A NUMBER TO KEEP IN THE FOREFRONT…
As many of you are that proud parent and attend graduation for your precious child or relative you may not be contemplating how they are going to survive in the real world. Soon reality sets in. Even if you learned the ACT, SAT or grade point average number needed to meet the intended goal there’s one important number that is still needed to learn: one’s CREDIT SCORE. Here’s how to raise it.
1. Think before you borrow
When students are living on campus they are typically frugal. Once we enter the real world many times those frugal habits go by the wayside. Better idea: Maintain the thrifty habits. One of the best kept secrets to good credit is to have a lot available but use little. The main lesson here is that every dollar of interest you pay is one less dollar you have.
There are a lot of misconceptions about how credit scores work. Here are the components of your credit score:
- 35 percent: record of on-time payments
- 30 percent: amount owed
- 15 percent: length of credit history
- 10 percent: new credit
- 10 percent: type of credit used
Generally young adults are handicapped on the first component because they don’t have a lot of accounts that have been paid responsibly, and the third component because they don’t have a long credit history. So the focus should be on the other components.
“Amount owed” sounds obvious, but it’s important, so we’ll cover it separately in Tip 3 below.
“New credit” refers to applications for credit – regularly applying for new credit makes lenders think you might be desperate or bad at managing money. It’s best to make multiple credit inquiries within a small window, and keep applications to a minimum.
“Type of credit” means lenders want to see you’re well-rounded and can manage different kinds of credit. The two types are open-end or revolving lines of credit (like credit cards, which you pay back at your own rate and can borrow from again) and closed-end or installment loans (such as auto loans and mortgages – loans with fixed payments and a fixed pay-off date).
Ideally, you want to have both types, but you don’t have to buy a car or house to get the latter kind. If you have student loans, you already have closed-end credit. If not, try a signature loan.
3. Don’t overdo it
Back to “amount owed.” Part of this component is a “utilization ratio” of how much you owe relative to how much you’re approved to borrow. The sweet spot is at about 30 percent, so if you have a credit card with a $1,000 limit, try to keep your balance below $300..
4. Start small
As the credit score breakdown shows, young adults are at a disadvantage because they’re basically missing both a long credit history, and lots of credit accounts that have been paid on time and in full – that’s half their score. This leads to a catch-22: How can you build credit when you can’t get credit?
Fortunately, there are options. One is to join a credit union, which is like a bank but can be more flexible about lending. Another route is a secured credit card – easy to get because you deposit money in an account to guarantee the credit line.
One potential problem with secured cards: many don’t report your timely payments to credit bureaus, so are ineffective at helping build a credit history. Check to make sure before you sign up, and also be on the lookout for high fees and poor terms.
Another idea is to have someone to co-sign a loan, meaning payments will be reported in both names. Essentially, you’re getting a break from someone’s more established credit.
5. Be punctual
The best way to make sure your payments are always on time is to schedule or automate them. Then budget well, and start building an emergency fund of three to six months’ living expenses. You can’t avoid unexpected expenses, but you can prepare for them.