Financial lessons I wish I’d learned at 18 - It’s never too early to start building your credit rating
When I turned 18, I was concerned with choosing colleges and what my summer vacation plans looked like. Building a good credit score couldn’t have been further from my mind. As I inch up to graduation this December though, I’m learning that building my credit is essential to creating sustainable future wealth.
First off – what is a credit score?
Credit scores are on a scale of 300-850 and describe your creditworthiness, or how likely you are to repay a loan or debt. It's designed for consumers to understand their credit health at a glance, and for lenders to incorporate into their sophisticated assessments of whether you're good for any cash they let you borrow.
Why does creditworthiness matter?
Picture this, you’re fresh out of college, where you worked part time as a cashier at your local supermarket. You are debt free, having kept to a tight budget and avoided debt (including credit cards). You have even saved enough money to buy yourself a new car. You’re in a great position.
You go to the dealership, see the car you like and negotiate a price with the car sales person. To see if you qualify for the car loan, the first step for the salesperson is to run your credit history.
But you don’t have one.
Even though you thought you did everything right, you have to pay a higher interest rate and put more money towards a down payment.
Of course, this is only one of many examples where no credit can haunt you as you start your post college journey. Ultimately, a good score can result in a lower cost of borrowing (i.e. lower interest rates/down payments), which leads to better buying power and saving money in the long term.
Here are my top tips and tricks of how to achieve a high credit score at an early age.
1. Become an authorized user of your parent’s credit card
Building credit takes time and consistency. One of the best ways to do this is becoming an authorized user of your parent’s credit card. You won’t have to wait to get a credit card or have the income requirements to qualify. By being an authorized user, even if your parents won’t allow you to spend on their dime, will allow your credit score to build based on your parents pending and payments.
2. Apply for a credit card at 18
The time it takes to build a credit score means applying earlier makes sense. You could even apply for a credit card as soon as you turn 18, the typical age when you are qualified to apply.
There is a chance you will still need to show proof of some income. Getting a part time job when you’re 17 or 16 can help with these requirements. Ask your college student services or credit union if they have any options for incoming students.
3. Be smart with spending and payments
Once you qualify for a credit card, avoid overspending. Each card has a credit limit - the maximum amount of money you are eligible to spend. With your first credit card the limit is low, as credit card companies have no history of you paying off debt. You do not want to exceed your spending limit, since it can result in fees and damage your credit score. If you miss payments this also will hurt your credit score and could result in a reduction of credit.
Almost all credit cards have an interest rate that is charged based on your balance. It compounds if you do not pay the full the balance. That $200 flight you bought, can end up costing you significantly more if you don’t pay attention.
My top tip? Create automatic payments to pay off the balance each month!
4. Continue monitoring your credit score and make efforts to improve it
Submitting the credit card application and getting approved is not the final step in building good credit. Rather it is a continuous effort and involves six factors that can help or hurt your credit.
Age of credit history – Creditors want to know how long you’ve had credit/debt payments. They usually look at the average length of each account.
Total accounts – This is the total number of accounts you have opened that allow you to borrow money. This ranges from student loans, car payments, and any other credit cards.
Derogatory marks – These are negative long-lasting actions that stay on your credit report for longer periods. They include consistently late payments, loan defaults, collections, foreclosures, repos (claims on your property based on bad borrowing behavior), bankruptcies, tax liens (missing tax payments resulting in claims on your property), and civil judgments.
Credit card utilization – This is the ratio of outstanding balances to your available credit limit. It is idea to keep the percentage as low as possible and keep the ratio at below 10%.
Hard inquiries – Every time you apply for a credit card or a loan, the lender will review your history, which counts as an inquiry. These only stay on your credit history for two years and depending on the type and amount could nudge your score down a few points.
Payment history – This is your payment track record. The more on time payments accumulated the better!
There are quite a few websites and apps that can help you monitor and provide a free credit score estimate. Depending on your bank this service may come with your checking account. Just make sure to read the fine print and ensure the checks do not count as hard inquiries.
If you can manage to keep those six credit factors in good shape, it can result in an improved credit score.
Again, these efforts take time and consistency, which is why it is important to start at as soon as you can. After a few years, you’ll be in a perfect positon to buy that new car, start your new business, or even buy your first home at better rates.
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