One of my relatives is incredibly money-savvy. She and I can chat up about credit and retirement accounts all the time, whereas the rest of the family looks at us like we’re nuts. Yesterday she sent me a text message to let me know that her credit score is at 780 – she knew I’d appreciate what that meant.
Lambasted as we are day-in and day-out with the idea of credit (“No Credit? No Problem?” “Check your credit score FREE!” “Repair your credit NOW!”), no one is really jumping in our faces about the important part – establishing good credit in the first place. And there’s a reason – no one has any incentive to help you establish good credit except for YOU.
I don’t really have any incentive to help you out, either. But it just so happens that I do things all day long without incentive, so I guess you’re in luck.
How important is good credit, really?
Oh man, do you know how many things they can check your credit for? There’s the obvious: when you apply for a new credit card, car loan, mortgage, or any other type of loan. But it really don’t end there…
- Your credit card company can, and does, check your credit all the time. They can, and probably will, hike up your interest rate if your credit takes a nosedive.
- A landlord can check your credit when you apply for an apartment. If you pay your Visa bill late, they’re going to think you’re pretty likely to pay your rent late, as well.
- An employer can check your credit when you apply for a job. I grabbed an application for Bath and Body Works a couple months ago, and it included a “credit release” form. People who are irresponsible financially also tend to be irresponsible at their jobs.
- Your car insurance premiums can be partially based on your credit score, as well (in some states).
So basically, if you ever want to live anywhere, work anywhere, or drive a car… your credit matters to you.
But don’t some people live without credit?
Yes, they do. And it’s commendable to be able to save up for every purchase, including big ticket items like cars and houses, with cash. But the more ingrained in our society credit becomes, the more difficult life can become for people with no credit history.
The problem is, that when someone looks at your credit history, not having one can look as bad as having a bad credit history. Here’s an analogy: Say you’re going through scholarship applications, looking for a bright high schooler to give a scholarship to. The kid who doesn’t send in a transcript of his grades… how do you feel about him? Apprehensive because you have no data for him? You’re probably not going to give him the scholarship, are you? You want someone with an established history of doing well.
Is it hard to build good credit?
That really depends on you and your level of self-control. In theory, establishing a good credit history is easy as pie. Some people do it by accident! But it’s also easy to mess up and suddenly have a maxed-out credit card dragging down your score (trust me, I know).
FICO, the most common number used to represent your credit score, is all about the percentages. So focus on the following things, in order, and that’s all you have to do. Easy-peasy (in theory).
Payment history: 35% of your score
Make it a priority to never make a late payment, and 35% of your score is in the bag. Don’t freak out if your payment is a couple days late, however – late payments aren’t generally reported to the credit agencies until they’re 30 days late. But since you’ll still get slapped with a late charge if you’re even 10 minutes late with a payment, better stick with Never Make A Late Payment.
Debt ratio: 30% of your score
The percentage of debt you’re carrying, compared to how big your credit line is. This only applies to revolving balances (credit cards and home equity lines of credit). Basic rule of thumb: if you’re using more than 30% of your available credit, then you’re dragging down your score.
Understand that this is calculated across all of your revolving lines of credit. So if you’re using $500 on a credit card that has a $2000 limit, and $1000 on a card that has a $5000 limit, then you’re using $1500 out of your available $7000, or 21%. But if that $2000 card is maxed out, and you still have that $1000 on the other card, then you’re using 43%. Ouch.
This is calculated whether or not you pay off your balances every month. So if you’re going to get a loan/new job/new apartment in the next six months, Don’t Charge A Lot On Your Cards, Even If You Pay The Balance Off Every Month.
Length of credit history: 15% of your score
There’s not much you can do about this if you’re just starting out, except START NOW. Luckily, if you’re a college student and you have taken out student loans, at least you have something on your credit history. But you might want to consider getting a credit card now to help establish a payment history.
Feel like you’d go crazy if you put a credit card in your hand, and get yourself into a heap full of debt? Yeah, been there – done that. Self-control is a difficult thing, and only you know how capable you are with it. You’ll just have to figure this one out for yourself.
Trying to fix a bad credit history? Don’t make the rookie mistake of canceling all your credit cards. Keep the one you’ve had the longest that also has no annual fee. If you cancel your oldest card, you truncate the length of your credit history, and your score could take a nosedive.
Types of credit used: 10% of your score
Variety is the spice of life, and apparently it’s also part of the recipe for a good credit score. Just having a credit card is apparently, not good enough. Ideally, they’d like you to have a credit card, a car loan, student loans, a mortgage, and a home equity line of credit. Which is not to say you should run right out there and get all those things. Since it’s only 10% of your score, don’t worry about this too much, just keep it in mind.
Recent credit inquiries: the final 10%
There are two kinds of credit checks – a “hard pull” and a “soft pull.” A soft pull is when you check your own credit score. Or when a company checks your score to see if they should send you some junk mail. Just about any other kind of credit check is a “hard pull,” and will take a hit out of your credit score. Most of the time, these are unavoidable. Don’t worry about this too much, but understand that it means that if you go out and apply for every credit card on the planet in a two-week time span, your credit will nosedive.
What about piggy-backing?
In the past, a good way to build credit was to have someone with excellent credit list you as an “authorized user” on one of their credit cards. Then, all the good credit history from that card would show up on your report. Sorry, but FICO has decided to stop counting authorized users as of this fall, so this will no longer work. You’ll have to build your own good credit.
So… is it hard or what?
It’s easy to build good credit, but it’s also easy to slip up. Life happens – just ask the $1500 balance sitting on my credit card. The key is to not be discouraged, use your brain, and keep doing the best you can. Nobody’s perfect, but we can aim for great credit scores.
Wikipedia – Credit Score
My Money Blog – Future FICO Scores Won’t Consider Authorized Users