Some things in life are hard to really grasp until they affect you personally. This may sound mundane and boring, but it’s the truth … and credit scores are definitely one of those things.
Yawn, right? What could be more boring? The prospect of watching paint dry on a wall seems like it would be more interesting. I am not exaggerating when I tell you that the eyes of my own children immediately glazed over in a strange blend of horror and boredom each time I brought up the subject with one of them.
But it becomes a heck of a lot more ‘real’ when they find out you can’t rent a good apartment without a good credit score. Or that a good credit score saves you money on car payments and car insurance. After talking about it casually with a few other people, I realized that lots of people never really get explanations of things related to this subject. And very few want to take their free time to look it all up and try to figure it out. Once your credit gets messed up (which happens to great people all the time) you’ll have to put effort into trying to fix it – I’ll give you very specific information about how to do that, another day.
Right now, here’s some information about why your credit score is important, and how to build a good one. There are some ideas about how to build credit no matter your age, and a few specific comments for young people
Why does a good credit score matter?
A good credit score can help you save money on interest and fees. You’ll get better offers when you need credit cards, auto loans, rental deals, a mortgage and other unexpected things.
When you become an ‘adult’ in legal terms, that means you turned 18. In rare legal circumstances, you might be an emancipated minor with rights and privileges afforded an 18-year-old when you’re younger than that. Or, you could be under conservatorship, which gives those rights of yours into the hands of somebody else because of extenuating circumstances. [“Free Britney!”] In any case, when you legally become an adult it’s likely you have little to no credit history. Because of that, you’ll be unable to qualify for a loan or rent an apartment without having somebody co-sign for you – more about that later.
To solve this problem, take some of the steps I’ve listed below to start building credit as young as age 18. Remember that paying your bills on time and keeping your credit utilization ratio low are two of the most important things you can do to build credit. Though you won’t build a good credit score overnight, adopting good credit habits now can save you thousands of dollars during your lifetime.
1. Basics about credit scores
Your credit score is a three-digit number calculated based on information listed in your credit reports. In order to understand how you can build and maintain your credit, it helps to make sure you understand the components.
Your credit score is the number potential lenders, landlords or other businesses can use to determine how risky a transaction participant you may be. The higher your score, the more likely you are to qualify for the best interest rates and loan terms, take care of the property or merchandise entrusted to you, and so forth. Credit scores are frequently calculated by Fair Isaacs (FICO), which uses a scoring system that ranges from a low of 350 to high of 850.
The biggest credit reporting companies include Experian, Equifax and TransUnion. They track your credit history. Using the FICO I already mentioned, they each assign a credit score and credit history to every consumer. Anyone you authorize to do so reviews your data before deciding what action to take for or about you.
There are five factors that go into calculating your FICO score:
Factor in FICO Score Weighted % of Impact
Payment History 35%
Total Amount of Debt Owed 30%
Length of Credit History 15%
Credit Mix 10%
New Credit 10%
As you can see from the percentages assigned to them, Payment History and the Total Amount of Debt You Owe are the most important credit factors, making up 65% of your score. (By the way, you may sometimes see the Total Amount of Debt You Owe referred to as your Credit Utilization Ratio.) When building credit, remember that a solid payment history and low debt owed are the most critical. The Length of Credit History refers to the age of your credit accounts. Credit Mix is an assessment of different types of credit accounts you have making up your file. It can include things like student loans, used car loans, new car loans, personal loans, credit cards, and anything else that involves debt. It’s interesting to note that mobile phone accounts don’t appear on a credit report. New Credit assesses how many times you’ve recently applied for access to credit.
2. Basics about credit reports
Think of your credit report as a financial report card. And one easy-to-read place and format it gives a potential lender a summary of your payment history, a list of credit accounts that you have, and your balances currently owed.
When you make a payment more than 30 days late, it usually gets reported too at least one of the three main credit bureaus. Positive payment history on your credit accounts can improve your credit, and negative payment history will damage it. Negative history = Risk. Creditors, potential creditors, and landlords hate risk.
3. Check your credit score & report
It’s very important to know what’s on your credit report and be aware of your credit score. You’re legally entitled to a free copy of your credit reports once every year. To get yours, visit: annualcreditreport.com. It’s interesting to note that this website is offering free weekly copies of your credit report because of the ongoing pandemic. Currently they are offering this through April 20th. 2022. They can’t help with your physical health, so they’re trying to help with your financial health. With all the job losses and job changes, and upheaval because of COVID, it’s definitely a good idea to stay hyper-aware of your financial situation.
