Building an Eiffel Tower of Credit

by Rebecca Black on May 15, 2012

Anyone remotely connected to anything financial has probably heard that “you need good credit” and that there are ways to “build credit,” but without clarification and a point of reference, these phrases and terms can be utterly meaningless. There are three primary questions people ask about credit and the answers to each of them are nicely condensed right here in this article.

What is Credit?

By way of analogy, think of credit as your borrowing reputation. It represents the likelihood that you will repay your loans based on borrowing history and shows your consistency with payments. When your borrowing history is collected and compiled, it is called a credit report/history. Based on the information provided in this report, reference agencies can determine what rating to give you. The credit rating is totaled and evaluated before a score is awarded. This is the most important part of a credit process and consequently, where most of the confusion and technical details come into play.

Scores are established by using mathematical algorithms based on five key areas in your report: payment history, new credit, amounts owed, types used, and length of credit history. Based on the information provided in those categories, a three-digit number is generated to score your credit. This is the number used by bankers, landlords, and others in determining risk associated with your borrowing habits. Although your borrowing reputation is not really tangible, it certainly has a tangible impact for many aspects of life.

What is it used for?

Much the same way as your reputation earns trust with others and gives you greater opportunities for responsibilities and privileges, your credit score tells certain people whether or not to trust you with a loan, an apartment, a rental car, etc. The most common instances when scores are checked before trust is established include:

  • Loans
  • Renting
  • Utilities
  • Employment
  • Insurance

In each of these instances, your score gives the lenders, landlords, insurance companies, and the others an idea of whether or not you’re trustworthy enough to be given the privilege you are applying for. In some cases, a minimum score is required.

How to Build Good Credit

Knowing how important good credit is, the last question to be answered is “how do you attain it?” Students or those who have never had credit before may find themselves at an impasse when it comes to renting their first apartment or applying for a loan. If you’ve never borrowed before, it can be tough to acquire basic living quarters and other necessities with no history to prove your responsibility.
There are three basic principles to keep in mind when building your credit:

  • Charge only what you can afford.
  • Once you have obtained a credit card, make a relatively small purchase that you know you have the money for anyways. For example, if you’ve saved up enough money for a car, put the $4,500 on your credit card even though the money is in your bank. Although this seems like a fairly straightforward concept, many people are tempted to borrow outside their available means. When they can’t make all the payments, they end up with poor credit right off the bat.

  • Keep up with your payments.
  • It’s much easier to stay current on your payments if you’ve followed the first principle, simply because money is easier to spend when it’s in the bank. Since your history is evaluated partly on how consistently you make payments, this is one of the most important steps in establishing good credit. Furthermore, this is the best way to build credit over time as well.

  • Don’t apply for multiple accounts.
  • Every time you apply for a loan or new credit card, it affects your score. Although incremental, it can eat away a high percentage of your score over time. Like a leaky oil pan in your car, it drains the credit slowly but surely. Keeping your cards down to a minimum helps things stay uncomplicated and easier to manage. When you don’t have to worry about multiple payments, there is less chance of any of them being late. Furthermore, you will only have to deal with one or two interest rates at a time.

For those who have bad credit history and want to rebuild it, the steps are the same with one prerequisite. If you can’t get a card from a big bank because of your poor history, you can usually obtain a department store card (such as Target’s Red Card, or a Macy’s card), a secured card, or one from a smaller, local branch. Be sure to avoid prepaid credit cards regardless of the fact that they are available no matter what your history or score is. These cards do not build credit for you, only for the provider. The Federal Trade Commission will direct you to free checks and other services so you can evaluate your progress, score, rating, and more.

Categories: Building Credit

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