Credit
You have probably heard people talk about credit scores, or "building credit." Most people begin to establish credit in college or early adulthood, when you might first have a student loan, credit card, apartment lease, or cell phone bill.
Credit Reports and Credit Score
All of your credit accounts are reported to Credit Reporting Agencies (CRAs), which gather information about your finances, including credit accounts, payment history, where you live and work, and other information. There are three credit reporting agencies in the United States: Equifax, Experian, and TransUnion. These agencies are not operated by the government.
Your financial information is collected into a credit report, which outlines your complete credit history. Your credit report may be accompanied by your credit score, which is a snapshot of your financial history calculated into a three-digit numerical score, also frequently referred to as your FICO score. FICO scores range from 300 to 850, and a good credit score is typically considered to be 720 or higher.
Your credit report and credit score are the primary factors in your ability to borrow; they outline to potential lenders your level of responsibility (or risk) as a borrower. In other words, your past financial habits determine your ability to obtain credit in the future, as well as the interest rate you will have to pay on future loans. Responsible borrowers are generally able to open new credit accounts more easily and pay lower interest rates; irresponsible borrowers may have a harder time qualifying for new credit and generally must pay higher interest rates.
Some forms of credit are easy to establish, such as student loans and low-balance credit cards. Larger or more complicated forms of credit, such as mortgages, have more extensive requirements. Typically, you must demonstrate that you are a responsible borrower with smaller forms of credit before you will qualify for more significant forms of credit.
Per federal regulations, you can obtain a free copy of your credit report from each agency once every 12 months, available at Annual Credit Report https://www.annualcreditreport.com/index.action. You should review your credit reports annually to check for errors. While the report is free, you usually have to pay a fee (around $8-$15) to obtain your official calculated credit score. Some banks and credit cards will offer estimated scores using a similar formula for free.
Credit Factors
What do the credit agencies do with your account information? What are lenders looking for in potential borrowers? How is your credit score calculated? Your credit score is calculated based on the factors outlined below, which have varying impacts on your overall score.
- Payment History
The amount and timeliness of your monthly payments for all accounts is reported to the credit agencies and appears on your credit report. This factor is among the most important in determining your credit score: Consistent on-time payments demonstrate responsible borrowing, while even just a few late payments can really hurt your credit. Your credit report will also include any derogatory marks for accounts that have been reported delinquent, been referred to a collection agency (also known as "gone into collections"), or resulted in legal action (for example, if you are sued). Derogatory marks can have a correspondingly severe impact on your credit for several years into the future.
- Credit Card Utilization
It is generally recommended to keep your total credit card utilization under 30%. This means that if you have two credit cards with limits of $1,000 each, you should try to have a maximum total balance of $600 between the cards at any given time. Lower is even better.
- Age of Credit History
This includes the average length of time your credit accounts have been open, as well as the last activity or payment on each account. If you open a credit card in college, it may help boost your credit score if you keep it open and in good standing in the future, since it lengthens your overall credit history.
- Number and Types of Accounts
A high number of total accounts, accompanied by good payment history and account utilization, indicates to a lender that you are responsible and have trustworthy credit. The number of total accounts has a lower impact on your credit than your payment history, but this is another important factor that creates your credit score. Diversity of account types (e.g., credit cards, installment loans, mortgages, etc.) is also a factor; larger or more complex loans, such as real estate loans, can have a strong positive impact on your credit if properly managed.
- Credit Inquiries
Each time you submit a credit application to a lender (e.g., you apply to your bank for a credit card), the lender will run a credit check to review your credit report and score. This is called a "credit inquiry," or a "hard credit inquiry." This is a fairly low-impact category, but if you apply for many new accounts at the same time, this can indicate risk to lenders; if you borrow too much money at one time, you are less likely to be able to pay it back.
Credit Cards
A credit card is basically a short-term loan. Unlike debit cards, which take your
money directly out of your bank account, credit cards allow you to borrow money to
pay for goods or services. When you swipe your card, you're not spending your money;
you are spending the bank's money. If you pay them right back at the end of the month,
you won't incur any interest charges; if you don't, that short-term loan will incur
interest every month until you pay it off.
Managing debt effectively is a key part of building your history, and using credit
cards responsibly may be a good early step in that process. However, credit cards
can also become (too) easy to use for spending outside of your budget, which can create
a pattern of debt that you cannot readily pay back.
Tips for Credit Card Success
If you use your credit card responsibly, it can be a great building block for your financial future. Here are some tips to keep on top of your card and your budget:
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- Always pay your bill on time. No exceptions! Late payments carry fees, can increase your interest rate, and cause future credit problems.
- Pay your card off every month. Your card's interest charges will capitalize monthly, meaning that your interest charges also begin to accrue interest, making credit card debt much more expensive over time than the original purchase.
- If you can't pay it off completely, always make more than the minimum payment. Maybe you don't have the funds this month to completely pay off your flight home, but if you only make the minimum payment, you could end up paying off that flight for more than a year and spending double the original cost in interest alone. On the other hand, paying it off over a couple months will save you money and still help build your credit. The minimum payment is just the least required amount you have to pay that month but remember banks and credit card companies make their money on the interest they charge you, so they have no incentive to facilitate you paying it off faster.
- Don't ever max out your cards. You should keep your total credit card balance below 30% of your total available – on all cards.
- Don't apply for multiple cards at once. Too many credit applications in too short a period of time can indicate irresponsible borrowing, hurt your credit, and make your interest rates higher. If you actually need more than one card, space them out by at least 6 months or a year.
- Check your account often! Your monthly statement should not be the only time you look at your account – you should check it at least once a week. This can also help you realize if the balance is climbing too high and rein in your spending, rather than being surprised once a month and watching those interest charges add up. Checking your account frequently can also help you spot any fraudulent activity before it goes too far. You might even want to set up transaction alerts, either for all card activity or for any transaction above a certain amount. This might mean receiving/deleting additional text messages or emails, but that's less of a headache in the long run than finding out about fraud too late.
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While it may be advantageous to begin building your credit history now, it is also important to consider the impact of a potentially poor payment history on your credit if you open a credit card that you cannot properly manage while being a student.
Credit Resources:
Check Your Credit Report (FTC)
Your Credit History (consumer.gov)
Understanding Credit (Equifax)
