The final course in my lower-div series on credit. Now that you know what credit is and how to get it started (you paid attention right?!?) let’s talk about the most important part- how to get good credit. Like a dog, credit isn’t really pleasant unless you do a good job taking care of it. And even though we don’t know exactly how scores are generated, we know enough to make some good decisions (I hope). These good decisions helped me buy my own place a month after I turned 25.
The sparknotes version is pretty simple:
- Get credit
- Use it lightly
- Pay off what you used in full and on-time
*DO NOT BUY IT IF YOU CANNOT PAY FOR IT IN CASH IMMEDIATELY*
But it can get a little more complicated. Remember this guy? Your FICO credit score is based on 5 categories*:
- Payment History (35%) – are you paying on time?
- Amounts Owed (30%) – how much of your credit do you use?
- Length of Credit History (15%) – how long has your credit been open?
- Credit Mix (10%) – what types of credit accounts do you have?
- New Credit (10%) – how often do you request new credit?
*Exact changes to these categories based on your actions is unknown; percentages represent how important each category is toward your overall score.
Thangs To Do:
Having several credit cards and using them properly is great for your credit, but ultimately the best thing you can do is have credit from multiple sources.
In Credit 103 we discussed not opening up thangs like loans unless you need them for a specific purpose like going to med school or buying a car.
As you can see below, in 2012 I didn’t have any “installment” aka loan accounts open at the time, and this was seen as a negative attribute. It didn’t harm me in a major way, but it didn’t help either. Remember- even though you think you’re doing a good thang by avoiding loans, a creditor needs to see proof that you can borrow and pay money back successfully. In other words, having a loan that you successfully pay off is better than no loan at all (even if it technically means you have debt*).
*Debt from credit cards is bad. Other kinds of debt like mortgages are good as long as you are paying them off!
2. Try to keep your Credit Utilization Ratio under 20-30%- Ideally under 10%: Affects Amounts Owed, 30% of score
Just because your credit limit is $3000 does not mean you should spend that much- it’s really just there in case. This is the one thang that would ding me the most- even though I always paid every single monthly balance on-time and in full. If you don’t remember how Credit Utilization Ratio (CUR) is calculated, see here.
Side note on my report: I also didn’t have many accounts (affecting credit mix) and the ones I did have didn’t have a long history (affecting payment history). It still ended up being ok, but you can see why it’s important to get started early and do it right!
The obvious answer to this struggle is to use less credit. You don’t need to use that much of your credit to help it grow- in fact, you can buy something as small as a pack of gum every month or not use it at all other months. If you’re getting close to your limit, you may need to pay in cash/debit card instead, or better yet – hold off on buying something you probably don’t even need in the first place. Or…
3. Increase Your Credit Limit: Affects Amounts Owed, 30% of score
Have you ever asked for an increased credit limit? Chances are, you probably haven’t. You’ve probably received a small bump automatically from the credit card company but you can- and should– ask for an increase. Especially if you got a new job or a raise- this is a great time to ask for a bump! Try not to do this more than once every year, otherwise it looks desperate.
As far as I know, income here is self-reported, unlike a mortgage which requires you to prove with pay stubs, tax documents etc. (more on that later). Small bumps are usually approved automatically (either online or over the phone- however you decide to do it). Larger bumps may need to go to a special department and require human approval.
Here’s a rough idea of some numbers floating around out there. I obviously haven’t tested at each level, but I did request the upper limit for my pay range/credit score and was instantly approved. Don’t know your credit score? Click here
If you aren’t getting an increase in your credit limit that you are seeking you may want to consider…
4. Adding A New Credit Card: Affects pretty much all the categories
I personally have two cards- a Visa and an American Express through Bank of America, and they cover me in every situation that I need. I’ve thought about opening another one recently, but I’m waiting until I see one with a signing bonus (cash or airline miles) that makes it worth my time.
I wouldn’t really recommend going above 3-4 cards: it’s just not necessary and becomes more of a risk for accidentally missed payments (plus it leaves you more exposed to credit card fraud = headaches). Having 10 cards doesn’t help as much as you think because lenders don’t just look for credit limits, they also look for length of credit history and diversity of credit type (see chart).
So why do it then? Besides signup perks, having a higher limit gives you more cumulative credit to spread the debt over. Your usage is calculated multiple ways- first the amount you spend per card limit, and also the total amount you spend over your total limit of all cards. Example: You spend $500/$1000 on Card A (=50% CUR) + $500 /$10,000 on Card B (=5% CUR) which together is ($500+$500)/ ($1000+$10,000) = 9% CUR. Either way, keep that CUR low!
