October 17th is National “Get Smart About Credit Day”. Across the U.S., bankers will be volunteering their time to talk to young people about the responsible use of credit. In the spirit of the day, I wanted to share some ways to establish good credit and build successful credit habits.
What is Credit?
Credit means receiving a good or service before payment is made, based on trust that repayment will be made in the future. As a credit consumer, you build that trust by responsibly borrowing and paying off debts. Not paying off debts erodes that trust and limits your access to credit. While many factors determine the credit you can access, the most important is establishing a history of paying off debts.
Building Good Credit
Building good credit means establishing a history of responsible use, which simply means paying your debts as agreed. While it may seem surprising, you can do so with minimal expense and without incurring unnecessary debt.
Here are three ways you can start building for your credit future.
- Secured credit card:
A secured card provides you with a credit limit equal to the cash deposit that you make when you open the account. So, if you deposit $500, you’ll have a $500 credit limit. This bypasses the trust factor from the lender and demonstrates that you are willing and able to make payments on your debts.
- Credit-building loan:
A loan, usually for $1,000 or less, is given to you in the form of a secured account. You then make monthly payments on this account. Once you have paid the loan in full, you receive access to the original funds. Again, this removes the need for trust and builds a history of making payments on a debt.
- Authorized user account:
If you have a friend or family member who is willing to add you as an authorized user on one of their credit cards, this can give your trust factor a boost. The account will be added to your credit history and look as if it belongs to you.
Using Credit Wisely
Any of these accounts can help you build your credit. No matter what type of credit you choose to use, it’s important to pay your bills on time, every time. When it comes to a history of on-time payments, more is better. Successfully managing one account over time is good but doing so with two or more accounts builds a stronger payment history and improves lenders’ trust. However, it’s important to understand the pitfalls with each loan type.
Credit cards are not free money. They are a method of payment used to obtain a good or service. Unless absolutely necessary, avoid paying for something on a credit card if you don’t have cash on hand for it. That amazing sale you took advantage of to save $50 on clothes will cost you even more than that if you carry a credit card balance to pay for it. Pay the balance in full every month, not just the minimum amount. Carrying a balance costs interest and isn’t necessary to build credit trust. Finally, try to stay under 10% of the total credit limit. Limiting your use makes paying in full each month easier.
Loans can be a great way to build your future. Whether it’s for a house, a car, education, or anything else, access to money can be a wonderful thing. However, if the payments are unmanageable, the results can be devasting. The first thing you should consider when taking a loan is the affordability of the payments. Before signing for any loan, make sure you can easily afford the payments. Target a monthly payment that is considerably less that what you think you can pay. Also, look for a loan without prepayment fees so that you don’t pay extra to pay the loan off early. Whenever possible, get ahead on your payments by adding a little extra to each monthly payment or making extra payments as your budget allows.
Authorized user accounts:
Choose wisely when you ask someone to add you as an authorized user. Pick a person that’s reliable and always pays their bills on time. As for the credit card, it should be at least two years old, have a balance less than 20% of the credit limit, and the account should have a history of on-time payments.
Why It Matters
When you make payments to your credit accounts (or miss payments), the payments and credit account history is reported to credit bureaus. This history establishes your credit report and is summarized as a credit score. By building a history of responsible credit use, your credit report—and consequently, your credit scores—reflects your trustworthiness to future lenders, employers, apartment renters, and insurance companies, decreasing the price you pay and improving the availability of the things you want.