Whether you’re building or repairing your credit, it’s also really important to keep track of your progress. When you look at your credit reports, make sure the information is accurate and complete. Check all three of your reports. Information is sometimes not reported to all the credit bureaus. If information listed in one or more your reports is inaccurate or incomplete, you can and should definitely dispute it. If a few people contact me to request it, I’ll give you a step-by-step guide to doing that in the next few weeks.
Be aware that you will have a different credit score for each of the three main bureaus.
Why? Experian, TransUnion and Equifax all evaluate the same core factors of your credit history rate but use their own individual formulas to weigh the factors.
Further complicating things, the credit bureaus may not receive all of the same information about your accounts. Lenders aren’t required to report to all or any of the credit bureaus. The potential variables result in a lot of possible score differences.
4. Become an authorized user
This is a technique I’m using to help one of my children build her credit profile. If you have a small or nonexistent credit profile, you can add payment history to it by asking someone who has a good credit history to add you as an authorized user on their credit card. If their positive payment history is added to your credit report, it could improve your credit score.
If the person who lists you as an authorized user makes a late payment, it could negatively impact your score. And if the newly authorized user abuses the privilege, the order of the account is the one responsible for the debt. Essentially, the owner of the account is the only one taking a risk.
The goal is to spend sparingly using the card, pay your debts off before the payment due debt, and to start accumulating a track record of a responsible borrower.
5. Open a secured credit card
If you want to be the one responsible for your own credit card, open a secured credit card. These require a security deposit in exchange for opening up a credit line in an amount equivalent to the deposit. In other words, the amount you deposit is going to be your credit limit.
If you repay the amount you ‘charge’ on time, then whenever you cancel the card you’ll usually get your deposit money back. If you violate the terms of the card agreement, then you put all or some of your deposit at risk. Secured cards usually have the MasterCard logo, the same way debit cards do. They differ from a debit card because with those, the money charged comes directly from a bank account.
6. Apply for student credit card
Credit card providers are well-known for offering a variety of credit cards for college students. They often have very low credit limits and high interest rates. They’re notoriously easy to get as long as you’re a college student.
The fact is college students are frequently strapped for cash and don’t necessarily have enough life experience to make the best choices when it comes to resisting impulse spending. It can be easy to put things on the credit card and save their cash. But making only the minimum monthly payment is not going to build credit very well. In fact, demonstrating undesirable habits according to the factors I previously listed can actually hurt your chances of getting a better credit card a little further down the line.
If the student is conscientious about paying the bill each month in full, and not routinely charging the maximum amount available, then these starter credit cards can certainly be useful in building a good credit profile. If there’s any chance at all of not using them very strictly, then avoiding them entirely is probably the right idea. Student credit cards can really be very dangerous to your credit file and to your financial future.
7. Don’t make late payments
Refer back to the little list I gave you near the beginning of this article and notice again that Payment History makes up 35% of your FICO score. It’s important for your credit score that you pay your bills on time. If you don’t, you risk a company reporting a late payment. When a company reports a late payment, it can stay on your report for seven years.
If you’re at risk of making a late payment, pick up the phone and call the credit card company. You may be able to arrange for a lower payment fat month or an extended grace period. You won’t know until you ask.
9. Keep low credit card balances
Keeping the amount of credit you use in comparison to your credit limits low, improves your score. The general best guideline seems to be to keep your credit utilization rate under 30%. So, if your credit card limit is $1,000, ideally try not to have an outstanding balance of more than $300 at a time. Too high of a credit utilization negatively impacts your credit score.
10. Take out a loan
It seems totally illogical but borrowing money can help you build your credit file. This can work in two ways, depending upon whether or not you need a loan. A student loan or a car loan that you repay according to the agreed upon terms can definitely help you build your credit. If you don’t actually need a loan, you might want to investigate a credit-builder loan instead. It’s something I only learned about recently.
Instead of receiving a check or wire transfer for the loan proceeds and repaying the balance, you deposit a certain amount of money into an account each month. When the loan term ends, you get your money back – sometimes with a modest percentage of interest paid, minus fees. From what I’ve learned you can find these generally through credit unions and online lenders.
Have you made any money mistakes you wish you could go back and change? Is there some good advice you’ve taken, or have given to family members or friends? I’d love to hear about it … email me at email@example.com and you might be chosen as a winning commenter next week.