistaken belief that you have "use" credit in order to build up your credit profile and score. Nothing can be further from the truth according to Fair Issac themselves. From a credit scoring perspective there is no negative effect of paying off an installment loan early. It will simply go from "open" "paying as agreed" to "closed" "paid as agreed".

The primary drivers of your credit score are: The mix of credit products (revolving lines i.e credit cards, installment loans i.e auto loans, and mortgages); The utilization of revolving lines (the lower the better without getting cancelled for inactivity), On time payment of all accounts; The age of your accounts and NO collections.

So if you have adequate emergency funds, go ahead and pay off the auto loan. It will stay on your credit profile for 10 years, benefitting your score. Closed and positive accounts continue to be positive effects on your credit profile until they drop off after 10 years.

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Bogle101
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Re: Building Credit -- Keep the loan?

Post by Bogle101 » Wed Jul 31, 2013 1:57 pm

You're credit score went from 734 to 382? That does not seem right, any more information on that?
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mhalley
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Re: Building Credit -- Keep the loan?

Post by mhalley » Wed Jul 31, 2013 2:09 pm

Wow that was quite a drop. One thing that people often don't realize is exactly how the fico score works. I am sure that you thought that just paying off your credit card every month was improving your score, where in reality the card being almost maxed out was hurting it badly. If you had a long credit history and a good score, the car loan would not matter that much, but in your situation I agree that keeping it around is helping your score. I would sign up for credit karma and keep an eye on your score. After a couple of months of minimal utilization of your credit card, when your score goes up enough so that you would be approved, I would open another one, and/or increase the credit limit you have on the one you already have. Another option would be to open up a secured card, and put a thousand or so dollars in it to increase your credit limit and give you some more history.

https://www.creditkarma.com/

Bankrate article on how to pick a secured card:

http://www.bankrate.com/finance/credit- ... -card.aspx

Some cards from bankrate:

http://www.bankrate.com/funnel/credit-c ... 507&ec_id=

Myfico recommendations for improving credit score:

http://www.myfico.com/CreditEducation/i ... score.aspx

Good luck!

PS, I would probably go to https://www.annualcreditreport.com/cra/index.jsp and pull your report, just to make sure nothing else is going on to explain the drop, such as identity theft.
Mike

sesq
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Re: Building Credit -- Keep the loan?

Post by sesq » Wed Jul 31, 2013 3:03 pm

harikaried wrote:Can someone explain how keeping the loan helps build credit if one already has at least another active account, e.g., credit card?
It doesn't in the immediate sense. You get minor points for having a variety of credit sources that are paid timely. So if the loan is paid off, then it will stop being active. In TEN YEARS it will drop off the report if it was closed on good terms (seven years if it was a charge off). So, in ten years if the borrower never again took out a car loan, then whatever bonus the score got from being a different type of credit would no longer apply. That said, in ten years, this poster will have a long file of paying all sorts of other stuff timely that its a total non-issue.

OP - if your card gave points you can still use it if you pay it down to a reasonable utilization amount before the statement cuts (most banks), or the first of the month (a small handful of banks). The banks only report to the CR agencies once a month.
Also, in terms of sequencing - is it better to seek a CLI or a new credit card first?
Pick your poison. If you go CLI, then new card its two hard pulls (less is better). But your utilization when you get the second card will be lower if you got the higher line. I would just go for the new card and not worry about a CLI if there is a card you want. If you don't want a new card, just want a higher denominator in your utilization, not getting a new card will help your average age of accounts, which, like inquiries is a minor metric in determining the score.

Getting amex issued card (Blue Cash Express?) early in your credit history can be a plus down the road. Google Amex, backdating if you want to see ways to monkey around with your average age of accounts. That said, honestly other than paying your bills and avoiding erroneous things on your credit report, the juice isn't worth the squeeze when it comes to fico fretting.

Rebecca_S
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Re: Building Credit -- Keep the loan?

Post by Rebecca_S » Wed Jul 31, 2013 6:03 pm

If you have been paying on time for the current credit card, can you call them up and ask to raise your limit? Even a small raise, from $500 to $1000, would have a dramatic impact on your utilization. Then wait a couple months and try to open up a new card.

In the meantime I would take harikaried's advice and make a large payment on the car loan to safe interest but plan to pay it off within a year.

Do you have a particular need to raise your FICO score, such as purchasing a house in 1-2 years? If not, then time and on-time payments will help a lot. Length of credit history is one of the main factors in a FICO score and there is little you can do to lenghten your history except wait it out.

Caduceus
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Re: Building Credit -- Keep the loan?

Post by Caduceus » Wed Jul 31, 2013 6:58 pm

At that interest rate, I would pay off the loan. I got close to 800 for my FICO score in less than 2.5 years without ever having any mix of loans and simply paying off my bills on time. It would have been faster, had I not been maxing out my utilization on the first $500 credit card that I owned. (I didn't understand how scoring worked then.)

In general, unless you have a reason to believe you need a good credit score in the short-term, I wouldn't worry too much about the FICO and just behave responsibly with regard to credit. The score will take care of itself. Always pay your bills on time, use no more than approximately 20% of your credit available (across your accounts, and also per card), and when you have a longer credit history, have at least two credit cards that you pay on time, and the score will work itself out soon enough. It did for me without excessive "gaming" of the system.

Thrasymachus
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Re: Building Credit -- Keep the loan?

Post by Thrasymachus » Wed Jul 31, 2013 7:54 pm

Thanks all for the informative replies - it seems like there's some legitimate dispute!

