Credit
- What is Credit?
Credit is both a measure of your financial trustworthiness. The USA uses a credit score as a way to measure if you can be trusted to repay money you borrowed. A credit score ranges from 300-850, although if you have no credit history, your credit score may be 0. A good score is considered to be from 680-850.
There are three credit bureaus: Experian, Equifax, and TransUnion. These three bureaus keep track of your credit history and each has specific calculations to give you a credit score. Your credit score may be different between each of the three credit bureaus, but they should be pretty close.
To build credit and have a credit score, you would need to participate in lending and borrowing from a financial institution. This could be by taking out a student loan, getting a credit card, or even by having a service contract like a cell phone contract or utility contract. Service contracts are not always reported to credit bureaus, but they may be.
Your credit score is affected by five things: payment history (35%), amounts owed (30%), age of accounts (15%), new credit (10%), and credit mix (10%).
- Payment history (35%)
Are you paying your bills on time? Are you paying the minimum you owe monthly? If so, you have a good payment history. If you make late payments or do not pay at all on your bills, this can negatively affect your credit score. Missed payments and other negative marks can stay on your credit report for 7 years, although they have less effect on your credit the older they are. Bankruptcies will stay on your credit report for 10 years.
- Amounts Owed (30%)
It is not a bad thing to use the credit you have; in fact, it’s good to put some small purchases on your credit card every month. However, if you are constantly reaching the limit on your credit card, or if you keep taking out personal loans, this will bring down your credit score. Reaching the limit often shows lenders that you may be overextending yourself or making up for lost income, which means you may not be able to pay back loans or credit cards. Most financial experts recommend using no more than 25% of your available revolving credit, so if you have a credit card with a $1000 limit, have no more than $250 owed to the credit card at a time.
- Age of Accounts (15%)
The longer you’ve had credit, the better. This shows that you have been trustworthy for a long period. To help this, keep old credit cards open. Your age of accounts is an average of the time all of your accounts have been open, so when you close an account, that takes the account out of the equation. Closing an old credit card will shorten your age of accounts because that long history is now taken out of your age of account equation. Time is one of the only things that will affect this category, but closing loans and credit cards shortly after receiving them won’t help. Constantly closing or defaulting on young accounts and then opening new accounts keeps your history short. Try to keep your credit cards and other accounts open for long periods of time.
- New Credit (10%)
Financial institutions don’t want to see that you are constantly applying for new credit. Every time you apply for credit using your social security number, that is called a “pull” to your credit. There are soft pulls and hard pulls. Hard pulls are when you apply for credit, and having too many hard pulls too often can bring down your credit score. So, don’t open a new credit card at every store in the mall. However, if you are applying for a loan for a large purchase, like a car or a house, the credit bureaus understand you may need to apply to different banks and credit unions to see what loan amounts you can get. If you are doing this, try to send your loan applications within a window of two to three weeks. The credit bureaus will see all these hard pulls at the same time and only count them as one hard pull, which helps your credit.
- Credit Mix (10%)
It looks good if you can handle multiple types of credit. If you can handle a few loans and multiple credit cards without overextending yourself, that will help your score. However, don’t go open a bunch of credit cards in hopes of helping your credit mix. This, like the age of accounts, will come with time as you take out loans or open up multiple credit cards.
- Why is Credit Important?
Credit is important for large purchases. Whenever you prepare to buy a house or a car, lenders will pull your credit to make sure you can be trusted to pay back the loan you want. Credit scores may also be checked by service companies, like cell phone providers or utility companies, to see if you can be trusted to pay your bill every month. If you are looking to rent an apartment, the management of the apartment will most likely look at your credit for the same reason as the service providers. A growing trend is for employers to check the credit score of a potential employee. While you won’t owe any money to an employer, they can see from your credit score if you are a generally trustworthy person. So, if you have bad credit you may not be able to rent an apartment, get a cell phone, or even get a job.
- Fixing Bad Credit
If you have bad credit, there are ways to bring it back up. If your credit score is low due to missed payments, the best way to fix that is to bring those debts current by paying whatever amount is late. If you are constantly maxing out your credit card, that may be bringing your score down. Slowly pay down what you owe and stop using the card. Your credit score may start in the 600’s because your credit age is low, and only time can fix that. Negative or derogatory marks on your credit report will stay on the report for 7 years, but over time their effects will fade. So, if that is the problem, wait it out and your score will improve. If your score is low because you have a lot of credit inquiries (hard pulls), try to not apply for credit for a year or so until you absolutely have to. Hard pulls fall off your credit report after 2 years.
Some companies may promise to magically fix your credit for a large fee. There is a good chance the company will scam you. While there are legitimate credit counselors who can help you with your credit score by negotiating your debts and consolidating your loans, there is no quick magic solution to fixing your credit.
- Checking Your Credit
Checking your credit is easy and free. Annualcreditreport.com is a free website that is backed by the government. Through this website, you can pull each of your three credit reports from the credit bureaus for free once every 12 months. These reports will not contain a credit score for free, you can pay more to see your score, but it will contain your credit history. Your credit history will include past addresses, employers, and all your debts and repayment histories. The Fair Credit Reporting Act is a federal law that protects your credit report and history. This law protects you by regulating how the credit bureaus collect, use, and share your credit information. This is meant to protect you from any misinformation being used against you. A link to the full details on the FCRA is in the resources section.
You can also use free websites such as CreditKarma.com and CreditSesame.com to view your credit score. While the scores they show are not your exact credit score, they are very good estimates.
Checking your credit score is considered a soft pull, and it will never affect your credit score.
- Credit Cards
Credit Card vs. Debit Card Explained In Under 2 Minutes
Credit cards are like debit cards, but instead of taking the money out of your checking account, financial institutions loan you the money that is available on your credit card, and you have to pay it back later. Credit cards are considered revolving credit. A revolving credit gives you a credit limit, and you can spend up to that limit, pay it back, and spend up to the limit again. For example, if you have a credit limit of $1000, and you spend $250, you have a credit limit of $750. If you pay back $100 of the $250 you owe, you now have a credit limit of $850.
Credit cards are great for situations where you want to make a large purchase but want to space out your payments, but they do come at a cost. Credit cards often have high-interest rates (12-25% usually). This means that for every purchase you make with your credit card, you pay a large chunk of interest on it. The interest rate is a yearly rate that is divided into a daily rate by taking your rate, also known as an APR, and dividing it by the days in the year. Each day, the balance of your credit card is multiplied by that daily interest rate, and that is the interest you gained that day. However, most credit card companies will not charge you that interest every single day. Instead, they will calculate it every day and add it up. You will have a grace period to pay off your credit card bill, usually, this is up until the day your bill is calculated. If you do not pay off your credit card, you will be charged the daily interest for the month that the credit card company calculated. Because this interest is calculated every day and charged monthly, you continually pay interest on purchases, which can end up costing you more than you originally spent on your purchase.
Rewards credit cards pay back a small percentage of what you spend each month in gift cards, bill credit, or other perks. Some credit cards have large bonuses when you first open a card, such as a $250 bonus credit. These perks can add up, and if you can pay off your balance every month, you can use a credit card for your regular purchases to get the most out of the rewards program.
When applying for a credit card, make sure to check for all fees associated with the card. Some cards have annual fees or late payment fees. There are student credit cards that have low or no fees and may have a one-time pass on late payment.
If you use a credit card regularly, try to pay more than the minimum payments. If you only pay the minimum amount you have to, you can end up paying more in interest than the cost of your original purchase!
