Whether you consider credit a necessary evil, an avoid-at-all-cost risk, or your best friend for a shopping trip, it can feel like everyone holds a beloved piece of plastic with their name on it. Credit affects each one of us, and it’s crucial to our financial well-being that we understand how it works. I sat down with Dr. Blake Gray, an instructor in the Personal Financial Planning department here at K-State, to get some insight into the credit system. (See below transcript).
[Sarah Biehler]
To kick things off, do you have any particular thoughts you’re chomping at the bit to share about the credit system? Any common themes you’ve seen with your clients, frequently asked questions, or ideas/tips/tricks for someone wanting to start learning about credit?
[Blake Gray]
I think one thing is that people enter the world of credit with a lot of presuppositions, and those can affect the way they approach credit.
-They see credit as something that is a necessary evil and, quite often, something to avoid. They’ve seen people get trapped in it and end up not being able to fulfill things they want in their lives, so they don’t want any part of it. That can be damaging because credit needs to be built in order for you to do so many things. That kind of psychological history of what they’ve seen with credit is an important thing to learn about with clients and talk through with them to ease some anxieties. We have to understand – are they credit-loving people who just use all credit all the time (maybe too much), or are they so afraid of credit that it harms their financial position?
[Sarah Biehler]
So, could you speak to how the credit system works? How people might end up on one end of the spectrum or the other, as you described? We know when using a credit card, your bank account doesn’t take the hit, but the vendor is still willing to let you take whatever it may be you’re buying because they’re still getting paid.
-Where is this big stack of cash waiting to let me buy my cake and not pay for it, if you will?
[Blake Gray]
Well, from a macroeconomic extent, like if we look at it from the macroeconomic lens – credit is just freely available. There is so much money on the Fed[eral government] balance sheet. It’s the banks that have tons of cash. They get it at very, very low rates from the Fed and the central banks.
And so, the banks (or credit card companies) are fine extending credit to you so that you can pay for things. The bank is totally fine saying “Yeah, you don’t have to pay me back for a month. We’re just going to cover it in the short run. We not only have access to cash, but we have fees, we have interest, we have all the people paying us back from their loans, we have savings accounts, we have checking accounts, we have- you know- Apple has how many billions of dollars in cash in their account?” Like, there’s plenty of cash. And so, they’re not worried about covering the charge until you pay them back.
And, in fact, the banks are better off in the long run if you don’t pay them back and you just pay interest later. They will extend that credit for as long as they can, in a way, because then they collect the interest.
So, where does it come from? It comes from a seemingly endless pool of cash on our end. We’re just swiping a card; we don’t see the cash leave our wallet. Maybe we don’t feel the expense psychologically, that means that we are sometimes willing to overextend ourselves to credit because it just seems to come from ether*1 and go to the ether, like you said.
[Sarah Biehler]
Right- so this is a mind game that some companies are playing with us, that we can have the things we want without the loss of our cash. And that leads people to find themselves in situations where their spending is out of control, which is where this fear of credit usually comes from.
How do the banks, or creditors, or whoever is handing out this money- how do they decide how much cash each person is allowed to take?
[Blake Gray]
Well, it’s kind of like the way that you figure out amongst your friends and family how much credit you’re willing to extend to them.
They want to look at your credit history, so they want to see, have you been consistent in paying [your debt] back on time? You know, is this person somebody who pays other people back on time? If yes, then I can trust them more.
Is this person a person who’s taken different types of loans? If yes, well then, this type of loan? I can trust them with that. Because they have a history of paying back a car loan, a home loan, and a credit card. We can do this new type maybe for them because they have a different mix of credit history. Those are the really big ones.
And then, of the credit that they have, if they have, you know, a bunch of banks that say “hey, look, you have a line of credit we’re willing to give you up to $50,000 and we can trust you with that”. So, banks have already said that, and the consumer is only using $10,000 of that. Then you know they’re not overextended and so I’ll trust you if you’re a little- you know- within your means to pay me back.
So, I think those are kind of the big three ones in terms of what the banks use to figure out if you’re trustworthy or not.
[Sarah Biehler]
Yeah, so I know you kind of touched on it, but I’ll just reiterate those are specifically what makes up your credit score. *Be on the lookout in upcoming blogs to hear more on tips and tricks for your credit score*
And then, you’ve mentioned it a little- you know, this money or credit might be coming from a bank or a friend. You’re going to ask someone if not multiple people for cash at some point in your life, things are going to come up.
And there’s a couple of different types of credit. So, if you could, kind of walk through those briefly. Obviously, you know, I’m not going to ask my friend for the $25,000 car loan- that one’s pretty cut and dry to the bank. But if I am going to go to the bank, they might give me a couple options- is that right?
[Blake Gray]
That’s right, yeah. It’d have to be a pretty good friend to just get 25 grand off them, but it happens actually. People co-sign, there’s a couple different types of credit.
The one that we think of with big purchases like cars, houses, student loans- they’re installment loans. And so, you pay an equal amount, typically over time. So, you get a bunch of money up front and then you promise to pay a certain amount for the next 10 years, 5 years, 30 years. And those are often backed by an asset. Student loans aren’t, but with installment loans there’s typically a house, there’s a car, and those other things that the bank can repossess if you fail to pay.
But the biggest thing, I think, about installment loans is- you make small payments over a long period of time, you pay interest on that amount, the payments are typically level, and then there’s sometimes collateral involved.
The other kind is revolving credit. These are the credit cards. And they don’t have the stipulations really. Here’s a credit card and you can spend up to $10,000, $5,000, or $3,000 on it and we have no idea what you’re spending it on. If you can’t pay it back [the bank] doesn’t have anything to repossess. They don’t have any collateral, and that typically is more expensive money to borrow. If you don’t make your payments, the creditor doesn’t have any recourse. They don’t have any way to recollect their money, and so another thing about revolving is that it’s basically ‘you’re supposed to pay the whole thing off every month and then you have a new fresh line of credit and so you always have that maximum amount’. That pre-set limit that you can get up to, cumulatively.
[Sarah Biehler]
Well, that was all of the questions I had for today. Thank you so much for your time and going through all of those- answering questions and getting into the details.
[Blake Gray] No problem, happy to help!
If you’re interested in learning more about credit or want some help navigating your financial situation, schedule an appointment with us at Powercat Financial!
Upcoming events:
– Financial Well-being Ambassadors Meeting (come if interested!) THIS Monday, September 18th 4-5 pm
-Live Your Best Life (Game of LIFE! Simulation) Monday, October 16th 12-1:30pm, Union Courtyard
Sarah Biehler
Peer Counselor I
Powercat Financial
www.k-state.edu/powercatfinancial
