You’ve heard the name; you know the term – but what exactly is this almighty FICO score that you hear people talking about in commercials and on the news? And what does it have to do with building your credit?
Your FICO score is a number that represents how well you can pay off credit that you have borrowed from a lender. This credit can be a loan in the form of a mortgage, car loan, or even a credit card. The score itself represents tiers of creditworthiness:
Of course, the ultimate goal is to work your way to the highest credit score; the higher your score is, the less of a risk you are to the bank. When you are less of a risk, you will have a better chance of getting approved for a loan and lower interest rates.
If you have a poor credit score, the bank will consider you to be a bigger risk. Not only will this put your chances of getting a loan in jeopardy, but any loan you do have will come with a high-interest rate.
Your credit score will be negatively or positively impacted based on your payment history, how many credit cards you have, how many alternative lines of credit you open, and how quickly you pay down a balance in full.
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In order to acquire a credit card, you must be 18 or older. If you are under 21, you will need to show your bank that you have sufficient income to pay off the credit you wish to obtain.
If you do not have proof of sufficient income, you will need to have a cosigner on the card. This can be a parent or legal guardian, a spouse, or other trusted, a close individual who can prove their income to pay the debt in your stead.
Not all credit cards are the same. Some cards are easy to gain approval for, having little in the way of requirements other than age and/or having a cosigner. Others have limits or requirements that make them much harder to get, such as a minimum income, previous or current credit score, or other specifics.
When researching credit cards, you want to find one that matches your spending habits. Different cards will also provide a variety of different benefits, such as 3% cash back on certain purchases, building points toward rewards within the provider’s system, or accumulating airline miles toward a free flight.
It’s important to note that most cards won’t provide a high percentage of cashback on all items, instead favoring a selected few. This is why you will often see people purchasing gas with one card, groceries with another, clothes with a third, and so on.
Whether you’re looking for airline miles, cash back, or just to build your credit for the first time, don’t rush the process if you decide to apply for a credit card. Be strategical and find the best card that fits your needs.
After you’ve applied, there will be a 7 to 10-day gap before you receive the card. Upon receipt, you will have to activate the card online or through a toll-free number with the activation code on the card.
It’s important to ensure you find a safe place to keep your card, both so you know where it is, and to limit the chance of having your card stolen. This can be a wallet or secure pocket in a backpack or purse, but never just in your pants pocket or the dash of your vehicle if it can be helped.
If your card is stolen, you have to go through the hassle of canceling your card – and making sure whoever has your personal information can’t use it in other ways.
It’s especially important when using a credit card to adhere to a monthly budget. This will help you build your credit responsibly and avoid getting into unnecessary debt. Just because you have a credit card does not have you have free money – don’t spend more than you make in a month.
If you’ve never used a credit card before, start small and build up from there. Maybe your first steps include your regular gas and groceries on the same card. This is a good way to get into the habit of paying monthly bills with a low balance. Use the monthly budget you created to help you with this step.
Each month**,** you will be required to make a payment on your credit card. If you’re building credit for the first time, it’s crucial to make these payments on time. Credit card debt is a critical concern in current financial news. Debt can easily pile up if you can’t afford or miss your payments, which will negatively impact your credit score.
Never let anyone tell you that carrying a balance is “okay” or “normal” or a good way to build credit. Allowing a balance to remain on your cards can lead you into the debt trap. When you make your monthly payment, pay off the full amount – or as close to it as possible – whenever possible.
Maintaining a good credit utilization ratio will help improve your credit score. This ratio is determined by how much credit you use versus how much you have allotted. The goal is to keep your utilized ratio under 30% of your full credit limit.
For example, if you have a $10,000 limit and your goal is to keep your balance under 30%, you are looking at spending no more than $3,000 on credit. If you aspire to grow your score even faster, keep your ratio under 10%.
An alternative to building credit on a card is financing your auto payments through a bank. The same principles of credit-building apply here; namely, make your payments on time and in full. Kudos if you can make more than the minimum monthly payment regularly.
If you can’t afford a house outright, taking out a mortgage and making your payments on time will also help build your credit. However, if you have no credit whatsoever, this is not advised as your first foray into the world of massive debt.
If you’re like the average American in that you have to take out at least some student loans to afford higher education, making these payments can help build your credit. Of course, the need to build credit should not be your only excuse for taking out large student loans.
Taking out personal loans and making monthly payments can help you build your credit. However, personal loans tend to come with higher interest rates, so borrowers beware.
If you finance your new cell phone purchase through monthly payments, this also serves to build your credit.
Remember: though all of these options can help you build credit, it’s best to purchase items in cash whenever possible. When you finance any purchase, with specific, stated exceptions, you will pay more than the sticker price due to accumulated interest. Build credit responsibly, not for the sake of building credit.
Building good credit only occurs through discipline, a budget, and making those monthly payments on time and in full.
For most first-time borrowers, it’s crucial to start with smaller purchases and work toward more responsibility slowly. Further on in your credit career, proving you can take on debt responsibly by having a high credit score will help you secure larger loans, such as an auto loan or a mortgage.
It’s also advised that you check and track your credit score monthly through a free, non-penalty method such as CreditKarma.
One last point: it is so much easier to ruin your credit than to improve it.