When used wisely, credit is a financial resource that makes all of our lives easier. Often, however, many individuals find themselves either unable to obtain favorable credit terms or overburdened by high interest rates. The reason is the credit score. Credit unions, banks and other lending institutions use three agencies to monitor the credit histories of borrowers: Equifax, Experian and TransUnion. Each keeps track of borrowers’ active credit account and payment history. The fewer active accounts and shorter payment history a borrower has, the lower the credit score. A low score can result in low credit limits, high interest rates and the inability to obtain credit.
The reader may be thinking, “I don’t need a good credit score, I pay cash for my cars and do not plan to purchase a home.” While those choices may be ok for you, at the same time, the credit score impacts more than just lending decisions for major purchases. Landlords, utilities and even employers all check credit score when making decisions about to who to rent, sell electricity to or hire.
Even if you have no credit history or poor credit history, there are ways to improve. First, obtain copies of your credit report from all three agencies. You are entitled to a free report annually. Review the report carefully. If you believe there are errors to be corrected, each agencies has an online dispute process.
Second, put together a monthly budget and stick to it. Then, analyze it to determine how much of your income you are spending to pay down debt. This is called your debt to income ratio: your total credit payments (Mortgage, car loan, credit cards) divided by your gross monthly income. Ideally, this ratio is 40% or lower. Debt to income does not include recurring expenses like utilities, food and gas.
For the reader with no credit history or poor credit history, a good method to begin building credit is to apply for a secured credit card or loan. These are borrowing facilities that use a security deposit as collateral for the loan. With the collateral, the lender has stronger assurance of repayment and is more likely to approve the loan. Once you are approved for a card it is important to make all your payments on time and plan to pay your balance in full each month. Payment history is a large factor in good credit. The best way to keep your payments at an affordable rate is to only utilize 30% of your available credit.
Another helpful tip is to never close your old accounts. Even if they are unused! The more credit you have available, the lower your utilization will be, which looks good to lenders and the credit reporting agencies. It is also beneficial to have a variety of types of credit, like auto loans, credit cards and a mortgage. The more diverse your credit is, the better it will look on your report.