Good credit is something that pays off every day. With a high credit score and good credit history you can qualify for all kinds of perks, including better terms on loans and increased borrowing power. But it all starts with building credit. Let’s look at the fundamentals.
Types of credit
There are two kinds of credit. Installment credit includes things like car loans. These are debts that are repaid in equal monthly payments (installments), usually over 3-7 years. The amount of each installment depends on a number of variables, including the price of the item, the amount of any down payment and the loan terms.
Credit cards are an example of the other kind of credit—revolving credit. With revolving credit, you can defer payment on part of the balance. Interest is charged on the unpaid balance and added to the total you owe.
About credit reports
As you're working on building or re-building your credit, it helps to take a look at where you are. Your credit report is a good place to start, since it tells the story of how you manage your credit. Lenders will look at your credit report to decide whether you're a good credit “risk”. Employers may also use it to get a sense of how a potential employee manages money.
In addition to your identifying information, payment history, and total debts, your credit report will include the types of credit you have and how long you've had credit open. Additionally, any time you apply for credit, it shows up as an inquiry on your report. While a few inquiries are ok, too many are a red flag for lenders, indicating you may be seeking credit due to financial trouble.
Public information is another part of your credit report. This is where bankruptcies, tax liens, foreclosures, legal judgments and other credit-related issues are recorded. Hopefully this section on your credit report will be blank.
The information on your credit report stays there for up to seven years; 10 years if you were involved with a bankruptcy.
Get a free copy of your credit report
Thanks to The Fair and Accurate Credit Transaction Act (FACTA), consumers can get a free copy of their credit report, annually, from each of the three credit reporting bureaus: Equifax, Experian and TransUnion.
You can order copies of your credit report from all three credit-reporting bureaus at once. Or stagger them every four months to see any changes. Get your free reports through www.annualcreditreport.com or by calling 877-322-8228.
What's a credit score?
The information in your credit report is used to calculate your credit score, which is a 3-digit number that gives lenders and others a quick, objective assessment of your credit risk. The score ranges from 300 to 850. This is a case where higher is always better.
Let's take a closer look on what goes into your credit score.
Payment History: This is what lenders care about most. Do you pay your bills on time? Payment history has the biggest impact on your credit score.
Amounts owed: This is the amount of debt you're carrying. Having high balances or too much debt can impact your credit score, but the good news is, you can improve your score by paying down balances.
Length of credit history: Lenders like to see that you have good habits managing credit. It's good to leave accounts open that you've had for a long time.
New credit: How many credit cards have you applied for lately? Opening several accounts in a relatively short time period doesn't look good. It tells lenders you may be having some financial problems.
Types of credit (or credit mix): Having both installment and revolving credit shows you have experience managing different types of credit.
10 keys to building good credit
A few good habits and helpful reminders can go a long way to helping you establish or re-build your credit.
- Be patient with yourself. Building good credit doesn't happen all at once.
- Choose a good financial institution. Partner with a credit union or bank that can offer personal guidance as you build your financial health.
- Start small and then expand. Focus on individual actions, like paying more on your monthly credit card bills each month. Once that becomes a habit, turn your attention to a new action, like being a stickler about reviewing your statements every month.
- Use your credit card responsibly. Remember you'll pay more for an item when you buy it on credit. And every purchase impacts your credit report. If you can pay cash instead, do.
- Make payments on time. You might consider signing up for automatic bill-pay. You can also record payment due dates on your calendar. Some financial institutions will even send you an email reminder.
- Pay more than the minimum amount due. Even a little bit extra will make a difference.
- Keep card balances at one-third the credit limit (don't max out your credit card!) Pretend that your credit limit is lower than it is. Disciplining yourself this way can lower your monthly payment, and it looks better on your credit report.
- Check your credit report every year. Remember the free credit reports you're entitled to annually? Take advantage of them. If you find any errors, report them to the credit reporting bureau.
- Beware of offers in the mail. Don't give in to the deluge of credit card solicitations. Just say no.
- Take good care of your personal finances. Work on creating a budget that works for you. Start a spending journal, track purchases and save receipts. Don't spend more than you have.
Keys to maintaining good credit
Once you have a solid credit foundation, commit to keeping it that way. Continue making payments on time, and paying more than the minimum due whenever possible.
Try to get into the habit of paying off items within three months. When you're considering a purchase, ask yourself: will I be able to pay this off in the next three months?
Finally, think about your commitment to your financial health. Savings is an important piece of it. If you can't afford to save, you can't afford to buy something on credit—that is, if you want to reach your goal.
Where to start
If bad credit has foiled your ability to get new credit—or if you're building credit history for the first time—there are products and strategies created just for you.
If you're in school, you can apply for a student credit card. These usually have low loan amounts to keep students from racking up a large debt.
A secured credit card could be another good option. It offers all the benefits of a credit card, usually with lower spending limits, and includes the opportunity to start building credit responsibly. The difference is that a secured credit card requires you to make a security deposit, which is used as collateral in case of default on the loan.
Having a co-signer is another strategy. It means someone with good credit is accepting liability for your loan or other debt. Once they sign on the dotted line as your co-signer, they're legally obliged to pay your entire balance, plus interest and penalty fees if you can't pay for any reason. Being a co-signer can also negatively impact someone's credit score. If you decide to go this route, be mindful of the risks your co-signer is accepting, and let it motivate you to be responsible. Always pay on time and pay more than the minimum due.
Credit unions offer a different kind of product you might want to consider: Share Secured Loans. These are loans guaranteed by a member's savings account and allow you the opportunity to borrow money and use your savings account as collateral.
As you can see, the road to (or back to) good credit can be long. But it's definitely worth it. Be patient, stay vigilant about protecting the credit you build, and reach out for help when you need it.
Have questions? CFFCU is here to help. Give us a call at 423-267-7621.