You may be just graduating high school heading into college, purchasing your first home, retiring or looking to buy your dream car. No matter where you are in your life, odds are you will need your credit checked at some point. But you may have heard the simple saying “how can I build credit, if my credit score is low and I do not have the chance to?” This old paradox has left many individuals confused, frustrated and downright angry. Credit scores have always been difficult waters to navigate, but with proper guidance, you can set sail on a financially healthy life.
What is a credit score?
In order to build credit successfully, we need to define it! According to Investopedia, A Credit Score is a value that is assigned based on your level of financial risk to a lender. The FICO score is the most common method in measuring a credit score. Credit scores can range from 300 (very poor) to 850 (very good). When starting out, you may not know your credit score, you may not even have one! First, check sites like Experian and Creditkarma to see what your credit score may be. You can even visit your local financial institution for help on finding your credit score. Once you have it, now we can begin answering the question: How do we start building our credit score?
How to build your credit score?
Building your credit score takes time. It is not something that happens overnight. Although it may seem that a credit score is random, building your score should be considered a skill that can be developed! With the right steps, you can be well on your way to excellent credit. Here are some tips to help you improve your credit score.
1. Make your payments on time.
One of the most important things to do when building a credit score is to make your monthly payments on time. If you fail to do this, it can have a serious impact on your financial health. Investopedia shares what happens when you are 90 days overdue on your loan payments, your payment is “delinquent”. Your credit score will be hit, and if you do not make a payment soon, you will “default” on your loans. This can ruin your credit score. If payments are too far behind, a company could hand your debit off to a collection agency. They may even garnish your wages!
Besides the chance of debt being handed to a collection agency, you will be charged a late fee. Along with that, your interest rates will go up with a late payment (sometimes called the penalty limit). Increased interest rates may make it difficult to pay on your loans, causing you to go into debt even more. ALWAYS pay your loans/credit cards on time each month.
2. Do not spend what you do not have.
A credit card is not money. It is a promise to pay later. Do not spend money you do not have, rather use your card for purchases you know you can pay off. Using the card and then paying it off completely will show lenders you are low risk. This will increase you credit score! Spending money you do not have will result in maxed out credit cards, poor credit, and a stressed life. Choose to use your credit card wisely. Once again: A credit card is not money.
3. Ask for a credit limit increase, but do not max out your card.
Your credit limit can play a key role in helping you increase your credit score. Asking for an increase in your credit limit should automatically help in raising your score. This being said, do not use that new limit unless you absolutely have to. Maxing out a card can damage your overall credit score and put you in an even worse financial position. Increases on your credit limit over time increase trust in you from lenders, and in turn your credit score.
4. Small purchases go a long way
Often, credit cards are used for big ticket items like TVs, game systems, furniture, or appliances for your home. While this is one way to use the card, it can put you at risk if you do not have the money to pay the bill back on time. Remember: Do not spend what you do not have.
Another method is using your credit card for daily purchases you already make. Gas and groceries are very popular for credit card users. You can pay for gas on the card and then pay off your credit card a few days later. This shows that you can borrow money and repay it, increasing your credit score. Many cards even offer cash back rewards for groceries and gas, which is an added incentive!
5. Avoid excessive credit inquires
It is important to know where you stand with your credit score. That being said, did you know you can actually damage your credit score by doing excessive credit inquires. In order to be approved for a new credit card or loan, a lender may do what is called a “hard” pull on your credit. According to Investopedia, a hard pull includes your entire credit report history. A hard pull is automatically added to the credit report, causing a slight deduction of your credit score.
6. Pay off debt
This may seem obvious, but is an important step we often overlook. Paying off debt can improve your financial health, which leads to an increase in your credit score. By paying off debts, such as your auto loan, student loans, or your mortgage, you reduce your financial debt which improves the debt-to-income ratio. The debt-to-income ratio is:
Debt-to-Income Ratio = Total Monthly Payments/Gross Monthly Income
This ratio is important when assessing your financial risk to a borrower. According to Smartasset, when it comes to buying a home, an ideal Debt-to-Income Ratio is 36%. Reducing your percentage can decrease your financial risk as a borrower, increasing your overall credit score.
These tips can have you well on your way to being a credit card master. Having a healthy credit score can help in getting lower interest rates, pre-approvals, and avoid undue financial stress. Managing your credit score is a skill that takes time and practice. We are always here to help you get started building your credit score!
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