How and Why You Should Build Credit
Photo by kyler trautner on Unsplash
Unless you are uber-wealthy and never need to borrow money, you will eventually need to build your credit. This post will give you an overview of what a credit score is and how you can build and maintain a good credit score. Here’s how this post is broken down:
- What are credit scores
- Why your credit score matters
- How you can build your credit score
- How to maintain and grow your credit score
What are credit scores and why it’s important
Imagine you had to lend someone $1000 but that person wasn’t a close friend or relative. How would you decide whether or not to lend them money? Before you give them money you would probably want to know about their background, for example:
- How much money does this person earn
- Have they always paid back money they’ve borrowed on time?
- How much money do they owe other people?
- How long have they dealt with money?
This is where a credit score comes in. A credit score, sometimes called a FICO score, will tell answer all these questions all about a person with a single number: a credit score. This number will signal how well a particular person handles money, and whether or not they are trustworthy enough to lend money to.
A person’s credit score factors in:
- How much total money a person owes to others
- How long they have borrowed money for
- Whether or not they have a history of not paying others back or missing payments
- What type of purchases they have borrowed for
- Have they recently asked many people to borrow money
Combining these 5 factors gives a person their credit score and signals the following to lenders:
- 300-580 signals that this person has little history of borrowing money, or can’t be trusted to pay back the money they’ve borrowed
- 580-670 signals that they have borrowed money but have a track record of missing payments. This person probably can’t be trusted with large amounts of money
- 670-740 signals that this person is average with money, and they have probably missed a couple of payments here or there.
- 740-800 signals that a person is pretty good at paying back the money they’ve borrowed. Their track record isn’t perfect, but they can most likely be trusted to borrow money in large amounts.
- 800-850 -> Signals that a person has an excellent track record and is extremely likely to pay back the money they have borrowed.
My credit score is 760 – it’s not perfect because I’ve forgotten to make some payments on bills.
Why your credit score matters
Most of us can’t afford to buy a house or pay for university in cash. Whether or not a lender will give you a loan to pay for things we can’t afford up-front depends on our credit score. Sometimes, a poor credit score may mean we don’t get the loan. Other times, it may require us to pay higher interest rates on our loans. On a 30-year home loan, a 1% difference in interest rate may mean more than $100,000 in added interest payments over the life of the loan.
How to build your credit score
- Start applying for student credit cards. These credit cards often require a cash deposit and come with a small line of credit. Start developing your credit history by covering small expenses with a student credit card.
- If you’re younger you can ask your parent or guardian to make you an authorized user on their credit card. That way, payments they make on time will also reflect on your credit score.
- Start paying for your own bills. If you have an electricity bill or internet bill, make sure your name is on the bill. Even if a parent or guardian pays the bill, make sure your name is on it.
Tips on Maintaining a Good Credit Score
Once you’ve started to build a credit history and a credit score, you will want to maintain it. Here are some tips:
- Don’t apply for too much credit in a short period of time.
- Make sure you don’t spend over 30% of your credit card’s limit. For example, if your credit card has a limit of $1000, then you should only spend $300 a month using it. As your expenses and income grow, make sure you call your credit card company to ask them to increase your credit limit.
- Set up automatic payments for all of your bills. Even missing a single payment can stay on your credit report for a long time.
- Start budgeting to you don’t overstretch yourself.
- Set up accounts with Experian, Equifax, and Transunion. These are the companies that are responsible for giving you a credit score. They can also provide you with a credit history every year. Make sure you check it once a year and report anything that’s suspicious, for example, a credit card that’s opened in your name that you didn’t open yourself.
- Pay down your debt on your credit card and make sure you don’t have a revolving balance.