How to Build and Maintain Good Credit
Have you ever missed out on an opportunity because your credit score didn’t qualify you for something like a loan or rewards credit card? This scenario is common, but you don’t have to let your poor or nonexistent credit rating limit your opportunities forever. You have the power to build and improve your credit score.
Find out how good credit is defined and what you can do to build your credit from scratch or boost your current credit score.
Defining a Good FICO Score
A good credit score is 720 or higher; however, lenders will use varying standards to determine one. Therefore, you should always continue improving your score to obtain high credit approval rates and low-interest rates.
A FICO (Fair Isaac Corporation) credit score is the most common score that lenders use to determine your creditworthiness. This three digit score is based on five components: 35% Payment History, 30% Amounts Owed, 15% Length of Credit History, 10% Types of Credit in Use and 10% New Credit. Your activity in each of those areas determines your credit score.
Credit Score Ranges
Here is an example of five common credit score ranges and how they are labeled:
- Excellent Credit: 750+
- Good Credit: 700-749
- Fair Credit: 650-699
- Poor Credit: 600-649
- Bad Credit: below 600
Why is Good Credit Important?
Your score determines whether or not you’ll be approved or denied for credit and a higher or lower interest rate on loans. People with poor to bad credit are likelier to be denied a loan altogether. With a good credit score, it will be easier to get that credit card, rent an apartment or sign up for an insurance policy. Sometimes employers even look at the credit scores of potential employees. Your good credit demonstrates your ability to be reliable and responsible in numerous aspects of life.
With a higher credit score, you’ll be eligible for more opportunities to take out different types of loans and credit cards, benefit from credit card rewards schemes, enjoy higher spending limits and principal loan amounts, and you’ll pay lower interest rates.
Effects on Interest Rates
A general rule of thumb when it comes to borrowing is that the higher your credit score, the less you ultimately end up paying back, because you will be approved for a lower interest rate. Some lenders break up credit score classification into even smaller categories than the five ranges listed above, with 20-point intervals to determine which interest rates a borrower will pay. That means if you can bring up your credit score by just ten points or so, you can be approved for a lower interest rate.
Tips for Building Credit
Now that you can see why your credit score is crucial for your financial opportunities, you understand why it’s important to have good credit. We offer advice below for both people who are new to financial responsibility and have no credit yet at all, and those who already have some credit history and want to work on improving their score.
How to Build Your Credit from Scratch
1. Get a personal credit card.
The best way to start building credit if you have none is to sign up for a credit card and use it responsibly. If you have no credit, you may not be eligible for a high-limit card, but you will be able to get a low limit “starter” card to start proving that you’re responsible with credit. Use it regularly for a few small purchases and pay it back in full each month, on time. Starter credit cards may have higher interest rates or annual fees, but if you keep paying it off, the interest rates won’t impact you too much. Late payments and excessive debt will bring your credit score down, so be sure you only use it in situations you know you can pay back.
2. Open a credit account with a cosigner who has good credit.
An alternative to opening a personal credit card account is to have someone (like a parent) add you to one of their credit card accounts and add you as an authorized user. Make sure the credit card company asks for your social security number. Otherwise, this technique won’t help you build your own credit. And, of course, be sure this account is being used responsibly and paid back on time.
3. Take out a loan.
If you don’t want to get a credit card now, another way to establish credit is to take out a loan. You may be approved for lower interest rates or have an easier time getting the loan when you have a cosigner with good credit. Student loans are a common loan for first-time borrowers, and your parent or another close relative can co-sign on it. If you were on the fence about borrowing money to pay for education, one benefit of doing so would be that it contributes to your long-term credit history. Typically, you don’t have to pay them back until after you’re finished with your degree. If you make payments on time and pay them back quickly, you will bring up your credit score, but late payments will negatively impact your credit, just as late credit card payments do. Learn more about student loans here.
How to Improve Your Credit Score
It’s an ongoing process, but you should always work to improve your credit score. Here are some tips to help you do so.
1. Pay your bills on time.
At 35 percent of your credit score, payment history is important so pay your bills on time, not after the due date. You can start paying your bills on time immediately, but remember this positive action can take up to a year to raise your score. Setting up payment reminders or auto-pay with your credit card companies and other debtors will help you make payments on time.
2. Have a variety of types of credit lines open.
If you have loans in addition to a couple of credit cards in your name, your credit score will be higher than if you have just one line of credit. Doing so shows that you can responsibly handle different types of credit.
3. Keep an eye on your credit card balances.
Keep your debt at about 30% or less of your total credit limit. Use your credit card regularly, but pay it off as soon as you can. This effort is a less is more situation: by using less than 30% of your total credit limit, you will be rewarded with an increase in your credit score.
4. Keep your accounts open.
The longer your line of credit has been open, the more it adds to your credit score. Closing a credit account could bring your score down.
5. Don’t show risk.
Avoid opening too many credit accounts around the same time, as it will bring down the average age of your credit lines. Each time your credit report is pulled (i.e. applying for a loan or credit card) this will be reflected in your credit score and seen as a red flag by lenders. Keep this activity to a minimum.
6. Be patient.
It takes time for your credit score to improve so be patient. Adopt a proactive stance. If you have any questions, you may consider undergoing credit counseling.
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