You’ve been working hard and saving money to buy a house (or perhaps a vehicle or other large purchase). You’ve done the math, budgeted and saved, and you’ve finally ready to make that big purchase. You’ve found something you liked and can afford, and it will cost you much less monthly then you are currently paying for rent – so it seems like a total win – an absolute no brainer. Then, when you think everything is all set to go, the bank tells you that you do not qualify for a loan. You might either have bad credit or no credit established at all.
While most places only recommended that you have a credit score of 620 or above for a conventional loan, the higher your score, the better interest rates you might qualify for, and the more likely you are to be qualified as lenders will see you of less of a risk.
While having stellar credit (800+) actually doesn’t add many additional perks from those within the good credit range (like, let’s just say in the 700-799 range) other then maybe a slightly lower interest rate, it is still important to build good credit. Even if you don’t necessarily use it for anything, the important thing to remember is you never know when you might need to use it for something.
I have heard lately many people talking about living completely debt free, eliminating credit cards all together. While I do agree with living completely debt-free, credit cards can be an important tool if used correctly – mostly for building up good credit. And the important part to having good/excellent credit, is you never know when you might actually need it for something – whether it’s buying a house, new car, maybe a student loan or even an investment.
So, how do you build up good credit? Most importantly, you exercise and show good money handling responsibilities.
When you pay your bills on time, you are showing financial responsibility. When you pay more than the due amount, pay before it’s due, or paying a loan/debt off early, it also shows financial responsibility. Showing financial responsibility makes you less of a liability for lenders, hence borrowing money is usually cheaper and more easily accessible because you are less of a risk.
The best ways to show good money handling responsibility is to do as follows:
Always Pay Your Bills on Time – this seems pretty straightforward… but you’d be surprised how many people think missing just one payment here or there will be okay. If you miss even one payment by more than the allowed time, not only will you get a late fee, but your score will drop significantly. Truth is, this stays on your credit file for up to seven years, and even after that it might still come up to haunt you. Just like how bankruptcy might go away after 10 years; but once you file it will always be true that you have filed. Missing a payment is sort of the same thing. When a lender looks into your credit history and sees you have missed a payment, they are less likely to approve you (although likelihood does go back up overtime).
Keep Credit Card Balances Low – although it is stated that anything below 30% of your max credit is considered good… depending on your purchase, lenders might still look at this number too high and you still might not qualify or have a lower credit score then you otherwise could. This can either be due to your debt to income ratio, or just the fact they still find you as a liability. Keeping low credit card balances is always ideal, as it shows financial responsibility. The overall best way to do this is making sure you pay off your balances each month.
Pay Credit Card Balances off Each Month (if you can) – unless you have a large purchase or something comes up, you shouldn’t have a reason to let your balances get high enough that you have to pay it off over a monthly basis. Use your credit card like a debit card, but instead of the balance being directly deducted from your account, pay it off right after you make a purchase. This will show the banks financial responsibility – by not letting balances stay that high. It’s also a great way to build up your credit score, keep your balances low, and build good money managing habits for yourself.
Never File Bankruptcy – nobody’s perfect and we all fall into unforeseen hard times. The key is (especially while you are still young) to never let yourself get into that situation. Stay out of debt and don’t make purchases that you don’t need. Bankruptcy might go away after 7-10 years, but anytime you ever fill out a loan application it will be brought up. You will be asked if you’ve ever filed bankruptcy, and even if you have stellar credit now, some lenders might still look at it as a red flag.
Avoid Too Many Loans – some places might tell you this doesn’t hurt, it might even help your credit. But this isn’t necessarily the case. Although yes it’s true your credit score might go up a little, it’s not as much as it could if your total debt to income ratio was low. If you only have X amount of dollars, and you have too many loans you’re paying on, that doesn’t leave you with much available income. The more you have you’re paying on, the less available money you have. Lenders will be more likely to refuse your credit application even if you do have good credit, because you are more of a risk.
Don’t Take Out New Credit Cards – opening a new line of credit will generally drop your credit score a little, although it usually goes right back up. It might even help build up your credit, by bringing your available credit limit up. But overall, this goes along with the last topic of too many loans. Although the number varies, 2 – 3 seems to be the magic number (of credit cards). Some places will even tell you five or more accounts is a good number to have, but keep in mind, the credit card companies want you to have more credit cards because they make money on them. If you can actually monitor your credit well, then there probably is no good or bad number. Some people might find it harder to manage more than five accounts (thus making it easy to miss a payment), while others might have no problem (so keep that in mind). Opening a new credit card will also impact your average credit age if you’ve already had an account open for a while.
- While having too many accounts (with high balances), both credit and loans could negatively impact your credit, having two few might also – especially if you are trying to build up credit for the first time. If you have no credit, it might be a good idea to take out a credit card, pay it, and don’t use it while leaving it open. You could do this with several accounts, as long as you use them once in a while and you make sure you pay them off on time.
Building credit does take time. There is no quick and easy way to build up your credit, but you do have to start somewhere. Taking out small loans or credit cards, and making sure you pay them off is probably the best and quickest way to build up credit. Just make sure you don’t exceed what you can afford and be diligent about always paying your bills on time!