Credit is a big thing in the United States. It is how you open up credit cards. Your mortgage rates are based on your credit score. Plus, having a good credit score can help you save money through the interest rates that banks give you to buy things. It is time to improve your credit.
Credit is important. It gives banks trust that you will pay all of your financial obligations. If your credit score is poor or you have no credit at all, this article will help you make it better. This is one of the first steps to establishing your financial history.
What is Credit?
You may have made many payments with cash or even a debit card when growing up. The money comes out of your account; you cannot buy anything if you have no money.
Credit works a bit differently. The money that purchases items for you comes from a banking institution. The bank figures you will pay it back and lends you the money to buy things.
Suppose you go to a store to buy something and use a credit card. The bank is the one that purchases the item. Then you have the responsibility to pay the bank back for the purchase you made. That is how a credit card works.
A good credit score is based on the notion that you will pay back the loan. If you can pay bills on time and not leave any bills outstanding, your credit score will increase.
If you cannot pay bills and have creditors knocking on your door for payments, banks will see that you are not a low-risk, and your credit score will be lower.
Lenders score your credit in many different ways. The most famous is the FICO score, Fair Isaac Corporation. There is a range of 300-850.
300-650 = Poor or fair: Lenders may not want to lead to people in this category. They may also have a higher interest rate on any loans they may wish to take out.
650-720 = Good: You should be okay with taking out credit cards and some small loans.
720-850 = Excellent: With this score, you will get the best interest rates on loans and probably multiple credit card offers.
Three companies give each person a score to help with the FICO score. They are Equifax, Transunion, and Experian. Each company may provide a different score, but they are based on five categories.
5 Categories for Credit:
- Payment History (35%)
The first thing any creditor will want to know is if you pay your bills. Creditors want to know if the individual will pay back the loan on time. Lenders want to see if it is high-risk vs low-risk. This factor is the essential part of your FICO score. That is why it is 35% of your score.
- Amounts Owed (30%)
This is the utilization of your credit. Banks want to know how much of your credit you are using. The rule of thumb is to keep your credit utilization below 30%. If you are maxing out your credit cards, this may be a red flag to banks seeing that you could be over-extended and unable to pay off your financial obligations. It is best practice to keep your utilization down.
- Length of Credit History (15%)
Creditors take into account how old your credit history is. They will find the oldest account and the newest account and make an average. They will also see when you first established credit and how long it has been since you used certain accounts.
It is best to keep those fee-free credit cards that you have had forever. Now and then, make a purchase to show the banks you are still using them, so they do not get shut down.
- New Credit (10%)
History has shown that opening up many credit cards in a short amount of time may offer some risks. It is better to spread out applications throughout the year not to hurt your score.
- Credit Mix (10%)
Creditors will also look at the different kinds of accounts of credit you may have, such as a credit card, home mortgage loan, or any other loans.
How to find your credit score:
There are several places to look to locate your credit score. If you have a credit card, it may be possible to offer a free check of your credit. Several different websites can do a review for free as well.
Knowing your credit score is a great way to save money if you want to purchase a home, refinance a home, or even buy a new vehicle using a loan. It is better to know your score than to be blindsided.
5 Tips on How to Improve Your Credit Score:
If you have taken a look at your credit and noticed it was not as good as you had hoped, then it is time to start improving it. Here are some tips that can help you make a difference in your credit score.
Pay Your Bills:
One of the biggest things hurting people is not paying their bills on time. If you have a credit card, make sure to pay it in full at the end of the month. Do not pay the minimum that the credit card companies offer. They hope you pay the minimum to put a significant interest rate on your balance.
Having the discipline to continue to pay your bills on time gives the banks more trust. They will then be able to lend more money to you. Continue to always pay your bills on time.
Open up a Second Credit Card:
This is one way to create more credit for yourself. If you open up a new card, you will have the opportunity to have more credit afforded to you, making a lower utilization of your credit. This will then put more trust in banks, increasing your credit score.
A few years back, I opened many more credit cards when learning about travel hacking. In the process, my score jumped up to 80 points. Ever since then, I have not worried about credit. It has been excellent for the longest time, and with low credit utilization, banks trust me more and keep upping my credit score.
Be an Authorized User:
Often, we have such poor credit that we need some help. Becoming an authorized user on another person’s account will help you increase your score. It is like someone co-signing for you on loan. They use their good credit to help you improve your own.
Don’t Close Unused Credit Cards
If you have some unused old credit cards that do not have a fee, do not close them. That affects your credit history. Once that card is closed, your score will be negatively affected by the average of your past.
Make sure to also use those cards once in a while. I know certain banks like Chase and American Express have been known to close accounts that are frequently inactive.
Low Credit Balance
Make sure to keep your credit balance below 30%. If you use too much, the creditors will bring down your score due to the risk involved. As long as your balance is relatively low, you will be a low-risk to the banks.
A Word of Caution:
Credit cards are great tools to improve your credit, get cash-back points, and use for purchases. As a word of caution, do not go over and beyond what you can afford. Budgeting your money and not overspending is imperative to have a good credit score.
Use your credit wisely. Do not overspend.
Keep Working on Your Credit
I hope these tips and guidelines can help you with your credit. When I first learned about this, it opened my mind to numerous possibilities. It also gives you many more financial opportunities. This will also help with financial independence.
Keep working, keep saving, and keep improving your finances for your life. It only takes one step to start moving.
As you are working on improving your credit, remember to stay organized and disciplined. Credit can help you with saving money on making bigger purchases, and also allow you to have lower interest rates.
It can take some time to allow that credit to build up. Even those that work on opening up many credit cards as they try to travel hack, they need to know that opening too many credit cards at once can affect credit as well. Be wary about how you use your credit and make sure you follow the tips to create a better score.
I’m Steve. I’m an English Teacher, traveler, and an avid outdoorsman. If you’d like to comment, ask a question, or simply say hi, leave me a message here, on Twitter (@thefrugalexpat1). Many of my posts have been written to help those in their journey to financial independence. I am on my journey, and as I learn more I hope to share more. And as always, thanks for reading The Frugal Expat.