Building Credit 101

Building Credit 101

July 06, 2021
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There are things that you can constantly work on in order to improve your financial position/knowledge. You have to build a strong foundation before you build an empire. 

One of the most important financial metrics that you should track is your credit score. The typical credit score range is 300 to 850, the higher the score the better. Your credit score is essentially your report card on how well you handle your money. To have a FICO credit score, you need to have at least one account open six months or longer.

Good credit can lead to lower interest rates on credit cards/loans, better car insurance rates, and easier approval for apartments/houses. During a tough economy, banks will become more selective on who they will lend money to. If you have a great credit score, it will be easier for you to obtain loans.

A lot of people don’t have a credit card because they say they don’t trust themselves. While this is a valid reason (also look up secured credit cards), you definitely need to consider the benefits, like cash back. For example, there are credit cards that have 5%+ cash back for groceries or restaurants. This is an example of being rewarded for expenses that you were undoubtedly going to spend regardless. Also, if you are still using a debit card for every transaction, I would highly suggest you reconsider. Just ask Frank Abagnale from ‘Catch Me If You Can’.

Here are some ways to help improve your credit:

  1. Never miss a payment: You can accumulate a balance on your credit card, but they will ask each month that you make a minimum payment. In order to avoid late fees, and to keep your account in good standing, you should be paying at least that minimum payment. However, this is not a viable long-term strategy. Paying your credit card balance in full will keep your credit utilization lower, avoid interest charges, and create good habits of not becoming over leveraged. Payment history makes up 35% of your FICO Score.

 

  1. Don’t reach your credit max: When you apply for a credit card, they will approve you for a certain credit amount. Never exceed the limit. One of the factors that affects your score is your credit utilization (i.e. how much you owe on your accounts). The lower the utilization the better. If you have a $5,500 credit limit, and your current balance is at $4,500, you have an 82% credit utilization which hurts your score. Try and keep this less than 30%. Credit utilization makes up 30% of your FICO Score.

 

 

  1. Length of Credit: Another factor that goes into your credit score is how long you have established credit history. In general, the longer your credit history, the better your score will be. This shows lenders that you are capable of borrowing money and that you aren’t a deadbeat. Start building your credit now. Length of Credit makes up 15% of your FICO Score.

 

  1. Number of Accounts: Another factor that affects your credit score is the amount of accounts you have outstanding. For example, if you have student loans, these would be considered accounts as that is money that you owe. Lenders want to make sure you don’t have hundreds of accounts out there that might show you are over extended and potentially will not pay back your debts. Total accounts make up 10% of your FICO Score.

The last 10% is about inquiries (i.e. how many times a lender does a ‘hard inquiry’ on your credit). This typically occurs when you apply for a new credit card or loan. I wouldn’t stress too much about this one as its only 10%.

Don’t know your credit? No problem, look up Credit Karma or various other sites in order to obtain your number. The quicker you start tracking it, the longer you have to improve it.


Exploring some Credit Myths:

 

  1. Checking your credit score will hurt you: As noted above, 10% of your score is related to inquiries. It is worth noting, that if you go on and check your credit score, this will not impact your credit score. These are referred to as a ‘soft pull’. Only in instances where that inquiry is related to you taking on more debt, will it ultimately impact your score. These are typically called a ‘hard pull’. However, if you are simply checking it on your credit card application or through Credit Karma, this will not impact your score.
  2. Once a debt is paid, it’s gone forever: Once you’ve finally paid off a particular debt, you may think that its gone forever. But with credit scores, these debts will remain on your credit report for years. On one hand, this can be a good thing to show lenders that you have history of paying debts on time and in full. But if you have a history of missed payments, this negative information can remain on your report for up to seven years and some bankruptcies can stay on your report for up to ten years.
  3. Closing a bank account affects your credit score: Typically, closing a bank account, either checking or savings, does not impact your credit score. Generally, bank accounts do not show up in your credit report. Curious what makes up your credit report? See here. Prior to closing an account, ensure all balances have been paid off. This includes any unpaid fees, negative balances, debts, anything that could be associated to that account. If recent checks have been sent out from that account, may make sense to wait until that check clears to then officially close the account.
  4. I don’t need to track my credit until I’m older: As noted above, the length of your credit history impacts your score. The earlier your start to build credit, the better off you will be, as long as you are being responsible. Although the minimum age at which you can apply for credit is 18, some parents add their children as authorized users on their credit cards to help them build their credit history early.

 

Kyle – Client Services Associate

Disclosure: This material is for general information only and is not intended to provide specific advice or recommendations for any individual.