Why Is Credit So Important?
Credit is something we all need to survive in this world, and how you handle your credit will dictate how well your peers, employers, and lenders will be willing to do business with you.
Good credit can help you in many ways besides with successful loan applications. When you’re looking for a new apartment or a new job, your landlord or employers usually take your credit standing as an indication of your likelihood to pay on time or work according to company rules.
Establishing a good credit score ensures you get the best rates on auto, home, and even business loans. Potential lenders can see that you handle your finances responsibly and that you can be trusted with other people’s money.
So, when you’re operating an online business, you will eventually need to open a business account.
In addition to that, you may want to apply for a business credit card to help pay for expenses if necessary.
Whatever you choose….a healthy credit score is vital!
Why credit cards are the best tools for building credit
Having a credit card is the fastest and most efficient way to establish and build credit.
When you buy things with cash, check, or debit- the transaction happens without using any credit. Therefore, it isn’t factored into your score. Making transactions through a credit card, you can establish financial responsibility quickly and easily.
In addition to being effective tools for building credit, credit cards are also the most flexible form of payment available. Molst major brands like Visa and Mastercard, are accepted anywhere.
Credit cards provide a flexible payment option along with benefits and rewards (based on the lender). Different companies use benefits and incentives to get you to open an account with them such as free flight mileage (if you travel a lot), rental insurance, cash back bonuses, 0% APR for one year, etc.
As great as this sounds, however, you must be discerning before making a decision.
Credit Cards are Like Hammers
It must be noted that these wonderful tools can also hurt you when used improperly. PLEASE….use with caution.
I like to use the metaphor of credits cards and hammers.
When used properly, credit cards are an excellent tool that builds and/or repairs your credit score. Hammers are also handy little tools used to repair and build things.
Consequently, when used improperly, it can wreck your credit score and create mounds of debt that won’t be easy to pay off due to high interest rates. Imagine how a hammer can be used as a tool of destruction.
After using your credit card for about a month, these are basic factors that determine how good (or bad) your credit score will be:
- Number of Open/ Closed Accounts On Your Report
In addition to credit cards, this includes other accounts like auto loans and student loans. The more accounts you have open in good standing, the better your score will be. It’s never a good idea to close an account on your own terms as it brings down your score.
- Hard Inquiries
So, you didn’t get approved for the first card application, so you apply for another. And another…..and another.
Don’t do this! When you apply for an account, the credit company checks your report to see if you’re qualified, and that causes a ding to your credit score. The more hard inquiries you have, the lower your score will be.
- Credit Card Utilization
The general rule is to keep your utilization score under 30%. This shows that you have control over your spending habits and are less likely to max out your card. Just FYI- it’s never a good idea to max out your credit card!
Sometimes lenders are willing to increase your credit limit if you have proven that you’re responsible by maintaining your spending habits.
Having an increased limit increases your debt to utilization ratio (great news).
See example below:
$500 used on a $1,000 limit = 50% utilization (not good)
$500 used on a $2,000 limit= 25% utilization (good)
- Number of On Time Payments
This is possibly the biggest factor in determining your score. This is why it’s best to not carry a huge balance that you can’t pay off within a month. The general rule is to never spend more than you have in cash (or your checking account) to pay it off with.
However, this isn’t always possible. Emergencies, car repairs, etc. Life happens!
It cannot be stressed enough…..It is important to stay on top of your monthly payments. DO NOT MISS A PAYMENT!! One missed payment can bring down your score by as much as 100 points!
My advice is to pay more than the minimum each month. This limits the amount of interest that will add up from carrying a balance.
Now here’s a contradiction:
It’s ok and even encouraged, to carry a SMALL balance each month so it actually looks like you’re using your credit card. The goal is to BUILD/ ESTABLISH/ REPAIR credit…..so show it!
What If I Have No Credit or Bad Credit?
To build or repair your credit, you’ll obviously need to take some form of modest credit when only starting out.
Getting a secured credit card is a good way to begin – it’s a credit card that requires a bank deposit to get.
Your credit limit is usually the same amount you deposit.
When you start using a secured credit card and pay your monthly dues on time, then your credit standing begins to grow.
The benefit they offer is that they can help you establish or improve your credit until you qualify for better terms.
With a secured card, however, you have to make sure that it reports to all three reporting agencies, and preferably doesn’t report as a secured card.
You have to actually use your card to improve your credit history; just having the account open without using it won’t improve your credit.
You will hurt your credit score by closing old accounts and opening new ones. It’s best to see if you can upgrade the terms of your card while keeping the same account number.
As stated previously, the best way for you to build your credit is to use your card every month, use no more than 30% of your credit limit, and pay your bill in full every month to avoid finance charges.
You Must Prove Yourself
In general, if you have no credit, you can get a card with a modest limit. Over time, this limit will increase as your score increases. You have to prove yourself, so be patient!
If you’ve had a secured credit card for some time, you’ve stayed within your credit limit, and you’ve always paid your bill on time, contact your credit card issuer to see if or when you’ll qualify for a better card.
They may agree to return your security deposit, reduce your interest rate, or do away with the annual fee. You may even qualify for a card with rewards!
Why start with a secured credit card then?
- It will teach you a good financial behavior.
- You will not be able to spend more than your limit allows.
- You will not miss a deadline since your deposit will count as a payment
This is pretty much a win-win for you and the credit card company.
By being responsible with your credit card, your score will increase as you have shown the reporting agencies that you can be trusted and financially responsible!