Many people start creating a credit score around the age of 18, when they are able to apply for a credit card. Getting a credit card at such a young age is very easy and might seem like a good idea. Sales reps will highlight all of the benefits of having a credit card like being able to buy something you have wanted for a while without having to pay for it immediately. They won’t tell you that you will most likely have a sky high interest rate on this card. Additionally, if you don’t pay off your total bill, by the end of the billing cycle, you will get hit with fees that could equate to as much as 25 cents for every dollar you have on the card.
Having an outstanding monthly amount on a credit card with high interest is the quickest way to ruin your financial future. If you are not mindful of accumulating debt, you could find yourself in a deep hole that could take you years to dig out.
In this post, we will work on increasing your understanding of credit, how to build it, and use it to your advantage to set yourself up for the future.
What is credit?
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Here are simple definitions of credit from the Merriman-Webster dictionary:
1. money that a bank or business will allow a person to use and then pay back in the future (For the purposes of this post – think of this as a credit card)
2 . a record of how well you have paid your bills in the past
(Think of this as your credit history. You are given a score based on whether or not you pay your bills on time)
What is a credit score?
A credit score is a number that helps give others an idea about how likely you are to pay back money and the likelihood it will be paid back on time. The most respected scores are generated by three financial credit agencies – Transunion, Experian, and Equifax. The most popular credit score used is called a FICO score. It’s based on a scale from 300-850. The closer your score is to 850, the better your credit.
If you have never borrowed money from a bank, pay for everything in cash, or have never signed a contract for payments (i.e. cell phone bill) you will not have a credit score. You may think that this is a good thing, but it’s not. Since it is not known how dependable you are at paying your bills, not having a credit score can hurt you just as much as having a bad credit score.
Why is a credit score important?
To break it down easily, your credit score will determine:
- Where you live and whether you will live by yourself or with roommates
- Cell phone plan
- What you can drive
- If you will be offered the job you have been wanting (this is becoming illegal now)
Credit scores and Housing
When you go to rent a place to live, you will be asked for proof of how much money you make, your credit history, and your credit score. Your landlord will ask for this information because he/she is trying to understand if they will be paid their rent on time. If you have no credit or bad credit, chances are that the landlord will not be willing to take a risk on you, because renting is a business transaction. However, if you are lucky enough to be accepted, they may make you pay more upfront to limit the risk or have someone co-sign for you. For example, you could be asked to give 6 months of rent upfront instead of just 1 month. Paying more may not be an option for you so your next option would be to get a roommate in order to secure a place to stay. This is not the worse thing in the world but, at one point you will want to get your own place. Why not give yourself a leg up on everyone else searching for a place to live? Make sure your credit is straight before submitting the paperwork to a landlord.
Credit Score and Cars
There are some purchases in life that will most likely require a loan such as buying a car. If you don’t have a decent credit score you can still get a loan, but you will be paying huge amounts in interest payments. The interest rate on your loan can be ridiculously high like 17% or more. If you are quoted interest rates that high, save your money and take cabs.
If you say whatever and still get the car, then please look at the following example of a typical $25,000 car loan for 36 months:
Based on this graphic you can see that if you value your money, you should focused on your credit. Bad credit and not knowing the interest rates you are paying will leave you crying broke!
So how do I start taking control of my credit?
We know you have heard someone say that they have bad credit or a low credit score. You may even think you have bad credit, but have you ever took the time to look at your credit score or address any of your problems head on?
The first step in taking control of your credit is knowing where you stand:
1. Get a copy of your score from each of the credit agencies mentioned above and your free annual credit report. Everyone in the US is entitled to one free credit report every year. For your free government sponsored credit report go to www.annualcreditreport.com. Don’t trust other sites, some will ask for money or will try to get something else from you.
2. Check your credit report for the following: discrepancies, old information on the account, and signs of identity theft (like having a cable bill when you were 5 years old). If you find anything that is not correct, you need to contact the credit agency that is reporting the error. Remember there are three main credit agencies and each could report something different. It is key that you look over the information carefully and get any errors corrected.
3. Apply for a credit card with a small line of credit. A credit card with a small line of credit could be useful and help your credit even if it has a high interest rate. In regards to a credit card you have to keep a few rules in mind:
- The main reason to get this card is to try to build a credit history. Do not get carried away with this card and go on a spending spree. Just buy something small on this card and quickly pay it off.
- Never use more than 30% of your available credit. Example: if your credit line is $500 make sure you never have a bill more than $150 on the card.
- Always pay on time. Paying late will result in a fee and can lower your credit score.
- Pay it off by the payment due date. If you cannot pay the full bill, make sure you pay more than the minimum payment. If you only pay the minimum amount, it will take a longer time to pay off your balance. In addition, the total amount you will pay will also be way higher than the initial amount you put on the card.
- Don’t get amped up and start applying for every credit card you can get. It will hurt your efforts to build credit and could backfire.
4. Avoid credit repair companies. A recent radio advertisement stated that for $99 per credit agency they could guarantee to get you a 720 credit score. Most of what they can do are things you can do by yourself for free. A credit repair company cannot have a credit agency remove any valid negative information from your record. If you’ve made mistakes in the past, only paying on time, lowering the amount you owe, and time will help you repair your credit.
If you are repairing your credit, don’t be in a rush to get into debt. Many people want a better credit score so that they can purchase a new car or a home. However, if you haven’t yet corrected the underlying problem you might end up negating your efforts.
We can go on forever about credit, but this post is just meant to give you a brief overview about the importance of credit. To give you more on this topic, let us know what you want to hear and we will address it step by step.
Nadia is a Financial Independence Coach from New York City. She holds a B.A from Columbia University and worked 13+ years in Investment Banking and Financial Services. She is an entrepreneur, investor, and partner at Wealth Twins LLC. She reached Financial Independence in her 30’s and is passionate about showing others how to achieve the same.