Credit: it's an important financial tool that can seem complicated at first. To get credit, you need a good credit history. How does that work? What are the steps an individual must take to establish credit? Once you learn the basics of credit, you can start your journey to building your own creditworthiness.
So, what is it? Credit gives people the ability to buy items with borrowed money that is paid back over time. For many people, their first major purchase—such as a car or home—will be bought using credit. However, credit is not something that you're just simply given.
Lenders base credit decisions on your creditworthiness, or how likely you are to repay what you borrow. This is where a credit score comes in handy.
What Is a Credit Score?
Simply put, your credit score is a number between 300 and 850 that is used to represent your creditworthiness. Lenders use it to determine what amount they are comfortable lending you, how long the loan should be for, and what interest rate they should charge. Lenders rely on independent credit agencies to monitor an individual's credit behavior and assign a credit score—also called a FICO score. In general, a good FICO score will range from 670 to 739, which is at or slightly above the average credit score of a U.S. borrower.
Typically, if you have a high credit score, lenders are more willing to lend you a larger amount over a longer period of time, and at more favorable (meaning lower) interest rates. Alternatively, the lower your credit score, the less you will likely be able to borrow, and you may have to pay potentially higher rates.
How To Start Building Credit
Establishing a credit score when you're right out of college or in your first job can be difficult. When you're just starting, you have no credit score or credit history, and without any prior information on your financial behavior, you will have limited access to credit.
So how does building credit work? To build your credit, you will need to establish a credit history and evidence of responsible financial behavior. If you are just starting out or have little to no credit history, you will likely have fewer options of credit cards to choose from. But don't worry—there are still ways for you to build credit.
Those just beginning to establish credit might opt to open a secured credit card like Teachers Visa Secured Credit Card. Secured credit cards often don't have as many credit requirements as unsecured cards. A secured credit card is essentially a card that requires a cash deposit—in case the cardholder forgets to pay their monthly bill—and has a lower credit limit. When used responsibly, a secured credit card can give you the ability to show your creditworthiness and is an excellent tool to form your credit capacity and build your credit score.
What Factors Go Into Building Credit and Credit Scores?
Once you have established a line of credit, whether it’s a secured or unsecured credit card, it’s important to know how you can use it to help you build a good credit score. Below are the factors that impact your credit score and some healthy habits you should know in order to establish good credit. Payment History
Your ability to pay your bills on time has the most significant influence on your credit score. Establishing good credit means paying at least the minimum amount due on your credit card (paying in full is even better) before the payment due date. Lenders want to see your payment history to assure themselves that if they lend you money, you're likely to pay them back.
A credit card can help you establish a strong payment history. By charging small purchases on your credit card and paying your monthly bill on time, you will establish a pattern of good financial behavior. To avoid missing payments or making late payments, you can set up email and text reminders or automatic electronic payments. Teachers offers Bill Payer services that let you pay all your bills online from one secure login, making it easy to never miss a payment.
Credit usage is the outstanding balance on your credit card divided by your credit card limit, or the total amount you can charge on your card. If you borrow too much against your credit limit, lenders may worry that you will not have the ability to pay them back.
To establish good credit, a good rule of thumb is charging no more than 30% of your limit on your credit card. For example, if an individual has a $1,000 limit on their card, they would want to charge $300 or less and, as mentioned earlier, pay their balance in a timely manner.
Again, take note that you will likely have limited access to credit on your card when you're just starting out. This means that the credit limit, or the total amount you can borrow, will be fairly low. As you build your credit history and demonstrate good payment habits, over time, you will be eligible for a higher credit limit on your credit card.
Length of Credit History
Credit history, which is how long you’ve had your credit card account, will also impact your credit score. Lenders want to see that you’ve had a credit account for a substantial period of time and that you have demonstrated your ability to pay back all amounts owed.
The more information companies have to assess your credit, the better it is for you. If you're planning a future purchase of a home or car, it's best to establish credit as soon as possible. Using a credit card responsibly will allow you to set the highest credit score possible. Then, when you're ready to make your big purchase, your high credit score can make you eligible for the best rates and loan amounts.
The number of credit accounts you have open or the number of companies checking your credit can also impact your credit score. If you have too many credit card accounts or have applied for multiple new accounts, your credit can be negatively impacted.
When you're establishing credit, it's best to limit the number of credit card accounts you have to one or two. Having fewer cards will ensure that you can manage payments and limit your credit usage, both of which are good practices for achieving a strong credit score.
A credit card is a useful financial tool to help you establish credit. Consistently using one or two cards, making regular and on-time payments, and maintaining credit usage below 30% or less, are all good practices that can help you in the future. By using your credit card responsibly, you can build a good credit score, giving you financial flexibility when you're ready to borrow for a house, car, or other large purchase. The more you know how credit works, the better you can use these best practices to build up your borrowing power and level up that credit score.