I got asked recently how to build up your credit score, especially when it comes to a young adult trying to build credit. Your credit score is important because the higher it is, the lower risk you are to lenders, so lenders are willing to give you lower interest rates. This could potentially save tens of thousands of dollars when it comes to getting a mortgage, a car loan, and having low interest credit cards. There are many factors to creating credit and building up a good credit score. I am going to focus on the ‘credit utlilization rate’, paying your bills on time, and checking your credit reports.
The credit utilization rate is something that most people don’t understand. The credit reporting agencies are looking at the ratio of total credit available to total credit being used. In example, if you had a credit card with a $1,000 limit and you charged $500, then your utilization rate is 50%. I had previously thought (incorrectly), that you did not want a high limit on your credit card as that would look bad to a credit reporting agency. In my case, my utilization ratio was always high, even though I paid off my credit cards in full every month. The optimum rate is actually under 30%. Once I increased my limits on my credit cards to a level where my monthly charges were under 30%, my credit score started to rise dramatically. I advise that you be aware of your credit card limit is keep your charges to under 30% of the limit. If you go over that 30% with a big purchase, then you can make a partial payment before your credit card closing period, so the closing balance is under 30%.
Next is the importance of paying your bills on time. It is vitally important that you do not miss payments or make late payments. I remember one time that I accidentally put in an online payment to my credit card that was two days after the due date. They sent me a letter that said they were raising my interest rate by 4% due to the late payment. I argued to no avail and ended up with a higher interest rate along with a ding on my credit report. For credit cards, be sure to pay your bill as soon as you receive it, so you don’t run into paying late by accident. This is incredibly important when it comes to ‘no interest financing’. If you are a student and buy that new couch with a great offer of “24 months NO INTEREST!”, then you can’t have one missed or late payment or all interest is triggered from day 1 and typically at over 20%… Bottom line here is to ALWAYS pay your bills on time. I strongly suggest that for any regular, recurring payment, that you use a banks online bill pay system. That way you can specify when the payment goes out and the amount and make sure it gets paid on time.
Finally, this day and age is rampant with identity theft, so it is important to check your credit report. Also, credit reporting agencies make mistakes. I knew of one person who’s credit history got merged with someone else of the same name, even though they had entirely different Social Security numbers! You may or may not know that you are entitled to a free credit report each year through www.AnnualCreditReport.com. It allows you to check and see all the debts in your name and review for mistakes. This is important to do because you can see if anyone is trying to use your information to open credit as well. I advise that once per year, login and get your free report and review it!
One last comment is that if you are 18 years old and just starting out and want to build credit, then get a no annual fee credit card, try to get a high limit on it, charge under 30% of that limit and pay it off in full every month (use it, don’t keep it in a drawer), and that will be a good start. Then when it comes time to maybe get a car loan, pay it every month on time, and by the time that is done, your credit score will be looking pretty good for potentially buying your first home!
I hope you enjoyed this month’s topic and please email me if you have ideas for things you would like me to discuss!