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Few things in life will impact your finances as seriously as credit. Your credit score is one of the first things reviewed when applying for a loan, credit card, rental vacancy, or mortgage. It even appears when shopping for insurance, setting up utility services, and applying for a job.
Credit scores can be challenging to understand, and it’s easy to be your own worst enemy accidentally. Millions of Americans are struggling with poor credit, and getting back on the right track can be tricky. Perhaps even more challenging is trying to get your credit score journey started. If you don’t have credit, you’ll need to be very careful about your financial actions.
- What is credit?
- What are the benefits of having good credit?
- How can you build credit from scratch?
- Build credit history for an easier credit future
What is credit?
Credit is the ability to borrow money, access services, or consume goods based on the understanding that you’ll pay it back later. Lenders, merchants, and credit card companies are willing to extend various credit levels to individuals based on their confidence that it will be repaid. The way that they determine who can or can’t be trusted is by reviewing their credit score.
A credit score is a three-digit number that ranges from 300 to 850 and represents an individual’s overall creditworthiness. The higher the number, the more likely they will repay their credit obligation. The lower the number, the more risky offering credit will be.
Credit scores are compiled based on information offered to the three major national credit bureaus: Equifax, TransUnion, and Experian. These three bureaus (along with several others throughout the U.S.) will receive the positive and negative about how an individual has managed their debt. Positive information will increase the overall score, and negative information will decrease it.
These credit unions are primarily interested in information that falls under five different categories:
- Payment history represents 35% of your score and focuses on whether or not you’ve made on-time payments and met due dates on things like rent payments and auto loans.
- Total debt represents 30% of your score and focuses on how much of your available credit you’re using.
- Credit history represents 15% of your score and focuses on how long your various credit accounts have been established.
- Credit mix represents 10% of your score and focuses on the different types of credit you use.
- New credit represents 10% of your score and focuses on how often you open new credit accounts.
The information regarding these various criteria is compiled and plugged into a mathematical algorithm to determine your score. Depending on where your score lands on the overall scale, it will be classified as one of five categories:
- Poor: 300 to 579
- Fair: 580 to 669
- Good: 670 to 739
- Very Good: 740 to 799
- Excellent: 800 to 850
What are the benefits of having good credit?
Slowly improving your credit score over time can be a lot of work. However, the benefits of having a good credit score will make all the necessary sacrifices worthwhile. These are just a few examples of the rewards that come with having a good credit score:
Higher approval rates
You have to apply to receive a loan or credit card. The first thing that the lender will be reviewing is your credit score. Virtually all credit lenders will have minimum credit score requirements. Your application will be denied if your score doesn’t reach the minimum.
Lower interest rates
The most expensive part of taking out a loan or using a credit card is the interest you’ll need to repay. Interest rates often vary significantly and are based primarily on your credit score. If you have a low credit score, a lender is assuming a greater risk that you’ll default. To make the risk worth their while, lenders will charge a higher interest rate that will cost you more money.
Higher credit limits
All revolving lines of credit have an upper limit for how much credit you can use. A good credit score can help you get a higher credit limit. You’ll have access to more credit if you ever need it, which will help keep your credit utilization rate low.
Better credit card rewards
Virtually all credit cards offer incentive programs aimed at pushing their customers to use their credit cards. For instance, cashback bonuses of varying percentage points are a standard reward for most credit cards.
The programs with the best rewards are reserved for individuals with the highest credit score. So instead of a 1% cash back bonus, you might receive a 3% bonus or higher.
How can you build credit from scratch?
One of the most frustrating aspects of personal finance is building credit. It’s kind of like when you’re first entering the workforce. You can’t get a job because you don’t have any experience, and you can’t get experience because you can’t get a job.
For many people, that forces them to take on loans with astronomical interest rates that will be very difficult to repay on time. That’s one of the primary reasons why student loan debt has become a national crisis. Fortunately, there are a few options that can help you to develop good credit habits and start building your own credit healthily:
Open a secured credit card
A secured credit card can be a great first credit card to start building credit. It works pretty simply: you make a cash deposit upfront, which acts like your credit limit. You’ll then use the card just like any other credit card. You would make purchases, pay back the balance, and incur interest if you make late payments.
Secured credit cards aren’t meant to be used forever. The goal is to use them long enough to build your credit so that you can qualify for an unsecured card. You’ll receive your initial cash deposit back whenever you close the account. Most credit card issuers offer borrowers secured cards and bank accounts as credit-building options.
Use a retail credit card
Retail credit cards operate like exclusive credit cards that only work in one place. The best part about applying for a retail credit card is that the requirements are much less stringent than traditional credit cards. You should be able to take out credit cards at several different stores, even with no credit.
The critical thing to remember about taking out these cards is that they usually come with low limits and very high-interest rates. The best credit cards of this type come with no annual fees and security deposit; however, not all options come with these features.
Be careful about how much you spend using each card. You should only spend what you can quickly pay off in full within the month. Otherwise, you risk missing minimum payments, high credit utilization rates, and expensive interest charges, which can lead to bad credit.
Become an authorized user
Authorized users are people who are added to existing credit card accounts. Becoming an authorized user will grant you access to the account to make purchases and payments. Perhaps the best aspect is that you can experience the benefits of having a credit account without ever even using the card. Family members or friends can be the primary cardholder and make monthly payments, and it will help you build major credit.
Any actions made regarding the credit account will be reflected in your credit report or hard inquiries. That means that if they make payments on time, your credit score will also experience a boost. However, negative actions are also reflected in your score. If they miss repayments or their card is closed or sent to collections, your credit will also take a hit. Make sure that the owner of the account is financially responsible and will have a positive impact on your credit.
Use a co-signer to take out a loan
Using a co-signer can help you take out a personal loan. Since you have no credit, you’ll use your co-signer’s credit to convince the bank to accept your loan application. In the eyes of the lender, both of you will be equally responsible for paying back the loan. The co-signer will be assuming many risks, so it will have to be someone very close to you. This can be an excellent option for college students with supportive parents or family members willing to co-sign.
The amount of money you borrow and your use won’t matter. The best course of action is to simply put it in the bank and use it to repay the loan slowly. Remember that the goal isn’t for you to procure more money. It’s about showing lenders that you can adequately manage debt. Choosing this option will cost you some money via interest, but consider it a fee to build up your credit.
Build credit history for an easier credit future
Building your credit is a long journey and will not happen overnight. You’ll need to spend years making the right moves and limiting the mistakes to secure a solid score. Sometimes, you’ll have to make sacrifices in the name of your credit score. However, the potential rewards in the long term will be worth all of the struggles in the short term.
Getting started is one of the most complex parts of building a credit history. The only loans and credit card offers you’ll receive are usually risky ones with sky-high interest rates. It’s best to use one (or more) of the methods listed above for a little while. You can slowly and safely build up your credit score to qualify for credit with more friendly terms.
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