What is a credit score?
Credit scores are a three digit numeric summary that tells lenders about your creditworthiness. It is formulated to predict your credit risk – the risk you will pay back what you borrow.
A good credit score can earn you lots of advantages in your life like: lower interest rates on lines of credit and loans like auto and home loans, better insurance rates, lower security deposits on – rentals, cell phone services and utilities. Overall, those who have higher credit are more easily granted credit and receive better interest rates.
Why is it important to build good credit?
Good credit plays a vital role in your financial life. Most people think of good credit for obvious reasons like getting a credit card, car loan or mortgage. But credit can play a less obvious role in things like renting a car, apartment, or home, getting approved for a cellphone contract, and perhaps even getting a job. When applying for a loan or lease, lenders want to see a credit reference to see if you’ll be able to responsibly manage the money they lend you by paying them back on time.
Building Credit from scratch
If you are new to credit and need to establish credit from scratch, here are a few things you can do:
- Open a credit account- The first step in building credit is to open a credit account. You may have to start with a secured credit card or credit builder loan.
- Pay your bills on time- This includes everything from credit cards and loans to rent payments, utilities and cell phone plans. Even accounts that aren’t normally reported to the credit bureau can negatively impact your credit score if they are referred to a collection’s agency.
- Apply for new credit cautiously- When you apply for new credit, the lender will check your credit, resulting in a “hard inquiry” on your credit report. Hard inquires bring down your credit score, especially if you open several new lines of credit in a short time frame.
- Monitor your credit- Get in the habit of checking your credit report regularly. Analyze it for inaccurate information and dispute any incorrect information with the credit reporting agency immediately.
Building Credit Responsibly
The first step in building credit is to apply for your first credit account. For many, their first credit application is for a credit card. But without any credit history, you may not qualify for one of the major credit card issuers such as Visa or MasterCard. The good news is, there are other ways to start building responsible credit history without a credit card.
Seven alternatives to traditional, unsecured credit cards:
- Store card
- Secured card
- Credit builder loan
- Certificate of Deposit – insured loan
- Student loan
- Authorized user
In order to continue building credit responsibly it is important to make your payments on time, pay down your current debt, limit credit applications and keep old accounts open to help lengthen your credit history.
- Pay on time every time- A commitment to never make a payment late is one of the most powerful steps you can take to demonstrate responsible use of credit.
- Pay down existing debt- Paying down debt decreases your current debt which makes up 30% of your credit score calculation.
- Avoid taking on additional debt- Applying for additonal credit will result in a "hard inquiry" negatively impacting your credit score.
- Pay collection accounts- Pay any collections accounts you may owe to tie up loose ends. Then focus on your other debts.
- Keep old accounts open - Length of credit history accounts for 30% of your credit score calculation. Keeping old accounts open longer can lengthen your credit history.
- Avoid excess credit applications- If you apply for credit too many times within a short period of time it can look to lenders as if you need credit to pay your bills.
If you can follow the above six steps, you should be able to easily maintain your credit score and watch your score climb over time.
The best way to build and maintain your credit score is to sit down and study your credit history. Be patient, diligent and watch your credit score rise.
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