5 Things You Need to Know About Credit
My first real job out of college was as a loan underwriter. When I started I didn’t have a lot of personal experience with credit cards or loans; however, I had heard the stories of people getting in too deep and was interested in learning. Where better than in the shark tank?
By evaluating the credit risk of loan applicants, their credit reports, and then securing liens on assets put up for collateral of those who qualified, I learned a lot in a short amount of time. One of my biggest takeaways from the experience was that most people actually want to use credit wisely; they just haven’t had anyone tell them what that actually means.
This is not an exhaustive list of everything you could know about credit cards, loans, and other credit offerings. However, there are…
5 basic things that I think everyone should know about credit:
1. Your credit score is your financial reputation…and it carries a lot of weight
It’s helpful to think of your credit score as your financial GPA and reputation: People will see your score as a reflection of your character. In the minds of many who are reviewing it (and have no personal knowledge about you) it can be seen as a reflection of your integrity; it says something about your ability to borrow money, keep your word, and pay it back. The three major credit bureaus, TransUnion, Experian and Equifax, each have their own credit scores. Among the three major credit bureaus individual credit scores can range from 280 to 850 and the higher the number the better. Blemishes on your credit report last seven years, so it is vital to take credit seriously. When borrowing money, your credit score may affect your interest rate which can translate into thousands of dollars paid in interest over time. That’s thousands of dollars you could have kept instead. Employers, landlords and insurance agencies also may review your score to determine your responsibility and character.
2. Good and Bad Uses of Credit
It’s important to only take credit out for a specific purpose because every time you obtain credit you are putting something else on the line. For example, if you take out a home equity loan, you are giving someone else the right to take your home and sell it in order to repay your loan if you are unable to. Putting your home on the line to repair a leaky roof (that could damage your home) may be appropriate, but other uses of the funds, like using it to go on vacation, are probably not. Using credit cards puts your credit score on the line, so if you are going to use them at all make sure to use them wisely. If you need to take out student loans, use them for tuition or books, but try to limit the amount you take out as much as possible. Since you are always putting something on the line when you use credit, a good rule of thumb is to minimize or eliminate the need for credit where possible, and when you do use it match the type of credit to the use of the credit.
3. Your credit score is made up of 5 factors
To build good credit, it is important to know the 5 factors that determine your score:
- 35% – Payment history (do you pay right away or do you miss bills?)
- 30% – Amounts owed (how much debt do you have?)
- 15% – How long you’ve been using credit (the longer the better—but better to be smart for a shorter amount of time, than not smart for a long period of time)
- 10% – Types of credit used (It’s helpful to diversify)
- 10% – How many accounts you’ve recently opened (The fewer accounts, the better)
Now that you know what a credit score is made of, here are some tips to start building good credit as a young adult:
- Stay under your credit limit.
- Always make payments on time. Always. You can set up automatic monthly payments on your credit cards website so that when your bill is due, the money is automatically drawn from your checking account.
- If you use a credit card, make sure you are not buying more than you can afford and pay off your bill in full every month.
- Only use a few accounts and commit to them. Keep current accounts open for as long as possible and be hesitant and smart about opening new accounts.
4. The role credit cards play
Credit cards can help or hurt you. They can help you build credit history, offer protection against theft of cash, and are useful in case of an emergency. However they are dangerous when used to make purchases you cannot afford and, if you only pay the minimum balance every month, the interest you pay on your balance can compound rapidly and overtime can be incredibly expensive. Credit cards can also damage your credit score if you fall behind on paying the bills. If you are thinking about getting a credit card, here are some tips for new plastic users:
- Don’t depend on credit cards for everyday spending. Use a debit card or cash for daily expenses—that way you won’t need to worry about paying it back, and you’ll be more apt to spend only what you can afford.
- Try not to own more than 1-2 credit cards.
- When looking for a credit card, compare these features: the Annual Percentage Rate (APR), the “grace period” between when you buy a purchase to when interest starts being charged on that purchase, annual fees (some cards are free while some charge a yearly fee for use), additional fees, and perks or benefits (airline miles, cash advances, etc.)
- Check out these sites to learn about the best cards for students: Nerd Wallet and US News Money.
5. Check your credit report annually
It is possible that errors could appear on your credit report, so it is important to regularly check it for accuracy. Because of how important your credit score is, you don’t want to risk anything falsely affecting it. Checking your credit score is also a way to catch identity theft early on. You have the right to a free copy of your credit report, at your request, once every 12 months from the three major national credit bureaus. You are also entitled to see your report within 60 days of being denied credit. You can check your credit report once a year for free at the three major national credit bureaus: EQUIFAX , EXPERIAN and TRANS UNION.
Written by Tricia Brown
This blog post is from the Author's perspective and doesn't speak for brightpeak financial. Contact brightpeak if you want to know more about brightpeak products, and keep in mind that they are not available in all states and there are some limitations (some exclusions and restrictions may apply).