Oh C’mon, Give Yourself Some Credit
Congratulations new high school graduate! You’ve come a long way and I’m sure you have many aspirations for your bright future. Unfortunately, most of us need some sort of credit to help achieve our personal and professional goals. If that sounds like you, then investing in your credit now can be just as important—if not more important—than investing in your finances. For folks like us, good credit is the key to securing an automobile, activating utilities, buying or renting a home, and even getting hired for a job. Those things are all somewhat possible with bad credit, but that usually means lots of hassle, longer processing times, ridiculously high interest rates, co-signers, and substandard products/services.
One of the problems you will face is not having any credit. Lenders won’t know if you’re a risk, so it will be much more difficult for you to get approved for the things you want. Don’t worry, there are ways to invest in your credit score early so you’re set up for success later. There are both short and long-term benefits to investing in your credit immediately upon reaching legal age to do so. To get your credit history started, you need to (1) understand how credit scoring works; (2) understand the risks/rewards; and (3) take some simple steps toward success.
Understand how your credit scoring works!
As a certified professional coach (CPC), I often ask clients about their credit when they share their goals. Knowing and understanding your credit score allows you to make informed, realistic decisions about how to design a personal strategy to achieve your goals. Unfortunately, a lot of people (a) don’t know their credit score and (b) don’t truly understand why their score is what it is.
Your credit score—depending on the credit bureau—ranges from 300 to 850 (TransUnion & Equifax) or 330 to 830 (Experian). Although each bureau scores slightly differently, the following will serve a solid basic foundation.
In short: (a) having more credit with lower balances, (b) the right kind of credit, (c) less new credit, (d) a longer credit history, and (e) paying reportable bills on time will maximize your credit score. There are some other factors, depending on the bureau, such as average credit limit. It is also important to note that some bills, such as utility and cell phone bills, are not reported unless you fail to pay them on-time so they need to be paid just to stay out of trouble! So as long as you are paying, these bills do not count toward your good score but can count toward a bad one.
Understand the risks and rewards associated with credit.
Credit is not free money! You might be thinking, “yeah, I know that—thanks Jason”; but you’d be surprised at the number of people who use credit as free money when times get tough. Part of building your credit history, especially as a new adult, is being strategic about your approach to spending and using the advantages of credit without being caught up with debt, annual fees, or higher interest payments.
Debt – When you use credit, you incur a debt to the creditor. You must pay your obligation, on time, or you credit score will drop; this makes you a higher risk to lenders.
Annual Fees – Bottom line: stay away from any credit that comes with an annual fee! There are too many fee-free opportunities out there for you to start your credit history with. Read the terms of agreement carefully; some creditors offer 12-month specials with low interest rates or annual fees that later change to increased amounts.
Interest Rates – This is the percentage of the amount you borrowed that will have to be paid to the lender in addition to the amount borrowed. For example, if you have a credit card with a 15% interest rate and you spend $100.00. If you do not pay the card off before the grace period, you will owe $115 to the lender. You can avoid interest rates on credit cards by paying them off before the grace period which varies, but is often 20 days after the date you are billed. The higher your credit score, the lower your interest rates will be. So the main benefit of establishing good credit early is benefit of lower interest rates later when you go to buy a house or vehicle; for which there are usually no grace periods. A low credit score vs. a high credit score can be the difference between paying $15,000 for a car or $18,000—for the same car! That extra $3,000 in your pocket can be used to invest in other things, like a house, replacement vehicle, or investment accounts.
Predators – There are plenty of lenders around that deliberately target borrowers with low or no credit so they can profit from the absurd interest rates they charge as a result. You are better off saving up and going somewhere else vs. being prey to such lenders. Some auto dealerships and rent-to-own type businesses are examples of what you should watch out for.
Some simple steps toward success!
OK, so now that you have a fundamental understanding of how your credit works. What do you do? A lot of people say, “I’ll get a cell phone to establish credit!”—NOT! Contrary to popular belief, a cell phone bill (or any other utility for that matter) does not go on your credit report unless you don’t pay it! Try this instead:
- Pull a current credit report from the major credit bureaus. You get one of these per year for free so take advantage of it by using the free report to track your progress.
- Apply for a low-balance, no annual fee, secure, major credit card (e.g. VISA, MasterCard, or American Express). They are out there, trust me, I did this when I was young and it worked. For me, I applied for a $500.00 balance, no fee, VISA through the former Providian Bank. Check with your local bank or credit union.
- Each month, use your card only for purchases that you have the cash to pay for. Do not use it as a loan! You are trying to build your credit, not use it. It takes discipline, like all investing.
- Each month, prior to the grace period, pay the card off in full. This should be easy since you did not use the card for anything that you did not already have the cash for. I still use this technique and I pay off balances about once a week to make sure I get anything from the previous week. As long as you beat the grace period, it doesn’t really matter. The point here is to use your credit card to buy what you were already going to buy with cash, and then pay it back before the bank gets interest.
The foregoing will quickly help you establish credit, and before you know it, you will be in good shape. Two major credit cards helps raise your score, but starting with one card is the best option until you raise your score a bit. In about six months, the bank will likely “reward” you for on-time payments, thus raising your credit limit. This is a good thing! Now you have a lower debt-to-credit ratio, higher average credit limit, more on-time payments, and longer credit history; all factors that will raise your score! The banks will repeat this process until you reach—about—$2,000 or so. At that point you can start requesting higher limits (that you won’t use) to keep raising your score. Again, discipline is the key here. Having higher limits opens the door to more trouble if you get behind on bills and start racking up your credit debt. Don’t let that happen.
Once your credit score is raised, typically after a year or so, you can start taking advantage of the lower interest rates for other things you want or need. The key is to always pay everything off as soon as possible, but at least on-time without ever going overdue. The earlier you start this process, the younger you will be when you finally reach an excellent credit status. It will take a few years to reach high-good/low-excellent credit, but it will take about 15 years to maximize your credit score due to the history requirements; that’s why it’s an investment. As you pay off student loans, installment accounts (auto loans), and buy a home, your score will make spiked increases with each. It’s a life-long marathon, not a sprint; invest in your credit now!
Dr. Jason M. Newcomer
Vice Chairman of the Board
& Chief Strategy Officer