Having access to credit is critical in making important purchases and, eventually, building wealth through homeownership. I like to call it a “ticket to play,” because good credit can open the door to many opportunities. But how do you understand what “good credit” actually is and how credit works? These three tips can help you build and maintain your own credit.
Review your credit report
Everyone is entitled to a free annual credit report at annualcreditreport.com. Reviewing your report is a great way to assess your current situation, identify and correct any errors, and map out your finances. Important information in your credit report includes:
Identifying information, such as your name, address and Social Security number.
Specific details about your credit cards and accounts, car loans and other loans.
Public record information, including bankruptcies, foreclosures, tax liens and monetary judgments.
Inquiries. This includes the names of those who have obtained a copy of your credit report and how often you have applied for credit in the past two years.
Understand how credit scores work
A credit score is a number grade attached to your credit report. It is also available via resources such as Credit Karma. Credit scoring is a factor that creditors consider when deciding whether to approve your application for a credit card, a mortgage or another type of loan, as well as how much credit to extend and at what interest rate.
Credit scores are often called FICO scores because most credit scores are produced from software developed by a company called FICO. These scores range between 300 and 850. For a score to be calculated on your credit report, you must have at least one account that has been open for six months or longer. FICO scores are provided by the three major credit reporting agencies: Equifax, Experian and TransUnion.
The higher your score, the more likely you will be able and willing to repay a loan. This in turn makes creditors more likely to approve an application and offer favorable rates.
If your score is lower than you’d like, you can take steps to improve it. These include:
Paying off overdue debts and making future payments on time.
Keeping account balances below 40% of the credit limit.
Establishing a good mix of credit types.
Control your debt so it doesn't control you
People today have more consumer debt — from credit cards and other sources — than ever before. Having some debt is practically unavoidable, but it’s important not to get carried away. Otherwise, you could find yourself in a credit crunch, with piled-up bills, cash flow problems and a lot of stress. It’s important to keep account balances manageable so you can comfortably make payments, which helps your credit score.
Credit cards present the biggest challenge for most people. In addition to the cards issued by financial institutions, many stores offer easy credit to encourage you to buy from them. These credit cards can feature “discounted” interest rates up front, possibly around 10-15%. However, they might charge you 20% interest or more in the long run, so you don’t really get a true discount and it’s easy to rack up debt if you use the card too frequently.
That’s why it’s also important to understand the terms of a credit offer before you open an account. In the example of the store credit card, being aware that the interest rate will go up can help you avoid surprises.
If you review your credit report regularly, keep your credit score up and manage your debt, you’ll be well on your way to having good credit. When you’re ready to buy a home or make another big expenditure that requires a loan, this credit will be the ticket that gets you in the door.