What’s your credit score? I try to stay on top of mine (it’s around 802 currently!) More importantly, do you know why your credit score is important? In short, having a good credit score can save you thousands over the course of your life. Lenders base their interest rates on your credit score, among other factors. Having a high credit score shows lenders that you are trustworthy and lenders will loan money at lower interest rates. This is the same when buying a car, purchasing a house, or refinancing student loans. So how are credit scores are calculated, what kind of credit score you should want, and finally, how should you build credit to get a good score?
There are a number of credit scores in use around the country, however the most important for our purposes is the FICO credit score. It’s a number between 300 and 850, with a good score for a young professional being above 700. If you want to check your credit, the easiest way is to go to CreditKarma.com, where you can receive a free credit report from two of the three major credit agencies (Equifax and TransUnion). Stay away from their credit card offers and take advantage of the fact that you can receive free updates on your credit scores.
Credit scores are calculated by a fairly complex algorithm and we’re not going to get into the specifics of how they’re calculated. What we are going to talk about are the factors that go into your credit score. Without knowing the factors behind a credit score, it’s impossible to know what to focus on in order to raise your score. There are five factors used in calculating a FICO credit score: payment history, credit utilization, length of credit history, new credit, and credit mix.
1. Payment history is the most important factor, which counts for 35% of your total credit score. Payment history means that you’ve made your payments in full and on time. If you’ve missed payments or made them late, it can quickly bring down your score. I can’t stress enough how important it is to make your payments on time.
2. Credit utilization refers to the amount of debt that you have, relative to your income and your actual credit limit. Ideally you want your credit usage, which is the amount of debt you’re using divided by your credit limit, to be less than 30%. Credit utilization counts for 30% of your FICO credit score.
3. Length of credit history is pretty self-explanatory. It refers to how long it’s been since you opened an account and the amount of time since you’ve had activity in that account. With this factor, longer is obviously better. This can be a tough one for young professionals, however I’ll talk about a few ways to pad this later in this article.
4. Types of credit used counts for 10% of your credit score. This means that credit bureaus take into account if all of your available credit is from a credit card or other single type of credit. You’re better off having a mix of types of credit.
5. New credit counts for 10% of your score, so it isn’t a huge factor. This counts the number of applications for new accounts that you have, as well as credit inquiries for things such as jobs or apartments.
So now you know how to check your credit score and what score you need to have in order to save money on interest. You also know the factors which affect your credit score. Let’s move on and talk about actionable tips that you can use in order to raise your credit score.
· Get a credit card as soon as possible and use it (but sparingly). I know this advice is the opposite of what you’ve heard your entire life. I promise, there is a method to my madness. By opening a line of credit, you’re establishing a credit history. This will start the clock on the length of your credit history. By spending (and paying off each month in full), you’ll be building a history of on-time payments. In the long run, this will help you build a good credit score more than anything else.
· Fine one item each month to put on your credit card. This can be either groceries, gas, or something else that you have to purchase each month. Put only this on the card and pay it off in full. I’m repeating myself a bit but I want to emphasize using the card only for one purpose.
· Become an authorized user on a credit card with a long credit history. This one isn’t intuitive, so stick with me. If you have a parent or family member with a long credit history, they can add you as an authorized user on one of their credit cards. By doing so, you receive the benefit of the entire credit history associated with that card. You don’t have to actually use the card and you don’t even have to have a physical copy of it. My parents did this for me with one of their cards and it has been a huge help. My average credit history is nearly 13 years old, despite the fact that I’m only 27, due to the fact that I have credit on my history that is over 30 years old. I don’t have a copy of their card and I’ve never used it; all that matters is that my name is on the account.
· See if your landlord will report your rent to the major credit bureaus. That’s right, paying your rent on time can positively affect your credit score. It’s possible to have your landlord report your on-time payments, which can help you build your credit score.
· Don’t apply for too many credit cards. Like I mentioned earlier, new credit counts for a portion of your credit score. While opening new lines of credit can help your credit, too many credit inquiries will hurt your score. Do your research before you apply for a credit card; know which one you want and only apply for that card. Same thing goes for mortgages or car loans.
As you probably noticed, there aren’t many shortcuts to building good credit. The most important thing when building your credit is to open a line of credit as soon as possible and to pay that line of credit off in full, each month. By using your credit responsibly, your credit score will get better over time. It isn’t an overnight process but it will work. If you want other ideas for getting your finances in order, check out this episode of the Plentiful Wealth Podcast, or this post.