Episode 303: February 19, 2013
Debt Loans Credit
by Laura Adams
Want to buy a home, a car, or get a credit card? Those are just a few situations when you need tip-top credit in order to get approved and to pay the lowest, most-competitive interest rates.
No matter if you’re building credit for the first time or you need to prop up sagging credit scores for a big purchase you have in mind, I’ll give you 3 simple actions steps to improve your credit.
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What Is Credit?
Credit plays a huge role in the health of your financial life. It’s a measure of how trustworthy you are when it comes to money. Your credit scores tell the world whether you’re likely to pay your bills and credit accounts on time.
The foundation of your credit is your credit report. It contains a complete history of your financial behavior, like late payments on credit accounts and certain legal actions—such as liens, judgments, and bankruptcies—that affect your finances.
Using the data in your credit report, various credit scoring models assign you a rating that potential lenders, merchants, and employers can use to evaluate you.
If you have excellent credit, you’ll be able to purchase many goods and services for less than someone with poor credit. That’s because most lenders offer lower interest rates and better terms to borrowers with high credit scores.
If you have poor credit, on the other hand, you’ll be shoved to the sidelines and denied credit altogether or be charged crazy-high interest rates.
How to Improve Your Credit Scores
Improving your credit scores is actually very easy when you take a few simple, proactive steps:
Action Step #1: Check Your Credit Report
Most people don’t know what’s on their credit report. If you’ve already been denied credit or are concerned about qualifying for a purchase, you’ve got to look under the hood. Plus, checking your credit is one way you’d know if you were the victim of identity theft.
When you pull your credit report, you’ll see your personal information, every credit account in your name, including account balances and credit limits, and any legal data that affects your credit. Look carefully for errors or accounts that aren’t yours and dispute them right away.
The easiest place to view your credit report and get errors corrected is at annualcreditreport.com, where you’re entitled to a free copy from each of the 3 major credit agencies (Experian, Equifax, and TransUnion) every 12 months.
I received a great question from Venesha H., who says:
“I understand that certain bills, like electric, gas, phone, and cable, are not reflected on a credit report. What role do these accounts play in your credit?”
As I mentioned, credit scores are calculated using the data in your credit reports. If a merchant doesn’t report your payment history to the credit agencies, then that account has no bearing on your credit.
Action Step #2: Use a Credit Card
One of the fundamental rules of credit is that you must have credit accounts and use them in order to build your credit scores. It’s just like building your muscles. You get results from doing regular exercise and weight lifting—not from sitting on the couch.
Credit cards are the perfect way to build credit because you decide how to use them and they showcase how responsible you are. If you pay a credit card bill on time and never max out your credit limit, you’ll build excellent credit scores over time.
I recommend using a credit card to make small, everyday purchases that you pay off in full every month. This strategy helps you build credit without ever having to pay any interest to the credit card company.
A reader named Andrew asks:
“I recently closed my only credit card and saw a significant drop in my credit score. I thought doing this would make my score go up, as I want to buy a house in a few years. Should I open another credit card?”
Yes, you need at least one credit card to maintain the highest credit scores possible. In general, closing a credit card is bad for your credit because it reduces the amount of available credit in your name.
Action Step #3: Increase Your Credit Limits
If closing a credit card and slashing your available credit limit has a negative effect on your credit scores you may wonder if the opposite is true.
I received this question from a reader named SK:
“I want to make a large purchase on a credit card so I get the purchase protections and rewards—and then pay it off in full when the bill arrives. However, my credit limit on the card isn’t high enough. Should I ask for a credit limit increase or will doing that hurt my credit score?”
Always ask your card company for a credit limit increase when you need it. They’ll probably grant your request if you’ve been a good customer. To build credit, you need high credit limits relative to your outstanding balances. However, never go overboard and max out a card because that will hurt your credit.
A good rule of thumb is to never charge more on a credit card than 25% to 30% of your credit limit—even if you pay off the bill right away. You can find out more about the best way to manage credit cards in Credit Utilization—What It Means for Your Credit Score.
The biggest factor in how credit scores are calculated is whether you pay bills on time. So don’t overlook this fundamental, yet powerful aspect of building credit.
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