First of all, if you’re reading this blog, CONGRATULATIONS! It means that you are in the right path to achieving financial success at a young age. Understanding how credit works is the best step! Unfortunately, we are not taught at school and in many occasions at our homes. We may come from a household in which the relationship with money has been non existent or/and which the opportunities were not presented. It is our job to chose better for ourselves, to be an example for the next generation to come.
Building a good credit takes time and patience; yes, a lot of patience! I started working at the bank when I was 18 years old, at that time I was fresh out of high school and I did not had the slightest idea on how to build credit. It was not taught at school and my parents did not have the best relationship with money. I had the misconception that credit was bad for you and that obtaining a credit card will place me in debt. What I was not told is that credit can open the doors to financial success. I obtained my first credit card at 19 years old, and you know what, that was one of the best financial decisions that I have ever made. By obtaining it at such a young age, I was able to buy my first investment property at the age of 24, only 5 years later, by leveraging credit. Now, that is another subject that I can touch later on.
I want to share what I did to achieve a good credit score in my early 20’s and I will be sharing tips and tricks I wish I knew when I started building credit.
A good credit score consist of 6 factors that are weighted from high impact to low impact.
1. Payment history:
This factor tracks on-time payments to your credit accounts. This accounts could be a credit card, a car note, a mortgage, etc. This is a high impact factor, meaning that if you miss one payment to any of your credit account it could significantly affect your credit score and/or your ability to obtain more credit in the future. Late payment range from 30-days to 90-days period. If you see yourself missing a single payment for only 30-days or 60-days (1-2 months) you can easily recover from it but it can still significantly hurt your credit score. If you are late for more than 90-days (3 months) this late payments can become charge-offs and can be sent to a collection agency. This could disqualify you from obtaining certain loans or credit in general. Therefore, it is best to stay on top of your payments.
What you can do to avoid missing any payments is set up automatic payments from your bank account and/or make your credit account payments every two weeks (this method applies mainly to credit cards). What worked for me was making my payments every time I would get paid, the reason being because I tend to forget the day in which the payments occurs and to avoid any late payments I would preferred to use this method. If you don’t want to pay twice in a month, another option you have is to call your credit account company and ask them to change your due date to a date that is more convenient to you or closer to the rest of your bills so you can avoid forgetting to make a payment.
Something that I wish I did back when I first started to build my credit is to set up a budget and a list of all my payments. At first, I was spending money and not understanding what I needed to pay and prioritize. Only if I would’ve set up a bill/payment journal along with a budget, things would have gone a lot smoother.
A simple organizer like one above would have save me a lot of headaches and misunderstanding like the one I had at the very beginning.
2. Credit Usage:
Credit Usage is another high impact factor. This is determine by how much of your credit card limit you use on a monthly basis. The good rule of thumb is to use up to 30% of your credit card limit. For example, if you own a credit card with a limit of $1,000 your monthly usage should be up to $300. This is to ensure that credit bureaus see how well you manage not only your credit limit, but also potential future limit increases. What I used to explained to my clients at the bank is that when credit companies sees you utilizing more than 30% of your credit limit on a monthly basis without bringing that balance down to 30% or under, they may see your credit profile as one who can potentially miss a payment. Now, I’m not saying that you are not allowed to use more than 30% limit, but what I do recommend is that if for whatever reason you have to go above that limit, make sure to pay it down back to where it needs to be on the due date or no later than a couple of months. What you don’t want to end up happening is to max out your credit card limit or go above your credit card limit. This will tell the credit bureaus that you are unreliable and unable to keep a high limit credit account.
For this reason, credit usage is very important and can hurt or benefit your credit score depending on how well you manage your credit limit. What I did from the beginning at 19 years old I only utilized 10% of my credit card limit. As the limit got increased, I decreased my utilization limit to avoid going above the 30%. Due to this, my credit account was periodically increased to a higher limits. What I recommend is to start using what you know you can potentially pay off at the end of the month. You do not want to see yourself owing more than what you can pay. Thats why it’s very important to set up a monthly budget and keep track of all your expenses to ensure that you are able to keep up with your credit account.