Protect Your Credit
5. Freeze Your Credit: Affects New Credit & Amounts Owed, 10% +30% of score
I know, I know. You’re sick of hearing me say this, but I am telling you- it is not a matter of if your identity will be stolen in this lifetime, but when. If you’re going through the steps of building good credit, why leave yourself vulnerable to strangers who can steal and ruin it?! FREEZE IT.
This will prevent thieves (and you) from opening up new credit and using the good credit you have to buy $800 worth of Verizon phones. <– Click dis link to learn more.
Remember: A credit freeze is preventative, does not harm your score, does not affect your current accounts, does not stop your credit from growing and can easily be removed as needed. It is basically your new best friend.
Thangs NOT To Do:
Wait… didn’t I just say opening a credit card was a good thang? It can be a good thang if you do it in the right way. What you don’t want to do is open up a whole bunch at the same time. I also wouldn’t do more than 1 per year, and I would stop at 3 or 4 max.
Timing also matters here! You don’t want to open up a card right before you are going to ask for a big ticket loan like auto or mortgage. It makes you look desperate and like you’re trying to cheat the system by bumping up your score.
Creating a new card also is considered a “hard inquiry” and may temporarily drop your score a few points until you prove that you are using it successfully for a year or more.
An inquiry is when someone or some institution looks into your credit. Creditors distinguish between two types of inquires: hard (when you are applying for new loans or cards) vs. soft (usually part of background checks, when you check your own score etc.)
Hard inquiries may drop your score if you have too many in a short period of time (i.e. if you are trying to get a mortgage, are rejected and then try to qualify with another lender, you’ll have multiple inquiries & it doesn’t paint the best picture) but they should go away in a year or so.
After my last post, my friend said she was inspired to open another credit card- awesome! But then she said she was going to close one of her cards instead- “noOooOoOoOoo” was my response and then my eyes popped out of my head.
Unless you are paying a high annual fee for the card, there is really no reason to close it- ESPECIALLY if it’s one of the first cards you opened. Keeping it open keeps your total credit limit higher (remember it’s calculated over all the cards) and helps preserve your credit history. The longer you’ve had it, the more valuable it is. Even if you only use it once every 6 months, just keep it open!
8. Do NOT Miss Payments: Affects Payment History & Amounts Owed, 35% + 30% of score
Pay your bill. On time. Every month. DO. NOT. EVER. MISS. A. SINGLE. PAYMENT. Being 30 days late is almost as bad as bankruptcy, and the higher your score, the bigger the dent from even a single slip up! Put your bill on Autopay from your checking account so you don’t have to worry about it. Yes, this means it will take the money out of your account without you, which can get you into trouble with things like …overdraft… but that’s why earlier I said:
*DO NOT BUY IT IF YOU CANNOT PAY FOR IT IN CASH IMMEDIATELY*
If I ever got into a pickle, I would have asked my parents or friends for a short loan rather than miss or under pay a bill. This never happened because I maintain emergency savings, but I get that sometimes that isn’t possible. Just do whatever you can to avoid this.
If you don’t spend too much, this is very possible to achieve!
9. Do NOT Underpay: Affects Payment History & Amounts Owed, 35% + 30% of score
You’ve probably noticed on your bill an option to “Pay Minimum” or pay some other amount. Never do this. Your credit report clearly shows how much you spend every month and how much you pay off- it’s not just some grading system with “yes she paid” or “no he didn’t.”
Creditors and lenders want to know that you are going to pay back the money you owe, and slipping up here doesn’t look good.
Most importantly- if you underpay or don’t pay at all you end up paying way MORE over time! Remember that little thing called interest. Well this is where it kicks in- if you don’t pay your monthly amount due, you will pay a percent interest on whatever balance you keep rolling over from month to month. Plus you may get hit with fees and/or not be allowed to spend as much in the future. Bye money.
10. Do NOT Default / Go Into Collections: Affects Payment History & Amounts Owed, 35% + 30% of your score
Remember our good friend collections? Yes, this is the good friend you never want to meet unless you are the one trying to collect $$. If you miss payments, not only will it mess up that beautiful payment chart, it can also show up in a separate section of your report. This is the “no-no” section and is populated by other judgments against you.
And that’s it! If you made it this far you are a true champ.
Want To Learn More?
Check out this blog for tips on CUR & your credit score! Now get out there and make some good decisions!