Your credit score is a number that represents how likely you are to pay off debt.
Unless you’re Dave Ramsey or someone who can afford to pay for everything in cash, including a home, then your credit score is important.
Why your credit score is important
- Your credit score is what lenders or banks use to determine whether or not they’ll approve you for a loan or credit card
If you need to borrow money for whatever reason (for a house, a car, to open a credit card, etc.), your credit score has a direct effect on that.
- Your credit score will also affect the interest rate you’ll pay
If your score is low, you’ll typically pay a higher interest rate and therefore end up paying more money for the life of the loan. If your score is higher, you can expect a lower interest rate. The difference can be thousands of dollars.
How to Build Credit
To get a credit score or to increase your score, you need to build your credit.
If you’re starting from scratch:
- Credit card or secured card: You may be able to apply for a credit card and start with a very low credit limit. For example, I got my first credit card at 18 because it was a student card with a limit of $400 or so.
- With a secured credit card you make a cash deposit upfront which would be your limit. You make purchases and payments as usual, then you would receive your money back once you close the card. Secured cards are really just to build your credit.
- Be a co-signer: Again if you’re starting from scratch, your parents or someone who is responsible can add you as a co-signer or authorized user on an account. THEY would still make the payments but those payments would help your score. I don’t recommend co-signing otherwise.
- Student loans: If you have student loans you will have credit. These become more impactful once you are out of school and have to start making payments. If you pay the minimum balance each month this will increase your score.
- Have utility bills or rent reported: There is also the option to report your utility bills or even your rent. Typically, those bills aren’t reported. If you’ve been paying them on time, there are services that can start using those toward your score.
- A free service is ExperianBoost
- Other services may cost money, but may be worth it if you really need to build credit.
If you already have credit, the tips below will help you.
Briefly, to build your credit you would need to use your credit cards regularly and pay them off on time and responsibly maintain multiple accounts.
Your Actual Credit Score
There are a number of scores on your record. All of which will be quite similar and the differences between them should not be a huge concern.
There is your:
FICO score: which you will typically find on the website/app of whomever you have a credit card with
VantageScore: This number is developed by collaborating scores at all three credit bureaus
Credit Bureau scores: There are 3 credit bureaus: Equifax, Transunion, and Experian. Depending on when things are reported to each, the scores may differ a bit. You can see your score for each on their websites.
The score range can differ as well, but the most common is 300-850.
300-629 = bad
630-689 = fair
690-719 = good
720-850 = excellent
Credit Score Factors
There are several factors that make up your credit score, these include:
- Payment history
- Credit card utilization
- Derogatory marks
- Age of credit history
- Total accounts
- Hard inquiries
Some factors impact your score more than others. We will cover each in detail.
Payment history – HIGH IMPACT (~35% of your score)
If you make a payment over 30 days late, it will be reported. The longer you go without making the payment, the worst the impact will be.
Eventually, if you don’t make a payment after 90 days you may go into collections or your items could be repossessed.
Late payments will drop your score dramatically so it is best to avoid them at all costs. Late payments also stay on your credit report for up to 7 years.
Tips to avoid late payments
- If you notice yourself making late payments at all, even if it’s only 1-2 days, you need to take action.
Determine what you need to do to always make payments on time (save more, spend less, make more money, get rid of something, etc.)
- Keep track of ALL your bills
Make sure you know who you owe, how much you owe, due dates, etc. Keep all that information organized.
- Create a budget
I know budgeting doesn’t sound fun but it’s SO important. Without a budget you may be overspending and this is usually how you end up making a late payment.
- Have an emergency savings
Determine what amount feels comfortable to you and work on saving that up. If a time ever comes where you need the money, you’ll be grateful to have it.
- Don’t spend more than you can afford
This comes back to your budget, but basically you shouldn’t be charging so much to your cards or buying a car that is well above your means.
- Set up auto payments
Auto payments are a great way to never miss a payment. You can set it once and never have to think about it.
- DO NOT co-sign
Do not co-sign on something for anyone else! I learned this the hard way and it caused my score to decrease dramatically due to missed payments.
Learn from my mistake:
Utilization Rate – HIGH IMPACT (~30% of your score)
Your utilization rate is how much of your credit limit is being used. This number is calculated by dividing your total debt by your credit limit and multiplying that by 100.
To be “in the green zone” it is best to keep your utilization rate below 30%, but 0% is ideal.
If you don’t have 0%, that means you have revolving debt and are paying interest.
- Prioritize paying down credit card debt
As this will quickly raise your credit score by lowering your utilization rate
- Request a credit limit increase but DON’T use the increase
If your limit gets increased, your utilization rate will decrease causing your score to increase
- Call your lender and ask for a lower interest rate
This wouldn’t raise your score directly but it was save you money by paying less on interest and you can then pay more toward your principal. Of course lowering your utilization rate.
Derogatory Marks -HIGH IMPACT
Derogatory marks include things like accounts going into collections, repossession of a vehicle, or bankruptcy. These marks can stay on your report for 7-10 years and you want to avoid them at all costs.
Tips to avoid derogatory marks
- Make your payments on time (refer to tips above)
- Be financially responsible
Don’t make poor financial decisions such as deciding to buy a car that costs half your income. Think long term and be reasonable.
- Weigh your options before filing bankruptcy
You may be able to get out of your situation with a plan and some focused effort. Bankruptcy is a big decision and will impact your life for the next decade. There is probably someone who was in the same situation as you but got through it. Do your research, read blogs, watch videos, get disciplined.
- Check your score regularly
If you’re financially responsible then you shouldn’t have to worry about any derogatory marks. However, mistakes can be made and that could reflect on your report. Check your score regularly to make sure nothing is incorrect.
Age of Credit – MEDIUM IMPACT (~15% of your score)
Your credit history is how lenders can see that you have experience using credit responsibly. To be “in the green” your average history would be >7 years.
Credit history tips
- If you don’t have credit, open an account sooner rather than later
- Keep your credit card accounts open once they are paid off.
If you close the account your credit history will decrease. You can maintain a $0 balance but be sure to use the card every couple of months or so, otherwise the bank may close the card without warning.
- Limit how often you open new accounts
Each time you open a new account it shortens your history
Total Accounts – LOW IMPACT
Lenders want to see that you can use a variety of accounts responsibly (credit cards, auto loan, student loans, mortgage, etc.). Your accounts include open and closed accounts but to be “in the green,” 11 or more accounts are needed.
- Be sure the accounts on your report are correct
- Don’t open unnecessary accounts just to increase your total
This impact is quite small and over time it will improve
Hard Inquiries – LOW IMPACT
Each time you apply for a loan or new account, an inquiry is reported. These inquiries can stay on your report up to 2 years but overtime their impact tends to fade. To be “in the green” you would need 2 or less inquiries at one time.
- Before applying for an account, be sure to determine your approval odds
Determine the average score required for what you are applying for. There are often tools to determine if you pre-qualify.
How do you track your credit score?
- Check your accounts online (or on the app). Your FICO score will be updated every month or so and you can see that for free
- Credit Karma or Credit Sesame. Personally, I use Credit Karma and love it. I think it’s organized in an easy to understand manner. These apps are free and use your VantageScore.
- Credit Bureau websites. You can visit the bureau’s websites and check your score. You should be able to check these scores once a year for free, otherwise you would have to pay.
Overall, your credit score is an important number and something you should be aware of.
It’s a number you should give attention to at least once a month. It is a part of your financial journey and increasing your score can save you tons of money in the long run.