Most people know that credit scores are important for their financial related transactions, but their knowledge of the credit scores is woefully inadequate. There is a tremendous lack of understanding in the US about how credit scores work. Lots of people are actively damaging their credit score while thinking they’re helping it. Others are completely ignoring it altogether.
Here are some tips to change several personal financial habits for the better.
Do Not Avoid Credit Cards
Recent recession has taken toll on many young folks as they witnessed destructive power of poorly managed loans and credits. In addition, most youngsters are buried in their own student loan debt. According to a recent Bankrate study, only a third of Americans under 30 own a credit card. By comparison twice as many people over 50 own a credit card.
As an alternative to credit cards, millennials and other Americans are using debit cards more than ever. The reason is obvious: debit cards are a great tool to help you avoid spending money you don’t have. But there are many misconceptions about debit cards.
Debit Cards Do Not Help Your Credit Score. Debit card gives you access only to YOUR funds. It does not give access to a line of credit. Thus, it does not help your credit score.
Debit Cards Are NOT Safer Than Credit Cards. It is true that debit cards may provide you protection against increasing your debts. But debit cards do not protect you from liability. You may be liable up to your entire bank account if your debit card is compromised. Most credit cards offer $0 fraud liability and there is a law called the Fair Credit Billing Act that caps credit card liability to $50.
Building Your Credit Adds Value
You need to strive for building a good credit score (over 680). Here are some top reasons to have a good credit score:
- Improves your ability to buy or rent a home
- Lowers interest rates on home loans saving you potentially thousands of dollars
- Increases your chances of landing a business loan if you want to start a business
- Gives you access to credit cards with better rewards programs
- Can improve your chances of getting certain types of government and finance jobs
Managing Your Credit Is Essential
Note that there are countless stories of credit misuse. The average US household owes more than $16,000 in credit card debt. Misusing credit can have a disastrous effect on your credit score. It is true that you need to use credit, but it is also true that you will need to focus on building improved budgeting, spending, and earning habits first before diving into the world of credit.
Misconceptions About Credit Score
Another reason millennials avoid, and misuse credit cards is due to some big misunderstandings about how a credit score works. Below is a list of the most common and egregious misconceptions:
Increasing Credit Use DOES NOT Improve Credit Score. Common belief that you can increase your credit score by spending more with credit cards is totally false. Having a high credit use rate will hurt your credit score.
Maxing Credit Card Limit Does Not Improve Credit Score. Often there may be needing to use the credit card to the maximum limit, but you need to make sure you reduce balance as soon as possible.
Checking Your Credit DOES NOT Lower Your Credit Score. Surprising many people believe that when you check your own credit score, will affect their credit score at least as much or more than a hard pull. You can check your credit once a year from each credit bureau for no cost or any impact to your score. Furthermore, if credit is pulled because of creditor’s inquiry during your search of a loan within a time frame, your score is not impacted.
Partially due to this big misunderstanding, there are tons of millennials walking around without knowing what their credit score is.
Factors Affecting Your Credit Score
Paying On Time. Paying your credit card bills and loan payments on time is hugely important to improving your credit score. Late and delinquent payments can stay on your credit report for up to seven years so it’s really important to avoid them. You need to note that service credit bills such as rent, phone, and electricity do not get reported to credit bureaus. So, you are not building good credit by paying those on time.
Reasonable Credit Utilization. Credit utilization simply means how much of your total available credit you’re actively using. For example, if you have one $5,000 credit card and you’ve spent $2,500 on it, your credit utilization rate is 50% for that card. If you have multiple cards and balances, they all get added together to figure out your overall credit utilization rate. Overall, the lower your credit utilization rate, the better your credit score will be. With that being said, as long as you keep it under 30%, you’ll be in pretty good shape.
Age of Credit History. Simple rule to remember is that the older your credit accounts, the higher your credit score will be. This is because the longer you responsibly utilize credit, the more trust you will build. Never close old account that is in good standing.
Credit Mix. Credit bureaus favor profiles that contain a wider mix of credit types. Somebody that has a credit card and a mortgage will score higher in this category than somebody with just a credit card, all else being equal.
New Credit and Credit Inquiries. If you open a bunch of new credit cards in rapid succession, it’s going to look like you’re desperate for money and it will negatively impact your credit score. When applying for loans, apartments, or new credit cards, the issuing provider will usually do some hard credit inquiries or “hard pull” on your credit score to get a detailed understanding of your credit worthiness.
Credit Score Summary
Different credit bureaus use different score calculations, but usually they fall into the same general pattern. FICO is very transparent about how they do their calculations and offer the following breakdown:
Payment History – 35%
Credit Utilization Rate – 30%
Length of Credit History – 15%
Credit Mix – 10%
New Credit – 10%
Impact of Student Loans
Student loans are treated like any other installment loan such as a mortgage or auto loan. And just like a mortgage, the total amount of your student loans won’t have much of an impact on your credit score.
Student loans can be a net positive on your credit score. Student loan payments are reported to credit bureaus, so if you’re making your payments on time that will be counted as a positive towards one of the most important factors.
Having student loan counts as another form of credit so it’ll help the “Mix of Credit” category by giving you a more diverse credit portfolio.
Being Proactive About Your Credit Score
Monitor and Understand Your Credit Report. Just as you check your balance in your bank account, you will need to monitor your credit regularly. Just monitoring is not enough but dispute any inaccuracies that might be present- such as a duplicate report or identity theft. Here are few tips to improve credit score.
Become an Authorized User. If you have a friend or family member that has excellent credit, they can make you an authorized user of one of their credit cards simply by calling the credit card company and requesting the addition. That account will then start to show up on your credit report as well as theirs. If the account is solid and the primary account holder hits all their payments on time, this can help your credit, especially if you’re just getting started building a credit history.
Pay Credit Card Balances Multiple Times Per Month. Credit bureaus will check your credit utilization rates at different times throughout the month. So even if you pay off your balance on time at the end of each month, your credit utilization rates might still appear to be very high if you used a large amount of your credit limit during the month. To get around this you can pay off your balance multiple times throughout the month.
Report Rent Payments To Credit Agencies. Even if you don’t have much of a credit history, you may have a nice history of paying your rent on time. All three major credit bureaus will include rent payment history if it’s reported to them. To accomplish this there are a variety of services and costs as well as some amount of assistance from your landlord.
The essentials that you need to note:
- Never use more than 30% of your available credit limits
- Pay all loans payments and credit card bills on time and in full
- Don’t generate more than three hard credit score pulls per year
If you follow these three simple rules, your credit will likely be in great shape. But it’s still best to more fully understand the way your credit score works.
You can manage your credit on your own, but seeking professional service will yield positive outlook in your financial matters. See additional information here.