What is credit?
Before you give your credit a fresh start, you first must know what credit is. Sure, it can be boiled down to that little plastic card sitting in your wallet, but in reality, credit is much, much more than that.
By definition, credit gives you the ability to borrow money to pay for goods and services now and pay for them later. Creditors will grant you lines of credit based on how likely you are to pay back what you borrowed, and sometimes more depending on interest accumulation and interest rates. Credit cards, loans and mortgages are some of the most common uses for establishing credit.
Building and improving your credit score is critical to your financial security. However, understanding how to maintain, raise and build your credit score can be difficult.
What does a credit score measure?
Simply speaking, your credit score is a summary of your credit history. Banks, creditors and other financial institutions report your borrowing and repayment history to credit bureaus.
Based on your financial and credit history, credit bureaus compile a list of your credit history and assign a three-digit number to it (depending on where in the world you live).
There are a few pieces of information that typically make up a credit report:
- Credit card balances
- Borrowing limits
- Number of credit cards
- Loans taken out, including auto loans, personal loans and student loans
- Repayment history, as well as on-time payments, late payments and missed payments
- Foreclosures, car repossessions or bankruptcy
The importance of credit
Having a good credit score is critical if you plan on borrowing money in the future. Higher credit scores will increase your chances of getting approved for a loan for a car or a house. They also lead to better interest rates and better loan terms.
Another reason a strong credit history is important is that landlords may check your credit to determine if they want to rent to you or how big of a security deposit to charge. Insurance companies may also look at your history to decide your rate.
Your credit can affect all aspects of your life and your score says a lot about you. Building your credit from scratch or improving a bad credit score is an important aspect of financial stability and good financial health.
Building your credit score
Whether you are building your credit score from scratch or just trying to get your credit score up, these are the best tips we’ve found to raise your credit. It’s all about the little things — how small changes can lead to huge rewards. If your credit history is already less-than-perfect, it can be fairly easy to see those big jumps in your credit score.
1. Pay bills on time
Your payment history is the biggest factor in determining your credit score. Not paying your bills and loans back on time can severely impact your score. Becoming current on your bills will get rid of accounts marked delinquent, which will hurt your score.
You can set up auto-pay through many companies to ensure that all of your bills are paid on time and that you never miss a payment. Another trick is to make small, frequent payments to keep your credit card balances down. This can also help you in the credit utilization category as well, which is covered below
2. Credit mix
The types of credit you have matter. If you only have credit cards or only have loans, you need to improve your credit mix. Having a diverse credit mix can help boost your score, however, it’s not always a good idea to open a line of credit just to have a good mix — make sure you actually need it.
3. Credit utilization
Your credit utilization ratio can be difficult to understand. In most cases, the lower you are from hitting your credit limit, the better. Having a utilization that is too high or too low can impact your score negatively.
Having revolving lines of credit each month can help lower your utilization rate if it is too high. An ideal ratio is somewhere around 30%.
Closing your credit cards and credit accounts can make raising your score more difficult as this will lower your credit limit and impact how your credit utilization is calculated, which can result in a lower score. Using the card occasionally and paying it off on time will do far more for your credit score than closing the account.
4. Become an authorized user
If you have a family member or friend with a strong credit history and high credit limit, you may consider asking if you can be an authorized user on one of their accounts. You may have to check if this affects any legal obligations or terms of service.
As an authorized user, the account balances will be reported to the credit bureaus, but you are not responsible for making payments on the card. You do not have to use the card to reap the benefits. This method is best used for those with a thin credit file and can be very helpful because it can lengthen your credit history.
5. Secured credit cards
Secured credit cards can help you safely build your credit. You use it as you would use any card, but it uses a cash deposit upfront to determine your credit limit. Like other credit cards, you must pay off the card each month to avoid accruing interest.
A related option is a prepaid credit card, which works similar to a debit card but doesn’t impact your credit history. The card is used for purchases and withdrawals with preloaded funds from your bank account, so no interest is accrued.
Managing your credit score
One of the most important parts of managing your credit score is understanding the different types of credit that exist. For example, in the US, the most common credit models fall under either a FICO Score or a VantageScore.
Many banks and credit card companies will give you one of these scores for free in your monthly statement. Other important aspects of credit management include regularly checking your credit score and monitoring your credit balances to make sure there are no errors.
With diligence, you can improve your credit score and help to build a better financial future for yourself. And remember, a strong payment history is the best way to build your credit. By making your payments on time, for a long period of time, you can quickly become an ideal borrower.