I opened an account on CreditKarma. My current credit scores stand at: 678 TransUnion, 758 VantageScore, 857 AutoInsurance Score, and 869 HomeInsurance Score.

These aren't great, but at least I'm out of the 382 hole! It appears that score was based on the confluence of a number of temporal, independent factors.

Additional relevant facts:
1. My Average Age of Accounts (AAoA) is 10 months, according to CreditKarma. I have two open accounts - one at 1 yr, 4 months (auto loan), and one at 5 months (credit card). I received an "F" in this category.
2. I have 16.5k in my checking/savings account (which is my emergency fund). My monthly expenses are around 2.5k, so paying the loan would still allow a sufficient cushion in my emergency funds.
3. The length of the auto loan is 36 months, so I'm nearly halfway complete with paying it. I opened the auto loan in April 2012 with an original amount of $8.8k.
4. My monthly auto loan payment is $263. My most recent payment was $240 in principal and $23 in interest.
5. My credit score was 753 when I applied for the car loan in April 2012.

Additional analysis:
1. Based on #1, closing my auto loan will decrease my AAoA - which will further hurt the category in which I'm weakest. That's a very strong argument against paying off the loan.
2. In retrospect, paying off my two student loans also damaged my AAoA. Paying those loans was a much more significant emotional triumph than paying the auto loan would be - so I'm not too regretful. :happy
3. I'm planning to call my auto loan provider to ask about paying off the principal - that's very good advice, Rebecca_S and harikaried. As long as it doesn't prematurely end my loan, I think that could be a useful compromise to avoid interest and also establish credit.
4. I'm wary of a secured card because I wouldn't want to keep the cash tied up permanently - the opportunity cost is too high, particularly with a 45 year time horizon before retirement. I'd prefer to wait a little longer and open an unsecured card that I could retain for a very long time.

Answers to questions:
Bogle101 wrote:You're credit score went from 734 to 382? That does not seem right, any more information on that?
You're right - it seemed strange to me at the time as well. I checked my credit report shortly afterward and did not notice anything out of the ordinary. The drop likely occurred because I was performing a large number of credit activities, with recent hard pulls, and with a very low AAoA and other credit history. It's still bizarre to me that the credit system penalizes those without established credit histories so heavily.
Rebecca_S wrote:Do you have a particular need to raise your FICO score, such as purchasing a house in 1-2 years? If not, then time and on-time payments will help a lot. Length of credit history is one of the main factors in a FICO score and there is little you can do to lenghten your history except wait it out.
No, I do not have a particular pressing need. I'm not considering buying a house for at least 4-5 years. Sounds like I'll be waiting it out - I'm just trying to do it smartly!

Thanks again for the great advice, all.

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grabiner
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Re: Building Credit -- Keep the loan?

Post by grabiner » Wed Jul 31, 2013 9:03 pm

Thrasymachus wrote:Thanks all for the informative replies - it seems like there's some legitimate dispute!

I opened an account on CreditKarma. My current credit scores stand at: 678 TransUnion, 758 VantageScore, 857 AutoInsurance Score, and 869 HomeInsurance Score.

These aren't great, but at least I'm out of the 382 hole! It appears that score was based on the confluence of a number of temporal, independent factors.
382 is on a different scale, and that's also the reason your scores are different. Credit Karma gives the score distribution for each of those scores among Credit Karma users, so that you can make sense of them.
1. My Average Age of Accounts (AAoA) is 10 months, according to CreditKarma. I have two open accounts - one at 1 yr, 4 months (auto loan), and one at 5 months (credit card). I received an "F" in this category.
The letter grades on Credit Karma are an oversimplification; each of the factors which is graded is important, but not as a single number. The average age of accounts as reported by Credit Karma counts only open accounts, but closed accounts are also relevant to your credit.
5. My credit score was 753 when I applied for the car loan in April 2012.
What kind of score was that? The report should say something like "FICO Auto score" or "VantageScore 2.0 Auto score," and have a score distribution. Without that information, you can't tell whether your credit improved or worsened since then.

And was it the same bureau? If your student lender doesn't report to Trans Union, then your Trans Union score won't be as good as your score with another bureau.
2. In retrospect, paying off my two student loans also damaged my AAoA. Paying those loans was a much more significant emotional triumph than paying the auto loan would be - so I'm not too regretful. :happy
The average age of accounts isn't that important; the reason paying off your student loans reduced your score is more likely that it reduced your number of open accounts. (Credit Karma's letter grades are based on total number of accounts, but open accounts are more important than closed accounts, as they indicate that you are currently managing credit.)
Wiki David Grabiner

sesq
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Re: Building Credit -- Keep the loan?

Post by sesq » Thu Aug 01, 2013 8:41 am

Credit Karma and Credit Sesame are useful to give a gist of what your score might be, but they are basically for entertainment purposes only. Mine are generally about 40 points below my real score.

Your AAoA includes closed accounts (despite what CK says), so closing accounts in good standing is irrelevant (until they fall off your report in ten years).

Spirit Rider
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Re: Building Credit -- Keep the loan?

Post by Spirit Rider » Thu Aug 01, 2013 9:58 am

sesq wrote:Your AAoA includes closed accounts (despite what CK says), so closing accounts in good standing is irrelevant (until they fall off your report in ten years).
+1

Thrasymachus
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Re: Building Credit -- Keep the loan?

Post by Thrasymachus » Sat Aug 03, 2013 12:58 pm

I paid off the loan - thanks for your advice. I'll revisit the possibility of opening another credit card in a few months.

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