What’s This Credit Game?
Learning about credit while you are young is like reading and not reading the assembling instructions before putting together an IKEA table. It’s either going to go great or very upsettingly for you. While I don’t speak a lick of Swedish, I can help you get on top of your credit game. So let’s get after it!
Image by: Paul Felberbauer
What is Credit?
Credit is receiving something now with the promise to pay it back later (typically with interest). That is as simple as it gets right there. However, to navigate the more intricate complexities of credit allow me to offer an analogy about a common activity amongst friends. Do you remember when you were out to dinner with some friends when you realized that they don’t split checks? Or maybe you dined more than you could afford to? Either way, your friend agreed to cover you this time. You say, “Thanks friend, I will pay you back when I get my wallet” or you probably now just say, “What’s your Venmo?” Thanks to Venmo, many of us have experienced the concept of credit.
You might ask, what’s a credit card for? And what about that credit score I’m always hearing about? Well, since you asked, a credit card is probably the most common way of building credit, while your credit score is a bit more complicated.
What is a Credit Score?
If you’re like most people, and you want to own your own house, rent an apartment, buy a car, change your phone plan, or get those fancy credit cards so you can travel; you are going to want to listen up real quick. A credit score is understood as the amount of credibility you have within the credit world. In other words, it informs people you want to buy from how trustworthy you are with repaying. A credit score is a range of numbers from (hopefully not this low!) 300 to about 850.
For example, if you are having a night out with your friends, and you have a history of “forgetting” to pay them back… chances are you’ve got a low trust score with them. Friends don’t keep credit scores, but car dealerships do.
If you have a low score near 300 or so, you pose as a high risk and are considered to have “bad credit.” If you have a score of about 680 or more, you have low risk and have “good credit.”
It’s that simple. It’s like a high stakes game of volleyball. You have to keep that ball from hitting the ground (forgetting to pay someone back) and you also have to make purchases with your credit card in order to start building credit. (like you build a reputation as an excellent volleyball team for the season) The more you consistently pay back debts on time, the better your credit.
~35% Payment History - How on time your payments have been. An easy solution is to set up “Autopay”
~30% Amount Owed - The percentage of credit limits available. How much credit are you using? If you are in some credit debt, that is okay: general recommendation is to stay under 30% of your credit limit. If your credit usage is higher than that, you are looking more risky as we speak.
~15% Length of Credit - How long you have managed credit. The sooner you open a credit card account, the easier it will be for you to build credit.
~10% Credit Mix - FICO takes into account the mix of credit cards, loans, mortgages, and other credit forms. (More on FICO below)
~10% New Credit - The number of credit inquiries and new lines of credit you’ve opened in the past year to two years.
Why do I Need Credit?
I’ll give you five good reasons:
College: Student loans also require good credit. Having good credit will enable you to grab those low interest rates.
Buying a home. Whether you are renting or buying, many places will have a minimum credit score for said place. Also, the best mortgage interest rates are only available to those with a score of 720 and up. So, if you have a lower score you will have a tough time paying off your mortgage.
Credit cards. Maybe you’ve heard of the “American Express Black Card”? Well, not just anyone can qualify for that level of rewards. The higher your score is, the more likely you will qualify for credit cards that will reward you.
Your next job. Employers can look at your credit reports and determine how much they should trust you.
Insurance rates. An insurance company will look at your credit score to determine what rate to offer you on all of your insurance.
Image by: Clay Banks
How Does One Build Credit?
Credit is scored by one of the credit bureaus that you may have heard of: Equifax, Experian, and TransUnion. These bureaus use either FICO or VantageScore to determine your credit score. And just to spice it up, they are both calculated differently. Remember before when I said I’d hook you up with more FICO information? Here is how FICO scores different credit scores:
Very Poor: 300-579
Very Good: 740-799
So what do I do if I have a score of 300? Essentially, you have to use all the tools we’ve just covered. How did you get to the pits of credit despair? You probably used way more credit than you had, and missed payments like a t-ball batter trying to hit in the majors. But don’t panic! Simply start by paying off your credit card debts and paying off new ones on time will help your score immensely.
Great! Now that you’ve gotten all that debt off of your first credit card, DO NOT CLOSE IT! It may be tempting to want to wash your hands of that old credit card, but that could negatively impact your credit score, as it will lower your credit limit. For example, if my credit limit was $2,000 before I closed a $500 dollar credit card, that brings my credit limit down to $1,500, which also increases my credit usage percent. Also, remember, a good mix is beneficial for your score.
How Do I Check My Credit Score?
“I heard if you check your credit score, it goes down. Is that true?”
This is not really the case anymore. There are loads of free websites to check your credit score for free. You should check out your own credit card’s website first and if they don’t do it for free: Capital One, Chase, Experian, and NerdWallet all do it too. Totally free! Also, because of COVID-19, you can access your credit history once a week free of charge through April 2021 at Annual Credit Report. This used to be a yearly treat, so take advantage of this while you can.
Now that you have some idea how to speak the language of credit, go out and build you a table! Or your credit score rather. Remember to keep your first credit card open for as long as you can, stay under 30% of your credit usage, pay bills on time and establish different loan types, and you’ll be in great shape!