We’ve all heard about the importance of having good credit, and those “free credit report” commercial jingles have gotten stuck in our heads more than once. But not everyone is given a crash course in Credit 101 before receiving their first paycheck. In fact, most of the time, how to manage and build good credit is learned about the hard way, through trial and error, resulting in a less-than-stellar credit score.
Below, you’ll find a brief breakdown of what exactly credit is and how to use that knowledge to better prepare for your future.
Credit refers to your ability to borrow money in exchange for goods and services, based on the trust that you’ll pay it back in a timely manner. Good credit is generally necessary to make major purchases, like a car or home, or to take advantage of the convenience credit can provide.
Your credit information may also be used by potential employers and landlords as part of the selection process. Having a strong line of credit paints you as trustworthy and reliable to loan lenders, landlords, and other such companies. They want to know that if they lend you money, extend you credit, or give you goods and services, you will pay them back accordingly.
They’re able to determine this by your credit score (also known as a FICO® score), which reflects your creditworthiness at a given point in time. It’s based on information from your credit report and calculated using these five general categories: new accounts and credit requests, your record of paying bills on time, amount of debt, length of credit history, and mix of credit lines. The median FICO score is 720 out of a possible 850. The riskiest customers have scores below 600, which translates to sky-high interest rates if granted a loan at all.
It certainly can seem like a tricky path to navigate, but having this basic knowledge of how credit works and is used can go a long way. Below are some important points to remember when starting to build credit or in trying to improve your score.
Healthy repayment habits are key. Keep your costs down with only necessary monthly payments, like your electric bill, for example. Paying your bills on time is one of the surefire ways to build strong credit.
It’s good to have at least one credit card, but take care to manage it responsibly. Don’t open new accounts one after the other just because you’re new to credit and need a mix of credit lines. Apply for and open only necessary accounts. Signing up for store cards for the initial discounts will usually hurt your credit score. Also, remember that closing an account doesn’t make it go away.
Things like unpaid medical bills and overdue parking tickets can harm your score.
Heavy credit use can also be detrimental, even if you pay off large balances in full in a short period of time. Manage your debt by paying it off incrementally rather than moving it around. Remember, it’s better to use credit in small amounts, and pay off the balance immediately. This establishes good spending and budgeting habits while strengthening your credit score, making you a great candidate in the eyes of lenders!
You can check your credit report free once per year. Take advantage of this each year to be sure of where you stand and where you might need to improve.