3. Derogatory Marks:
Derogatory Marks is a high impact factor which simply means your credit account is in a collection agency due to late payments and/or your credit profile has a public record such as bankruptcies, civil judgement, and tax lien. When an individual is unable to make payments on their credit account, banks sells this debt to a debt collector agency. This agency is in charge to contact you and collect payment. Derogatory marks are good to avoid at all cost since they can stay in your credit report for 7-10 years. If you believe or suspect that the information the debt collectors have is inaccurate, you can dispute the charge and have it taken off your record. This is a very sensitive subject that I can talk more in detail in another post if you all want. Simply Contact me with your request and I will be more than happy to explain further.
This is why is very important to stay on top of all your credit bills because it can easily turn into a headache when your account goes to a debt collector and this marks stays for up to 7 years on your record, preventing you from obtaining more credit.
4. Credit Age:
Credit Age is a medium impact factor. This is determined by dividing the ages of all your credit accounts by the total number of credit accounts you have, this will give you an average credit age. Lenders/banks wants to see your experience using credit responsibly. This is the reason why I encourage to start building credit as soon as you are legally able to obtain credit. The older your average credit age is, the more appealing you look in your credit profile. For example, typically to buy your first property, most lenders requires you to have a minimum of 2 years worth of credit utilization; this helps them determine how responsible you are at making consecutive payments in a long period of time.
Building a good credit age takes time, there’s no way to go around it and you have to be very patience, a good average age is between 6-10 years. Keep in mind that every time you apply for a new credit account this average gets recalculated and it may lower your average age. Another factor that contributes to the age of your credit profile is having an account closed. For example, if you have a credit card for the past 8 years and you closed this card your average credit age will decrease because this credit card will be remove from your credit profile.
This is why it’s very important to be selective on what type of credit accounts you apply for. I personally never applied for a store credit card and I am highly against it because it can potentially cause you to spend unecesarry money and you can’t even use it outside that store. I’ve came across with a lot of my clients wanting and having to closed those types of credit cards only to come to find out that it was affecting their credit age average.
BE VERY SELECTIVE!
5. Total Accounts:
Total accounts is a low impact factor on your credit report. This is determine by how many credit accounts you currently have open; including credit cards, car loans, personal loans, mortgage, etc. This allow the lenders to understand how well you are able to manage different and multiple credit account at the same time. Don’t worry on how many accounts you should have or the type of account you should have because this is build over time, all it matters is that you are using them responsibly. It is also important to keep in mind of accounts that get closed because it can lower your credit since you are losing a line of credit on your report. This is why it is very important to be very selective of the accounts that you are considering to open.
I recommended my clients to open accounts that they know they can use later on if its necessary. Now, this does not mean that you will go to every bank and apply to every credit product they may have, or run your credit every month to obtain more accounts. Only apply to those accounts that you know will be beneficial for you and your lifestyle.
6. Hard Inquiries:
Hard inquiries is a low impact factor that contributes to building a good credit score. Hard inquiries means a credit check perform by a lender or financial institution to determine wether you qualify to receive credit for them. Just because is a low impact don’t abuse having so many hard inquiries, meaning not to apply for so many credit accounts at the same time because this can negatively impact your credit profile and lower your credit score. Typically a hard inquiry stays on your credit report for about 2 years, after that it gets deleted and its effects fade over time. If you are planning on buying a property or acquiring a big loan, is important to not run your credit for at least 6-12 months. This ensures that you have higher probability to obtain them.
To summarize, do not run your credit all the time; be very selective to where and why you are acquiring a new credit line or account. The more responsible you are the better for you in the long run. Once you learn how to manage your money and credit, doors will open for new opportunities that will allow you to grow as an individual.