Our Two Cents

According to research performed by Debt.org, there are around 190 million Americans with credit cards. Understanding the best way to use credit cards is crucial.

It's also important to internalize the 5 Cs of Credit. Read on for a comprehensive overview of credit card usage and your credit score.

Is Debt Bad?

As with most things in life, there's a nuanced approach to understanding debt. While uncontrolled debt can certainly be a bad thing, many forms of debt are good. Using credit cards irresponsibly is an example of bad debt.

When you're trying to achieve a high credit score, certain types of debt can help you reach your goals, but they need to be used wisely.

Low Credit Scores

Low credit scores are usually a symptom of bad spending, bad borrowing, or bad debt. Sometimes, the reason you may have a low credit score is that you’ve simply never had debt. Many college students find that they have low credit scores and struggle to secure loans because of this.

How to Improve Credit Scores

Globally, debt is at an all-time high and consumers have little understanding of improving credit scores.

It can be difficult to improve your credit score if bad debt is the reason. However, many companies offer a credit repair service. These services usually work with the three credit bureaus (Experian, Transunion, and Equifax) to dispute negative findings on your credit report.

Of course, credit repair services can only do so much. You need to understand the 5 Cs of Credit for yourself.

The 5 Cs of Credit

Whether or not you're trying to improve your credit score, it's a good idea to understand the 5 Cs of Credit and how they impact your life. Next, we'll explain how lenders will evaluate your creditworthiness.

Character

The name Character is a little misleading. What lenders are really referring to is your credit history. 

Usually, your credit history is used to create a score that helps lenders identify if feel it's risky or not to lend to you.

Capacity

This indicator is all about comparing your income and your output. Lenders capture your total monthly income (from all sources) as well as your total monthly payments. They divide the two and end up with a formula that's referred to as your "Debt to Income" ratio.

There's no hard rule on what your DTI ratio should be, but most lenders prefer to have a number around 35% or lower. Some states have rules for lenders and will only allow them to lend to you if you have a DTI below the prescribed minimum.

How long you've been employed at your current workplace is also often used to calculate your capacity. This tells lenders how likely you are to stay at a job and maintain a stable income.

Capital

In the borrowing/lending sense, capital refers to how much money you are able or willing to put down before taking out a loan.

If you're looking at taking out a mortgage, you are usually required to put down a payment that's a percentage of your home value. 

Even when you take up a special mortgage that's guaranteed by a federal program, you'll need to put down between 2% and 3.5% of the home's value. Usually, lenders use your down payment to figure out how serious you are about paying back the loan.

Collateral

Whenever lenders are looking at granting a loan that's above a certain amount, they feel much more secure when there's collateral. These kinds of loans are usually called "secured loans" and are less risky for lenders to give out.

Sometimes, it's really simple to secure collateral for a loan. When you're buying a house, the house itself is the collateral for the mortgage. The same is true when you're buying a car. An auto loan doesn't need additional collateral because the car itself has enough value to secure the loan.

If you can provide collateral when taking out a loan, you'll probably get a lower interest rate and better terms of financing.

Conditions

How a loan is structured is often referred to as the conditions of the loan. That includes the interest rate, how much you're borrowing, and any collateral for the loan. How you plan to use the money is another condition.

When considering granting a loan, a lender will want to figure out how ready they are to grant you financing. If they feel you may be risky, they may impose extra conditions.

If there's a clear and easy way for a lender to have less risk, for example, by having a house as collateral, the loan is more likely to be approved.

Finding a Trusted Partner

Now that you understand how lenders view potential loans and how they use the 5 Cs of Credit to evaluate your application, it's time to find a partner you can trust. Understanding your financial needs will help you secure your financial future.

Take a look at our offerings and find an account that works for you and helps you achieve your goals.

You should also check out our Complete Guide to Finances for College Students. The guide will provide you with detailed instructions on budgeting and financial planning.