Financial responsibility is an important part of adulting that is complex and often scary for many millennials. With a lack of education around financial literacy, it’s easy to begin practicing bad habits. My sister and I recently took an online course on building and maintaining healthy credit that reinforced lessons we heard our dad share on repeat over the years and added some knowledge and tricks that were unknown.

According to Tiffany Aliche, also known as the budgetnista, “bad credit makes for an expensive life and although you can’t build your credit overnight the fastest way to success is action.” Before starting to build credit or continuing down the wrong road the information and best practices shared here will give you an introduction to credit and help lead you down the path toward a healthy financial future.

Vocabulary

Credit Score: A number between 300-850 totaling the average of an individual’s credit activity determined by various factors

Interest: Fee paid to borrow funds

Financial Debt: Money owed to a company or organization in exchange for funds, products, goods, and/or services

Credit Reporting Agencies: Companies that develop individual’s credit scores including TransUnion, Equifax and Experian.

Balance: The amount of outstanding debt owed to a lender

Limit: The maximum amount of money that can be borrowed or charged to an account for deferred payments

Factors that affect your credit score

Inquiries

An inquiry is a review of your credit score by a creditor or lender. Inquiries can be placed into two categories that affect changes in your score differently. A hard inquiry (made by a creditor or lender) can decrease your credit score between 8-30 points, while a soft inquiry (made by you or a business such as a potential employer) does not negatively affect your score. Inquiries can remain on your credit report up to two years.

Fun Fact: Similar applications within a 14-day period are only reported once, which means if you’re planning on making a big purchase comparing interests, benefits and other elements of lenders will only count as one inquiry on your report.  

Types of Debt

While there are many different types of debt, it typically falls into two categories including loans and recurring debt such as credit cards. Those who use multiple diverse accounts responsibly have a stronger likelihood of approval for future loans based on your ability to make payments on time.

Credit Age/History

Contrary to my original understanding, credit history isn’t limited to your oldest credit card or loan. It’s instead an average of your total accounts.

Example: If you have one active credit card opened in 2016 and one loan opened in 2018 your credit history is 1.5 years vs. 3 years.

Equation: 3 years total divided by two accounts total = 1.5 years of credit history.  

Debt to income ratio/ Utilization

This is simply the amount and frequency of your total debt in use. It can be calculated by taking an average of your balance and limit on open accounts. Although it’s best to avoid using credit cards you’re unable to pay the minimum or full amount on the due date, it’s important to keep your accounts active to avoid closure.

Example: If you have two credit cards with a $300 limit and a balance of $60 on one and a balance of $20 on the other your utilization amount would be 13%. Your total utilization should never exceed 30%.

Payment History

Your payment history audits your open accounts and impacts your score based on the frequency of payments made on time. Ideally you shouldn’t have any late payments, but it’s important to make future payments promptly especially if you have missed payment deadlines in the past. This can be calculated by dividing the number of late payments between 30-120 days by the number of prompt payments. Missed payments can turn into derogatory marks on your report and decrease your score.

Fun fact: Current creditors can cancel or increase your interest rate if you’re late on any credit, whether it’s to them or not.  

According to Aliche, credit can be seen as a grade point average and although the ideal level 620-680, you should aim for the highest grade possible in each category.

10 Ways to build and maintain good credit

1.     Pay bills on time.

Automatic payments can prevent missed payment deadlines.

2.     Become an authorized user on a trusted family member or friend with good credit.

3.     Open a secured credit card.

Within six months of responsible management, secured cards can be transferred to a regular account.  

4.     Check your credit scores from all three credit reporting agencies twice per year to maintain accuracy.

5.     Eliminate active debt starting with the highest interest rates, especially those created within the last two years.

Derogatory marks can show on your report up to seven years but inactive debts will not affect your score as much.

6.     Research the statute of limitations in your state.

7.     Dispute errors directly with a company or credit agency instead of a third party, which can prevent counter claims after an initial dispute.

8.     Do not cosign.

When you cosign you assume full responsibility for other’s debt. While negative activity can stay on your credit report up to seven years; positive accounts can stay longer. In the words of Aliche: “Lend your money not your name.”

9.     Avoid cancelling a cards that could decrease your utilization rate or credit history to six years or less.

10.  Avoid opening new cards randomly such as for incentives like earning a 15% discount at your favorite department store with an application.

What tips are best practices have you learned and implemented to help you build or maintain a good credit? Share in the comments below.

Hugs & Handshakes,

Jasmine C. Tate