Everyone needs to be concerned about their credit. Building credit is necessary in order to obtain a credit card, buy a car, buy a house, rent an apartment, or even apply for a job. Chances are that you are already building credit, whether you are aware of it or not, and maintaining a good credit score is important as your life changes. Being proactive about building your credit can open new doors for you as you plan for the future.
First, let’s consider what we mean by “credit.” Credit basically means that you receive something of value now with the promise that you will pay for it later, usually with added interest fees paid to the lender. There are different types of credit debts.
- When you enter into a contractual agreement for a loan, a lender lets you borrow money for a specific purpose, such as buying a car, purchasing a home, or paying for your education. The terms of most loans require you to pay a fixed monthly payment, including an interest charge, until the loan amount is repaid.
- Revolving credit gives you access to money up to a spending limit that you repay when you can. Credit cards are a form of revolving credit; the credit card company issues a card with a maximum spending limit, with the understanding that you will pay part or all of what you owe each month. Revolving credit means that as you pay down the amount you owe, the amount available to you in the form of credit increases. The amount of interest you pay is based on the amount you owe at any given time.
Your personal credit will determine what you can borrow and at what rate of interest. If you have a good credit history, it means you are considered a good credit risk, which makes it easier to borrow money. Your personal credit is reflected in your credit score.
Managing Your Credit Score
Your credit score is a number between 300-850 that indicates your credit worthiness (i.e., whether you can be trusted to repay the debt). Your credit score is administered by Equifax, Experian, and TransUnion, the three credit reporting agencies, using a formula that balances factors such as your payment history (do you pay your bills on time), how much you owe, how long you have had a credit history, and how much new credit you have. Based on these factors, you are given a credit score between 300-850. A credit score of 690 or higher is considered to be a good score, making you a good candidate for a loan.
It’s almost impossible to borrow money if you don’t have a credit score, and to establish credit, you need to borrow money. This may seem contradictory, but there are some simple strategies you can use to start introducing yourself to the credit bureaus and building your credit:
- Student loans are commonly issued to young adults entering college. Most students are still building their credit, and student loans can help establish credit by adding new accounts to your credit report.
- Credit cards are another easy way to help build credit. If you can’t qualify for a credit card on your own, consider getting one of your parents or a spouse or relative with established credit to cosign for you to help you establish credit.
- If you don’t want to rely on a cosigner, you can take out a secured credit card. With a secured credit card, you put down a cash deposit to guarantee payment. The amount of the deposit is usually your spending limit.
- Getting a cosigner for a car loan or lease is another way to build credit. If you can’t qualify for a car loan or lease, get someone else to guarantee the monthly payments.
As you build your credit, you want to be proactive about managing your credit score. The best strategy is to be sure you make all of your payments on time. You also want to limit the amount of debt you take on. Don’t accumulate too many credit cards, and keep spending well below your credit limit. You want to either pay off your cards or try to keep a minimum balance to demonstrate you can manage your money responsibly.
An important factor that affects your credit score is your debt-to-income ratio (DTI). This is the ratio of the amount of money you owe each month in payments divided by your gross monthly income. For example, if you owe $1,000 in payments and your monthly income is $5,000, then your DTI is 20%, which is relatively low. You don’t want to have a DTI higher than 36% if you plan to borrow money.
Four Reasons Building Credit Is Important
Even if you don’t plan on applying for a loan or credit card, starting to build credit early is important. Lenders, landlords, insurance companies, and even employers use your credit score as one of the metrics that tells them if you are trustworthy, and one of the most important aspects of building your credit is your credit history. The earlier you start building your credit, the sooner you will have a positive credit history.
Building credit as early as possible also will help you prepare for things you are sure to need at some time or other. Here are just four instances in which having good credit can give you a real advantage:
1. Applying for a Loan
We all need to borrow money sometimes. Whether you need help paying for a college education or a car, you want to be in a position to borrow when you have to. If you are looking to make a big financial commitment, such as buying a home, then you have to have good credit to get the loan.
Any lender, whether it’s a mortgage broker, a car dealer, or even Sallie Mae, needs to review a credit application before they will lend you money. The first thing they will look at is your FICO score, which is provided by Fair Isaac Corporation and uses your credit score and its own algorithm to assess your credit worthiness. If your credit score isn’t high enough, you will likely be refused a loan, even before you can make a case for borrowing.
Building good credit can also affect how much you pay for a loan. Having a good credit score will help you qualify for a loan, but having an excellent credit score can reduce the interest rate. If you are buying a car, for example, having poor credit limits your options considerably, whereas having a credit score of 700 or higher makes it easier to borrow more money at a lower rate of interest.
2. Buying a Home
If you want to own your own home one day, having good credit is essential. The type of mortgage you can qualify for depends on your credit. For example, the Federal Housing Administration (FHA) requires first-time homebuyers to have a credit score of 580 or higher to qualify for a home loan with a 3.5% down payment. If your score is lower than 580, then you need a down payment of 10% or more.
As with other types of loans, the better your credit score, the better your interest rate. It is easier to get a good deal on a mortgage if you can show you are a good credit risk.
Even if you don’t plan to buy a home, having a good credit score is important for renters. Most apartment managers require you to provide a credit report, proof of income such as a paycheck, and proof of renters insurance before they will let you sign a lease.
3. Qualifying for Insurance
Just as your credit score has an impact on loan interest rates, it can have a dramatic effect on care insurance as well. An insurance score, which is a credit-based score, is used by underwriters to determine the likelihood that you will file a claim. The lower your insurance score, the more likely you are to file a claim, which makes you a poor insurance risk.
When applying for auto insurance, for example, how much they charge for insurance depends on a variety of factors such as your driving record, how long you have been driving, the age and make of the car being insured, your zip code, and your insurance score. The only one of these factors you can control is your insurance score.
4. Finding a Job
Many employers look at your credit score as part of job qualifications. A good credit score may not affect whether or not you are hired, but a poor credit score could take you out of the running.
Human resource professionals review your credit history to learn about one aspect of your character. A poor credit record could indicate lack or organization or lack of reliability. Having too many delinquent accounts or high monthly payments could tell a hiring manager that you are a risky hire, especially if you have access to company funds or assets.
Clearly, monitoring your credit history and proactively working to build credit as soon as you can is valuable. If you do have to borrow, where you borrow matters as much as your credit score, or more. Most lenders, such as big banks, have strict qualification requirements for a loan, and if you don’t fit the criteria, including your credit score, you are simply refused. Credit unions, meanwhile, are member-owned and operated, which means that you can usually speak with a loan officer who has more power to approve or deny a loan.
At iQ Credit Union, we are committed to partnering with members on their financial journey, including offering competitive rates on auto loans, home loans, credit cards, and personal loans. We can help you start building your credit now. Come by any of the iQ Credit Union offices or contact us so we can show you how.