Most people don’t think about their credit scores until either they’re ready to buy a house or they’ve been declined for a credit card or loan. That’s a mistake, as credit reputation has become an increasingly important part of life, affecting much more than just borrowing money.
Building strong credit will improve your financial life from the time you get your first credit card and help you use debt to your advantage. Paying attention to your credit can help you develop better financial habits, which will serve your net worth and your future fortune.
How To Establish Your Credit
There are many reasons to establish good credit, but the main one is saving money. With a positive credit history and a strong credit score, you can save thousands of dollars every time you borrow money in the form of lower interest rates.
Lower interest rates mean smaller, more budget-friendly loan payments, plus less of your money goes to the bank (or mortgage lender or credit card issuer).
Credit Affects More Than You Think
Whether you’re thinking about borrowing money or not, it’s important to establish credit and maintain a good credit score. Most people don’t realize that your credit score can impact other areas of your life as well, such as:
- Renting an apartment
- Getting a job
- Getting life insurance
- The amount you pay for auto insurance
- Whether you have to pay a utility company deposit
Plus, when (if) you are ready to borrow some money, having a top credit score makes you eligible for the lowest interest rates and the best loan terms. That can make your borrowing a more effective part of your overall financial plan.
Meet FICO and the Bureaus
Generally, when people are talking about credit scores, they’re talking about FICO (named after the Fair Isaac Corporation), which is the most widely used credit scoring system in the US.
The three major credit-reporting bureaus each put their own spin on the FICO score and mix that with information they collect from lenders (otherwise there’d be no need for three of them). Those three credit bureaus are Equifax, Experian, and TransUnion.
Credit scores typically range from 300 to 850, and bigger is better. Your score is based on five main components (in order of weight):
- Payment history (whether you pay on time and in full)
- Credit utilization (how much you owe compared to available credit)
- Length of credit history
- Credit mix (the different types of debt you have, for example, credit cards and a mortgage)
- New credit (how much new credit you’ve applied for based on new inquiries)
Different lenders have slightly different guidelines when it comes to credit scores, but generally consider scores higher than 700 to be good, scores above 750 to be very good, and scores over 800 to be excellent.
How to Establish Credit When You Don’t Have Any
It seems like a catch-22: You can’t establish credit without borrowing, but you can’t borrow if you haven’t established credit. Luckily, there are simple tools you can use to get your credit history rolling (no matter how old you are).
On the credit card front, you have two choices: become an authorized user on someone else’s card or get your own secured credit card. If you have a willing family member or friend with stellar credit, ask them to make you an authorized user.
Their credit helps build your credit as long as the card issuer reports all authorized users to the credit bureaus. Alternately, you can get a secured credit card, which works like a regular credit card with a cash safety net.
Basically, you supply a cash deposit (the secured part) to cover your credit limit, then use the card and make on-time monthly payments. You can also use similar tools to take out loans. For credit newbies, there are credit-builder loans, which act sort of like a combination of forced saving and reverse borrowing.
Here, you make timely monthly payments on the loan until it’s paid off, and then you get the money. Look for credit-builder loans with the lowest interest rates and fees, often available at small banks and credit unions.
Another option: Get a cosigner—another person who guarantees that the loan will be paid back in full—for a regular loan. In some cases, regular bills you pay (such as rent, utility bills, and cell phone bills) can be used to build your credit. Look into programs like Rental Kharma, RentTrack, and Experian Boost to see if your bills apply.
How To Increase Your Credit Score
No matter how high or low your credit score is, there are steps you can take to increase it. This won’t happen overnight (and don’t believe anyone who says it can), but it can happen pretty quickly. You may be able to increase your score by 100 points or more in just a month or two. Once you do, you may be surprised by how much it helps your finances.
A better credit score could save you money on car insurance or help you avoid paying a utility deposit next time you move. Best of all, it will help you get lower interest rates every time you borrow—and that will save you tons of money in the long run.
Review Your Credit Report Every Year
Your score gives a quick snapshot of your credit reputation, backed by a full credit report that contains a detailed collection of personal and financial information. With all of the credit-based information flying around, it’s not really surprising that most people’s credit reports contain mistakes (such as charges that aren’t yours or a bill that’s paid but listed as open).
Those mistakes can lower your credit score, so it’s in your best interest to find errors and get them off of the report as quickly as you can. Your credit report can also alert you to fraud and identity theft, and it should be one of the first things you look at if you suspect foul financial play.
You’re entitled to one free credit report every year from each of the three major credit-reporting bureaus. The easiest way to get them is to order a free comprehensive report online at www.annualcreditreport.com.
You can also order a report from each of the three bureaus individually through their websites: www.equifax.com, www.experian.com, and www.transunion.com. If you do find mistakes (and you probably will), your best bet is to notify any one of the three bureaus by certified mail. You’ll find a good sample letter and instructions on the FTC website at www.consumer.ftc.gov.
Learn more about how to read your credit score.
Pay on Time and Pay It Down
Increasing your credit score can take some time, but there are two steps you can take to really jump-start the process.
First, get current with all of your bills, and stay current by making every payment on time and in full. If you know you’re going to be late or short with a payment, be proactive and contact the creditor before your account becomes delinquent; creditors will often work with you to protect your credit score if you let them know what’s going on.
Second, reduce your credit utilization below 30 percent; it’s one of the quickest ways to boost your score. The best way to do this is by paying down debt without taking on any new debt (by using credit cards or applying for new loans, for example).