Let’s talk credit scores. How do you build credit and why is it important?

Being a lender for 10+ years, I saw it all. Scores so low they didn’t even register and dang near perfect ones. I’m going to help you more understand credit scores, bust a few misconceptions regarding credit and then talk about what you need to do to have good credit.

First off, what is a credit score? Per Investopedia: “A credit score is a three-digit number that rates an individual’s creditworthiness and ability to obtain a loan, mortgage, or credit card. A credit score is based on a person’s credit history, which includes their active accounts, total debt levels, and repayment history.”

***There are 3 Credit Reporting Agencies; Experian, Equifax and TransUnion. You can pull a report from each one of these agencies for free, once a year from AnnualCreditReport.com. I HIGHLY recommend you start here as you look into what your history is and what you can do to improve it.***

Long term, you want to have enough wealth that your credit score doesn’t matter. But the reality is for most American’s, you’ll have to deal with debt at some point. You need to be prepared for making the right decisions when that time comes and the first step is to make sure that you are in the driver’s seat with a good credit score.

Now, let’s talk about misconceptions that I heard from the bank.

  • I can’t get a loan; I have no credit. I heard this one a lot and I would always respond with “no credit is better than bad credit.” Having no credit bureau score simply means that you haven’t borrowed money from places that report to the credit bureau. It doesn’t mean that you have no payment history. Local utilities are a great way to prove you can make payments consistently.
  • Dave says that having a good credit score is a bad thing. This is one of the areas where I disagree with Dave. Look, it’s really tough to get by in this world without using debt at some point, whether it be a home loan or an occasional credit card. Establishing your credit and building it up to a good score is a fantastic way to protect yourself financially. Absolutely, we all hope that we won’t need it. But if we do, it’s good to have a good score in place.
  • Fraud. I’ve worked at local banks. I’ve had both my debit and credit cards compromised. When it was with my debit card, I had to personally call the restaurant in Florida to try to get my money back. I WORKED AT THE BANK!! When it was my credit card, they immediately refunded my money and sent me a new card. Honestly, I haven’t used my debit card in years.

So let me tell you how to build your credit responsibly.

Here are the main factors that impact your credit score. (Outside of the obvious of not being late on a payment.)

  • Utilization matters. You may think you’re being responsible by having a low limit, but using $500 of a $1,000 limit is drastically different than $500 of a $10,000 limit. You may not want to tempt yourself with a higher limit, I get that. But this is telling the credit reporting agencies that you’re using 50% of your allotted credit, versus 5%, and that drives your score down. YOU HAVE TO HAVE DISCIPLINE no matter what your limits are.

How do you get around this? First off, pay off your credit card in full every month and know when it’s reported. Let’s say you do pay it off every month and are never charged interest, but they report your balance right before your payment is due. That is the highest it is all month, so your utilization is super high. Hurts your credit. Knowing when to pay it off is important too.

  • Time that you’ve had the account matters. You want to know the best way to build credit long term, keep those credit cards open if they are free. Cut the cards up, put them in the freezer, hide them in a drawer, ect., but don’t close them if you don’t have to. Having them open long term tells creditors you’re responsible with your credit. And keeping a $0 balance on them improves that utilization number too.

Here is what I tell young people starting out. My favorite way of building credit is to use your credit card for gas only. Pay it off same day. There is no limit on how many times you can pay on your credit card. Do it every time you use it and you’ll never have to worry about utilization or late fees.

Ultimately, building credit is a mental game, and that’s what banks are worried about. They need to know that you have the discipline to pay them back. If you can’t handle a credit card, you’re going to have a tough time paying on a home loan for 30 years. Build your score up and if you don’t need it, then that’s great. But if you do, you’re prepared to get the best deal.

If you need help building your credit or want to better understand how it impacts your personal finances, reach out and set up a meeting. This can be important for all ages, everyone needs to know how to build credit.