Expert Q&A

Learn the three Cs of credit


When deciding whether to finance an item over time, consider the three Cs of credit to see if it will hurt your credit score.

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Dear To Her Credit,

I have a credit score in the high 700s, but I’d like it to be higher. I pay my credit cards off every month and have no other debt besides my mortgage. I haven’t had a car loan in more than 15 years.

We’re buying a new tractor, and we thought that if we bought the tractor on credit, we’d be building up our credit history. Is that true? — Tricia

Dear Tricia,
Buying a tractor probably won’t help your credit score, and it may even hurt it. Opening a new account of any kind generally causes a small ding on your score — although the effects will be temporary.

If you didn’t have much of a credit history, getting an installment loan might help your score. But after that first loan, more is not necessarily better. “All you need is one piece of credit to generate a FICO score,” says Barry Paperno, consumer operations manager of FICO score developer Fair Isaac Corp. “Yes, you need some, but you don’t need much.”

Anyone with a score in the high 700s has already established a credit history by paying bills on time. Paperno says, “You’ve done all the good you can do. If you have a mortgage or car loan, it’s not going to help you to take out another loan for purposes of building up credit.”

Although a tractor loan isn’t likely to affect your score much one way or another (assuming you make your payments on time), that doesn’t mean it won’t affect how lenders see you. A common misconception is that your credit score is all that matters. Actually, your score is only one factor of three.

The three Cs of credit are:

  1. Credit score (or Character, as demonstrated and measured by your credit score).
  2. Capacity to pay (your income and other resources minus other debt payments).
  3. Collateral (the car, house, tractor, or other asset attached to the loan).

“All three factors go into lending decisions,” says Paperno. You could have a score of 800, for example, but that doesn’t mean you’ll qualify for a high credit limit if you have little income. On the other hand, a lender may be willing to lend you money to buy a car because the car is collateral and can easily  be repossessed if you default on the loan.

Let’s see how buying a tractor on time will affect each of the three Cs:

  1. Credit score. Little or no impact. You may have a temporary ding for opening more credit.
  2. Capacity to pay: Potential medium to high impact. Tractor payments will use some of your available income every month. If you apply for other credit before the tractor is paid off, that will be taken into consideration.
  3. Collateral: Little impact. The tractor provides security for the company that finances it, but it does nothing for other potential creditors.

I would rather people worry more about their long-term financial pictures than about making decisions based solely on how they will affect their credit scores. Before you buy that tractor, consider:

  • Could you afford to buy the tractor with cash? The fact that you are asking if you should buy it on credit indicates you might be able to pay for it outright.
  • How much interest will you pay over the life of the loan?
  • Do you really need a tractor right now? Would it be cheaper to rent one when you need it or to pay someone to do the work?

Take good care of your money, and your credit score will be fine!

See related:  Credit inquiries and your credit score

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