Now that we've discussed saving for big purchases and emergencies instead of putting them on credit, it's time to discuss the good things about credit! In this post, we'll discuss establishing great credit so that you are eligible for loans with low interest rates and a credit card with a great rewards program. More to come on choosing a credit card and using credit wisely later!
I recommend our previous post of credit score basics before reading this article (click here).
- The most important components of your credit score are credit history (average age of loans, age of oldest loan) and debt:credit utilization ratio. These two things make up 2/3 of your credit report.
- Don't get a credit card until you're responsible enough not to max it out!
- Pay your credit bills on time, all the time (but really, all of your bills because it's a good habit to establish).
- Confirm your correct mailing address for any place that may potentially send you a bill.
- Check your mail at least once a month.
- Don't use more than 30% of your total credit at any given time.
- Be judicious in your credit card applications.
- Borrow the least amount in loans as possible.
- Diversify your credit accounts.
Get a credit card as soon as your are responsible enough.
The most important component of your credit score is credit history (average age of loans, age of oldest loan). The longer you’ve had a credit account, the better its impact on your credit score (as long as you use it wisely). When my brothers were in high school, my mom made them an authorized user on her credit card which allowed them to earn credit for her responsible decisions. I was allowed my own credit card freshman year of college. I had a limit of $400 and my parents gave me an allowance to pay it off every month. Having my parents give me the money so that I was the one actually paying off the bill (vs being the person that says "my parents pay my credit card") was a great habit. I've carried a balance on a credit card a total of about 4 months of my life at different time periods and it has always given me a ton of anxiety. Another option to build credit is to make a large purchase on credit. For instance, instead of paying $2000 for a new macbook, you can do monthly payments. I don't recommend this unless it's interest free because you end up paying more than the item is worth (the markup on a macbook is enough). Get a credit card. Be responsible. Pay it off every month. (more to come on using credit wisely!)
Pay your bills on time, every time!
Your credit report only looks at your credit lines, so paying your utility bill late is a bad habit, but will not affect your credit score (exception: if you have an unpaid account that is sent to a collection agency - this will affect your credit score). I've almost gotten myself into trouble with this second line a couple of times. Once, I just didn't check my mail for three months so I didn't realize my doctor had sent a balance to my house (apparently, insurance doesn't pay for everything. more to come on this topic too!). A second time, my doctor didn't put my apartment number on the mailing address so I NEVER GOT THE STATEMENT. I literally had a collection agency call me about an overdue $10 balance. Luckily, when I called the office they were incredibly apologetic and all is well. Always confirm your mailing address for places that may potentially send you a bill and and check your mail at least once a month.
Don’t use more than 30% of any of your cards at any given time
Using a high percentage of your total credit makes creditors worry that you're overextended or close to default. This doesn't mean your monthly spending limit has to be 30% of your balance, but that you should keep 70% of your balance paid off. The percent of credit in use is usually generated from your previous month's statement balance, but some bureaus pick a random day of the month. If you allow $1500 to accumulate with a $3000 balance and pay it all off before the due date this is worst for your credit score than spending the same amount of money, but paying off your balance in increments over the month to keep your balance < $900. In order to not trick yourself into thinking you've spent less than you have, you should use a separate app to track your monthly expenses. I use mint. It's pretty ubiquitous these days and really nice because it links all of your accounts and notifies you when you've exceeded predetermined credit usage percentages. Again, this 30% limit goes for both total credit AND % use of each credit card. Spreading credit across multiple accounts is one way to do this, but it may make more sense to just pay one card down twice a month because that card has the best rewards system.
Don't apply for credit for a 20% discount.
Having multiple new accounts or credit inquiries makes you look risky. Each time you apply for a credit card, it remains on your credit report for two full years. So, when the nice girl at Victoria's Secret asks you if you want to save 20% on your $50 purchase by applying for a credit card, say no. I use that example because I was that girl years ago. That girl doesn't care about your credit.
Borrow the least amount in loans possible
How much do you owe in loans and credit card debt total? Less is better. I owe a ton from student loans, so credit card debt is an absolute no for me. I also own my car.
Diversify your credit profile.
Having multiple types of credit plays a small role in your credit number. Examples of types of credit include student loans, credit cards, retail credit, car loans, and a mortgage. I’m not sure why it matters, but I don’t make the rules.
After reviewing your credit report, contact lending institutions to make payment arrangements if it has an adverse impact on credit score.
We discuss credit reports - including how to check your credit report for free three times a year - in more detail in "Understanding your credit score."
Check out the official FICO website for more details on the different types of credit scores and what goes into them.
There will be more to come on using credit wisely in the next few months!