How to Build Credit While You’re Young
“What’s the point of using a credit card if you have the cash to pay for it?”
When I was growing up, this was a question I always asked of my dad until I truly understood the answer.
The simple answer to my question is, “to build credit so banks and companies can trust you when they lend you money.” However, there’s a lot more behind building credit than just that.
You probably see and hear all the commercials about knowing your credit score. Credit score scales range from company to company. Here is some information I found from credit.com. Most companies tend to range between 300-850 (poor-excellent). There are some companies on a scale of 100-900 or 501-990.
I know quite a few people who pay two times the amount I paid for my mortgage when I first bought my current house. For about a year and a half I was paying $631 per month toward a house that was under my name. Last Summer, I refinanced my mortgage to cut my loan down from 30 years to 15 years. This in return raised my mortgage to $808. Whereas, the houses in my same neighborhood that were up for rent were going for about $1000-$1200 per month. So even with a higher mortgage, I am still paying less than most apartment complexes and rental properties. My house is actually an investment as each month passes because I gain more equity in the house. When you rent an apartment you’re paying the property management company and basically throwing away a lot of money with nothing to show for it. Even though renting a house might be more enticing than an apartment, you are still throwing away money. What you are actually doing is helping the landlord/home owner pay off his or her mortgage quicker because of the inflated rent!
I always wonder why is it that if people can pay double what I am paying just for their rent, why can’t they own a house too? I would say there are two main reasons. The first and maybe less likely reason is that the person is unable to put a lump some of cash on the table for closing costs. However, the more likely reason is that even though they have the cash, they do not have the credit score to allow them to receive a decent loan in order to purchase a house. Now that’s a terrible situation to be in if you ask me. You have the money, but you aren’t deemed trustworthy enough. So you end up pouring out all of this unnecessary money to benefit someone else while you don’t get any financial benefit from renting.
Plus, a credit can come in handy should any unforeseen events occur like a medical emergency, car maintenance, traveling expenses, etc.
So have I convinced you on why building good credit is important? Well you’re still reading, so I hope so!
Credit cards are not the only way to build credit, but it’s typically the place to start when you don’t have any credit yet.
When I was a senior in high school, I applied for a Upromise card. It is a credit card geared toward students who are attending college, but others can become a member as well. They even give you cash-back rewards for using the card. I had a low credit limit when I first started with the card since this was my first card and I didn’t have any credit history to show. Over time though, I was able to increase the credit limit a bit. I mainly used my card for books, gas, and groceries while at college. Each month I made sure to pay the bill on time and in fact quite a few days ahead. That is the most important thing to remember about having a credit card: paying your bill on time and not missing payments. Simply keeping up with a payment due date is an easy way to build your credit score. While I was in college, I kept getting an offer from my bank saying that I was pre-approved for a credit card with about a $4000 credit limit. I kept throwing it out and ignoring it because I thought that was ridiculous. Eventually I talked with a representative from the bank and learned about the fine print of the credit card (read more about that in a bit). I decided to opt in with this card and I still have that account to this day. When the economy was dropping while I was a student, my credit limit decreased unfortunately since the bank knew I did not have much credit or income at the time. However, a few years later it jumped back up because I did gain a lot more credit history with time.
Once I graduated and started to have a more steady income, I was able to pay double the minimum due amount and in most cases now I pay ten times the amount the bank requests. So if the whole goal is to make yourself more desirable to banks and loan companies, then you want to show that you are timely with your payments and you are able to pay off your balances quickly.
After starting with the baby steps of obtaining a credit card and building a decent credit score, you can start building your credit in larger ways. Typically when you make a large purchase for furniture, technology, cars, and houses, there is a credit check that takes place. Even some utility companies will check your credit to see if you will be trustworthy enough to pay your bills each month. If your credit score checks out, you might even be able to avoid some initial deposit fees that less trustworthy buyers have to pay. When these companies run a credit report on you, they give you a copy of the report. I love this because then I am able to compare my previous score to my current one. It’s so exciting when you watch your credit score grow and don’t have to worry about being accepted. It almost becomes just a protocol thing for the company to do, but you don’t have to worry about your score getting in the way of your purchase.
Paying off student loans, making car payments, paying utility bills, and making mortgage payments will continue to help improve your score with time. Just because you were on time with all your bills for one month, that doesn’t mean you’re score will sky rocket to an 850. Like I said before, you have to pay on time and pay off more than the minimum due amount. You want to be consistent with this. If you can pay off your credit card in full each month, that’s even better! Also, keep in mind that your credit score will fluctuate. At first, the more debt you have and credit card accounts you have open might drop your score a bit. Also, applying and getting declined by a company can affect your score too. However, once you build up the trustworthiness again your score will also build up gradually.
Just to give you an idea of how a credit score can fluctuate quickly, here’s some of my details. Last Fall, I traded in my previous car lease for a newer car lease. (Yes, I said lease. Maybe that will be my next financial post!) The dealership ran my credit score and the sales rep was impressed because it came out to be an 801. I was super stoked of course because this was the highest it had ever been. He told me that he sees maybe 1 in 500 people with that score come into the dealership (keep in mind I’m only 26 years old)! This all happened within a three year period. When I leased my first car, I had just signed a contract for my current job, I had student loans, and not much of a credit history since I was fresh out of college. So within three years I went from not much of a credit history and a lower score (I believe it was high 600s) to an excellent score of 801. I say all this because you don’t have to be married in your 30s with a really large salary in order to have an excellent score and make these purchases.
However, I recently opened up another credit account so that I could purchase my lovely Mac I’m typing on right now. When I opened up the Apple Rewards credit card and received my newest credit report, it read as 748. That may seem like a drastic drop and it has nothing to do with late payments or just paying the minimum amount. Again, it probably goes back to the fact that I now have more debt under my name and more accounts. Once you get started on building your credit it becomes easier to keep building it.
Just stay consistent and give it time!
Watch Out For…
The Fine Print
Be sure you read the fine print on credit card offers before accepting them. Most companies start with 0% APR (annual percentage rate) which means you only pay what you borrowed and no interest. That does not mean you have 0% APR for the lifetime of the card. You need to see when the APR changes and what the rate will be after that time period is up. Look for companies that offer a longer period of 0% interest and a decent interest rate afterwards. Try to stay away from extremely high interest rates (upper teens, low twenties) especially if you don’t plan on paying off your balance each month. Otherwise, you’ll end up spending so much more money on interest alone which is just a waste.
You do NOT want to file for bankruptcy unless it’s an absolute dire situation, but don’t put yourself in that situation to begin with! Filing for bankruptcy will show on your credit history for a few years and it will make it very difficult to be deemed as trustworthy in that time period. So in order to avoid bankruptcy be sure to pay your bills each month, don’t max out your accounts, don’t have a lot of credit accounts open (I would keep it to 3 or less personally), and don’t purchase items if you can’t truly afford them. Once you get behind, it will be hard to get back on track.
Keeping an eye on your credit score can help you notice if something fishy is occurring with your accounts that you are unaware of. Unfortunately identity theft is a more prominent crime today, so if you see your credit score drop drastically you may want to check with the security of your accounts.
So whether you dream of making a large purchase in the near future or in a few years, ultimately having good credit is necessary (unless you are able to pay in cash). The sooner you start building credit, the easier it will be to achieve that dream.