Episode 293: November 27, 2012
Debt Loans Credit
by Laura Adams
A Money Girl reader named Erica H. asks:
“I’m a 25-year-old professional who is trying to save money and build credit so I can buy a home as quickly as possible. I have a credit card that I pay off in full every month. But what if I pay it off every week instead, would that raise my credit score? How about paying down my student loans ahead of schedule? I desperately need your advice about how to build credit fast!”
Maintaining good credit is an important part of a healthy financial life. It allows you to qualify for new credit accounts—like car loans, credit cards, and mortgages—at the lowest interest rates possible.
Having great credit also helps you:
get competitive quotes on insurance
get approved to rent a house or apartment
meet the requirements of a potential new employer
qualify for a corporate credit card to pay for reimbursed job expenses
Paying less for interest and insurance means you have more money left over to invest for the future, which is the key to building wealth.
If you’re having trouble improving your credit or you’re building credit for the first time, like Erica, it’s important to understand how credit really works and what influences scores the most.
Use the following 7 rules to build your credit as quickly as possible:
Rule #1: Credit scores come from data in your credit reports.
Credit scores are calculated using information in your credit files that are maintained by nationwide credit reporting agencies like Equifax, Experian, and TransUnion. The vast majority of consumers have errors on their credit reports that go undetected for years because they’ve never taken the time to review them.
If data in your credit reports is negative or incorrect, it’s probably dragging down your credit scores without you knowing. However, it’s easy to dispute errors and get your credit reports corrected. Start by visiting annualcreditreport.com to view or print each of your 3 free credit reports.
Rule #2: Bad credit marks can’t be erased.
The reason negative information on your credit history is so detrimental is because it stays there for a long time. Late payments remain for 7 years and some bankruptcies remain for 10 years.
So, one strategy to building and maintaining great credit is to never have a negative item added to your credit file in the first place!
Rule #3: Building good credit takes time.
If data in one or all 3 of your credit reports is negative or incorrect, it’s probably dragging down your credit scores without you knowing.
Don’t believe anyone who tells you that it’s possible to instantly improve or “fix” poor credit. There’s no way to immediately improve a credit score if it’s based on accurate information. Credit scores can’t be changed overnight because they’re designed to reflect your credit behavior over time.
The good news is that credit scores typically give more weight to recent activity and information. So, if you do have negative information on your credit report—like late payments, an account in collections, or a bankruptcy—time is on your side. Those bad marks won’t count against you as much as they age.
Rule #4: Paying bills on time influences credit the most.
Erica asked if paying her credit card more frequently than once a month would help raise her credit. Though you don’t earn additional credit points for paying bills early or making multiple payments, keeping a low balance on credit cards is beneficial.
Paying bills on time is the best way to build an impressive credit history, and missing payments and having accounts in collection will hurt your credit scores more than any other factor.
Rule #5: Credit cards are credit-building tools.
Credit cards are one of the most convenient and safe ways to make purchases—plus, they give you a powerful way to build a strong credit history. Since you decide how much to charge and pay off each month, a credit card reveals how responsible you are with credit and can really boost your scores.
The best way to manage a credit card is to avoid interest charges altogether by paying the balance off in full each month. You never have to carry a balance or pay any interest to build credit.
Rule #6: Keep balances low on credit cards.
Though using credit cards can help you build credit, they can also damage it if you rack up too much debt.
The amount of debt you have on revolving accounts—like credit cards and lines of credit—compared to your credit limits is called your credit utilization ratio. A major factor in maintaining good credit is to keep this ratio low.
Your outstanding balance on a credit card should never exceed 30% of your available credit limit, even if you pay it off by the statement due date. For example, if your credit limit on a card is $1,000, don’t allow your balance to exceed $300 ($1,000 x 30%) at any time during the billing cycle.
Rule #7: Installment loans build credit.
Having an installment loan—like a car loan, student loan, or mortgage—is great for your credit because it demonstrates that you’re a reliable borrower when you consistently pay on time.
Erica asked whether she should pay off her student loans early, which is a common question. While lowering your total amount of debt can improve credit, in most cases it isn’t better to pay off student loans and mortgages ahead of schedule.
However, I don’t recommend keeping debt that you really don’t need. If you have at least 6 month’s worth of living expenses stashed away in an emergency fund and you’re saving at least 15% for retirement, paying off installment loans early may be a smart move for you.
Rule #8: You must use credit to have a credit score.
The key to building credit fast is to use credit accounts—but in moderation! Never abuse credit by using it to pay for a lifestyle that you can’t afford because that destroys your financial future and your credit.
Since credit scores are based on what’s in your credit file, your goal should be to accumulate a long history of good credit behavior for different types of credit accounts, such as credit cards, lines of credit, and installment loans.
When you understand how the credit scoring system works and use credit strategically, you’ll build excellent credit that will improve many aspects of your personal finances.
To watch a step-by-step video tutorial about how to check your credit score, correct credit errors, and build credit, download the free Credit Score Survival Kit. This multimedia kit includes an ebook, audio program, and video tutorial to help you build and maintain excellent credit.
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