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© Frank


Necessary Debt

by Fred Selinger
September 5, 2020

This interview with Fred Selinger, lecturer at UC Berkeley and author, was conducted and condensed by franknews.

Fred  | My name is Fred Selinger. I am a professional faculty member at UC Berkeley. I have a background in all types of different financial enterprises - mergers and acquisitions on the investment banking side, I’ve managed people’s money, I have licenses in securities and insurance and real estate.

What I realized when I was hiring students and mentoring students, regardless of their station in life, the one common thread was they knew absolutely nothing about money. 

So I asked a good friend of mine, the provost at UC Berkeley - what do you do to teach these kids about money? He said, “Fred, I don't think we do anything - why don’t you pitch me on a class?” Eventually, I got the course at Berkeley.  I remember I went to my first class and I had no idea even if anybody would even show up for this thing, and there was a line out the door. 

I said, “Uh, what are you guys doing in this line?” They said, “Oh, we've got this class in personal financial management.” I said, okay and it just took off from there. Now, well over 10,000 students have completed the course. 

How do you structure the class? What is important to know? 

We basically divide the class into four sections. 

Number one, saving money. How do you save money and how much should you save? When you save money, what do you do with it? Number two, Investing money. You're going to invest it someplace - real estate, stocks, or a business. Number three, how do you grow that money? Number four, how do you protect your money? 

So many people go out into the working world, and businesses will spend thousands and sometimes tens of thousands of dollars to train them on how to make money for the company, but they never learn about how to make money from themselves. 

You will deal with money virtually every day for the rest of your life, and nobody shows you how to do it. 

You may have a parent here and there if you are lucky, but basically people have no idea about what they are getting into, and financial mistakes can be very, very costly. I have devoted my life to increasing that education.  We start with the educational part of it, and we start with the credit card. 

What are the basics of a credit card? 

First of all, you have to understand what a credit card is. A credit card is unsecured. What does that mean? It means there are no assets behind it. You're not backing it up with any type of collateral. Whoever is lending you that money is depending upon your good faith that you're going to pay it back. 

If you don't pay the money back what are they going to do? Are they going to kidnap your eldest child and hold it as a hostage someplace? What can they do? They can't go into your checking account. They can't go into your savings account. They can't force you to sell your car. 

But what they can do is notify the three major credit reporting agencies that you're a deadbeat, that you don't pay your bills.

Then, when you go to borrow money and somebody else gets your credit report, they will look at your credit score and see that you don’t pay your bills. And so either they won't lend you money, or they will charge you an enormous interest rate because you are considered to be more risky. 

Conversely, a debit card is guaranteed - it is guaranteed by the money in your bank account. When you use that card, the merchant runs it through its system, and if there's available money in your account, the sale continues. If not, they reject the transaction. Plain and simple. 

Why use a credit card over a debit card?

No one is tracking debit card transactions, so you are not building credit. Why? Because you're not borrowing any money. The money is already in the account. Credit depends on faith. 

People ask me what's money? I say, it is faith. It's what you believe it is. 

So credit is based upon your faith. You want to exhibit good faith, a good history on how you handle your financial affairs. You are being tracked and reported to these reporting agencies every day, every time you're doing something.

Let me just make one thing really clear: You want to establish good credit when you don't need it, because when you're desperate for money, nobody wants to give it to you. 

Why is credit important?

Good credit creates growth. Maybe you can buy a car that helps you drive to your work. Maybe credit will help you invest in a business. Maybe good credit will help buy a piece of real estate. Credit can generate growth. The greater your growth, the more credit you can get. Increased credit then enables you to grow even more. 

That's what enables people in our society, who handle their money well, to go out and borrow amounts of money that are far beyond what they even earn in a year. Somebody can make $150,000 a year and borrow $500,000 to buy a house. 

That is not always how things worked. At the peak of his career my dad made $40,000.

He bought a house for $18,500. He bought a house for less than his annual income. You can't do that anymore. 

What is your credit score made up of?

The FICO score is the big score that reflects our creditworthiness. You will actually have three FICO scores because there are three credit reporting agencies. Not every merchant reports to all three, so each of your scores will be different, they have different material. 

Your credit score is built from information on your credit report. A credit report lists everything. It lists any DUIs you've had, any time you've been arrested, any judgments against you. It lists every account you have ever had, and every credit card you have ever had. Your student loans, your rent, and all your transactions are going to be reflected in that report. 

There are five basic areas of the credit report. 35% of your score, the biggest chunk of your score, is based upon paying your bills on time, over time. 30% of your credit score is based on how much of your credit limit you are using from month to month. If you have a $1,000 credit limit, and you're spending $900, you are stretched out on your debt. You might be a little riskier than somebody who's been using and carrying around $300 worth of credit from month to month. They would look at that and say, this person could actually go out and buy more, but they're managing their money better because they're not out there spending money on debt. 15% of your score is constituted by how long you've had the credit card and what kind of debts you have.  Do you have debts that aren't just one thing? And then the other thing that they look for is, something that would be a red flag, is if you're trying to open up a bunch of accounts all at once. To them, it indicates that this person's getting really tight on money, so they're going out and borrowing, borrowing, borrowing. That scares them.

Are there things that you shouldn’t put on a credit card?

There are four things that they say you shouldn’t put on a credit card - and I got these from the FICO website - bars, massage parlors, pawnshops, and tire retread shops. You probably don't even know what the heck tire retread shops are, but we used to go to them all the time because we were poor. They keep the sides of the tire but put a new tread on it so you can drive it a little further. 

What is the biggest blind spot in personal finances for young people?

We have a rule in my class, the rule of Fred - I get paid first. I can't believe the number of people of all ages, who, when they get a paycheck, hand all that money out to somebody else, and don't pay themselves a dime. They don't put a penny away. 

Every dollar you save is a gift to yourself.

No matter what your situation, start saving something. And my recommendation is that the first thing you should save for is an emergency fund that will enable you to live three to six months without a paycheck coming in. I say that because emergencies will come up. 

I had a former student at Berkeley whose father died in New Jersey and he had to make a decision about whether to go to the funeral or to pay his rent?  I mean, look at what's happened to our economy during the COVID crisis. So many people are living day to day. If they don't get that paycheck, they can't pay the rent, they can’t buy food. 70% of the people in this country, if they had a bill for $400, would have to go borrow money or sell assets. They don't have it. So the first thing you need to do is take care of yourself.