Your credit score is your financial transcript. It is compiled from your credit report, which is a detailed accounting of your borrowing history. Lenders use it to establish your credit worthiness and determine what rates you are eligible to receive.
Landlords check it when reviewing your application to rent a property. Employers look to it to when assessing your financial habits and character. This is why it is so important to build a strong credit history by making sound financial decisions and using credit wisely.
How to build a positive credit history
Establishing good credit means much more than getting approved for credit cards and loans. It is about creating a path to financial independence. For instance, the result of qualifying for a low-interest rate 15-year mortgage versus a higher-rate 30-year mortgage can be tens of thousands of dollars — often more — in savings over the life of the loan. That savings can then be invested in your retirement account. Strong credit can also provide you with access to money when you need it most — during times of emergency.
So the question for young professionals looking to build a strong credit history, as well as those looking to repair and improve their credit score is this: how do you do it?
The American Bankers Associations recommends following a five-step credit road map. To summarize:
• Start with a credit card. They are relatively easy to obtain if you don’t have a credit history. If you have a negative credit history, you can get a secured credit card, which you guarantee by making a deposit. The important thing is to use credit cards for small purchases that you are able to pay off on a monthly basis.
• Move on to an auto loan. Try to limit the amount you borrow by saving enough to make a sizable down payment. This will keep your monthly debt obligations low while taking your credit score to the next level.
• Settle in with a home loan. First determine how much home you can afford. Between your mortgage and all other monthly payments (car, credit cards, student loans, taxes, insurance, etc.), you do not want to exceed 40 percent of your monthly income.
• Teach your kids about money and credit. It’s never too early to teach your kids about saving money and making smart buying decisions. In fact, you are their primary financial role model. The smarter your kids are with their financial decisions, the quicker they will become credit worthy themselves and the less likely you will be stuck repaying debts on any loans they may have you co-sign.
• Kick your feet up and relax. There’s a reward for building strong credit early in life … and it’s that you won’t be saddled with debt later in life, will have more money saved and have the financial freedom to do the things you want to do — because you will have been in the position to plan and budget for them.
Tips for maintaining your credit
The best way to maintain good credit is by demonstrating you are a financially responsible borrower. Here are some things you can do to help manage your credit cards and debt effectively while keeping your credit in good standing:
• Seek cards with low interest rates. One advantage of having a good credit score is being eligible for the lowest interest rates available. However, it’s not always easy to find a card with great rates. So look for the card with the lowest rates and best rewards for your lifestyle.
• Pay bills on time. Always pay your credit card bills on time. Late payments will have a negative effect on your credit score. If you forget to pay bills on time, consider setting up automatic withdrawal from your checking account. If you have overdue bills, plan to take care of them immediately.
• Make more than the minimum payment. If you only make the minimum payment to your credit card balance, costly interest payments will be added each month. If you can’t pay your credit card balance monthly, the next best solution is to pay more than your minimum monthly payment and stop borrowing.
• Avoid cash advances. Never say never, as emergency situations can call for resorting to any measure, but try to avoid cash advances. Interest rates on cash advances are often higher than the rate on purchases, and you can easily dig yourself into a deeper financial hole.
• Use credit cards wisely. You should only use your credit card under two conditions. One, you can afford to and will make full payment on all purchases at the end of each month. Two, for emergencies. If neither of these conditions apply, keep your credit card in your wallet.
• Keep accounts open. Surprisingly, closing a credit card can actually hurt your credit score because your credit score measures available credit versus credit balance. So the more credit you have available that you don’t use the better your score will be. So feel free to shred unused credit cards, just don’t cancel the account.
Remember, credit isn’t a bad thing. It allows us to make important purchases, such as cars and homes, we otherwise couldn’t afford. It can also help individuals launch and grow businesses. The key is to maintain a healthy relationship with it so it’s there when you need it.
Steven Gagnon is senior vice president and market leader for the business banking division of Key’s Northern Maine District. He may be reached at Steven_L_Gagnon@KeyBank.com or 760-4568.
