HOW TO BUILD GOOD CREDIT

I had a bit of a scare last week with my card when my mobile financial management app emailed me to tell me I had used 40% of my credit on my credit card. I thought this was fine since I would be paying off the full balance at the end of the month, but apparently if you charge more than 30% of your credit limit on any of your cards, it can negatively affect your credit! Who knew? I certainly didn’t. Source: NLG


This made me curious about what else could affect your credit. Other things that I found could hurt your credit are:

  • applying for and having too many credit cards

  • closing credit cards

  • not having any credit cards

  • only paying your minimum balance

  • late payments

  • checking your credit score too often as a hard pull

In that moment I realized I had a lot more to learn about credit and how to make sure I keep my credit score where I want it–as high and happy as possible; so I decided to delve into the topics above and make sure I was understanding why each of these things had a negative impact.


IF YOU WANT TO BUILD GOOD CREDIT, BE AWARE OF THESE POTENTIAL PITFALLS:

Applying for and having too many credit cards


Who doesn’t want a rewards card for TJMaxx? I want rewards coupons! Oh wait, I also shop at Nordstrom Rack a lot too….and Macy’s….and before you know it, you’ve got several store cards, all with super high interest rates to pay back. The most obvious danger of having several cards is that you may end up spending beyond your means, losing track of what you’ve spent, and not being able to pay off the full balances at the end of the month. This will hurt your credit; even if you’re still paying your minimum balance (see previous blog post for more info). But the other sneaky piece of having multiple cards is that you had to apply for each and every one of them. And each card you’ve applied for most likely took a hard pull on your credit unless you were pre-qualified. Each hard pull to your credit stays as part of your credit record and “it can be interpreted that you are either having trouble getting new credit or overextending yourself with your financial responsibilities” according to Forbes. If you already have several cards and are panicking and wanting to go ahead and close the ones you don’t use, wait, and keep reading.


Closing credit cards

Okay, so you have several open cards and now you’re wanting go and close them. Read this first. Ever heard of credit utilization? No? I hadn’t either. This is one of the factors used to calculate your credit score, and is calculated by dividing your credit card balance by the credit limit on that card. Therefore, if you have three cards and they each have a $5,000 limit, that’s a total limit of $15,000. If you owe $4,000 on one of the cards and close the other two, that credit utilization will go up simply because you have a lower overall credit limit with only one card with a $5,000 limit instead of 3. So, closing the credit cards themselves might not be too damaging, but it depends on how much you owe as an outstanding balance. If you decide you want to close one or two of your cards, make sure that you’re not going to be financing a major purchase in the next three to six months since applying for a new loan would require the lenders to see that you just closed some cards, causing your utilization rate to be higher, which is a sign of risk. If you decide to keep your cards, make sure you still use them, even if it’s just for a small monthly charge, as credit card companies can close cards for inactivity, or if fraudulent charges are made at any point, you won’t notice them if you’re not checking statements because you think they’re not being used.


Not having any credit cards

I used to be one of these people. The idea of having a credit card and making possible late payments which would cause insane interest rates and ruin my credit history used to haunt my dreams. I thought I could handle life with my trusty debit card and things would be just fine. I figured it would be easier to manage my cash flow with just one card to use. Well let me tell you, folks, getting a credit card has been one of the best financial decisions I could have made. Not only because it makes managing my money and cash flow easier, but because it sets me up for financial success. Here’s how: every big purchase you’ll ever want to make in your life like buying a car, buying a home, or any large loan you would want to take out is directly correlated to your ability to pay back these large loans and investments. How does a bank or other financial institution determine a) whether or not they should lend you money and b) how much they should charge you to pay it back? Bingo–your credit score. While there are a few different ways to build credit (student loans are a great place to start), a credit card is really the best way. By paying your balance off each month in full, you’re building a strong history so when your creditworthiness is evaluated, that financial institution says, “yeah, I’ll back you.”


Only paying your minimum balance or paying late

When your credit card statement shows the monthly amount due, that’s what you have to pay, right? Wrong! That amount, sometimes referred to as your minimum amount due, is usually a percentage of your entire outstanding balance (unless you never use the card). In order to maintain the best credit possible, you need to make sure you are paying off your entire outstanding balance at the end of each month. Don’t be fooled by the minimum amount due! Paying off only your minimum amount due negatively affects your credit.


Most credit cards have now started to offer ‘late payment forgiveness’, but this is a one time only deal. Do not pay your balance late, even by one day. In that multi-page document with tiny print that you signed, you agreed that if you neglected to pay your balance on the due date, the credit card company can increase your repayment interest rate in a big way. This is bad news, folks. If you were having a difficult time paying back your card balance at the interest rate you had before, it’s about to get harder. See my previous blog post for more details on this.


Lenders checking your credit score vs. you checking your credit score

Some good news! According to the largest crediting bureau, Experion, you can check your own credit score as often as you like without hurting your credit (this is considered a soft pull on your credit score). You’re also able to get a free credit report from each of the three largest crediting bureaus once every 12 months, but if someone else is checking (credit card company, car dealership, etc.), this is considered a hard pull and will affect your credit. Too many hard pulls on your credit makes it seem as if “you are either having trouble getting new credit or overextending yourself with your financial responsibilities” according to Forbes.


So what does all this mean? Here’s why all this stuff matters, as told by my colleague, a financial analyst at National Life Group, Patrick Meany:


Your credit score is one of the biggest factors in determining what rate you get when applying for a mortgage. Even a small difference in your credit score can make a huge difference in what you pay over the life of the loan. For example: an 80 point decrease in your credit score can cause your rate to increase by 100 basis points (bps) or 1%. This may not seem like a lot, but applied to a 30 year, $200,000 loan it would cause your monthly payment to be almost $120 higher a month. Over the 30 years of the loan you would end up paying over $42,000 more because of the 80 point decrease in your score.

If you’ve fallen into some of the credit pitfalls above, don’t fret—those mistakes will be erased after seven years. Maintaining a high credit score is the key to a happy life and the research above is just the tip of the iceberg, so I challenge each of you reading this to do some research of your own.


After all, knowledge is the truest success.


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