Unless you can pay cash for everything, it is probable that you will need a credit score to obtain financing and building your credit is an important factor to consider. Whether it is for a car, credit card, school loan, mortgage loan, or other types of financing, the better your score, the better the rate or deal you can receive. I’m sure you see those car advertisements for 0% for qualified borrowers. What exactly is a qualified borrower? Typically, it is one who has a high enough score to fit the risk of the lender.
From the moment our children enter school, they will learn many subjects that they may never use in the future. They take standardized tests to see if they have what it takes to enter college. But rarely will they learn a major life skill that they will use for their entire adult life, financial literacy.
Many children grow up in households where finances aren’t ever discussed. So, when it comes time to enter adulthood, many don’t understand where to start with their finances. They take advice from people who surround them. If those who provide the advice have not experienced financial literacy, then the new adult will possibly go down a path that leads them astray. And the cycle continues, which leads to low credit scores, bankruptcies, collections, and the inability to become a homeowner.
There aren’t many free classes that teach us about financial literacy. Yes, there are classes that you can pay for but if you don’t know how important the subject is, then you may be less likely to spend money for it.
How to Start Building Credit
It doesn’t take a lot to get started building credit. If you aren’t fortunate enough to have a co-signor to help you get started, you can likely get a secured credit card once you reach 18. A secured card requires you to deposit money with a bank that issues a credit card. They hold the money while you have the card and at the time you close it, then they will send you your money bank. You will want to keep the card open long enough to build a good credit score and possibly become eligible for a traditional card. Because age of accounts is a big part of your score, closing it out too soon will hurt your score.
The lowest balance that makes sense is around $200. I have seen some offers that allow you to open a card with a $50 deposit. However, what will happen is that your usage on that card will be too high. For example if you spend $20 on a $50 limit, your usage is 40%. If you get a card for $200 and only charge $20, then your usage is 10%. When starting out building credit, 10% is ideal. Over time, a 30% usage is what the credit score models suggest.
The mistake I see people make is that they are told to get a credit card and use it as much as they can. They think that the more they use it, the better their score will be. This is such bad advice. Even if they pay it off monthly, their usage is what hits the credit reports and the risk is evaluated. Maxing out credit cards shows a higher risk than a person who has a low balance to limit.
How Long Does It Take to Build Credit?
If you are starting from no score, it will take 6 months of usage to get a score. Some advice I give clients is to take a monthly recurring charge you have that may be $10 and have it billed to the credit card. Then, pay it off monthly. Keep repeating this monthly. You will be happy with your score if you do this and make the payments on time. Keep in mind, you may not jump to an 800 score immediately because you need the age of accounts to grow your score. Don’t close older accounts. Keep them open as long as you can.
Another method many choose is to be placed as an authorized user on another persons account. This can be good and bad. It is good if the person who does this for you makes on time payments, has had their account opened for a long time, and has low usage. This cannot be your only account you have as this is not an indication of your risk but it can get you building a score so other credit can be extended to you.
If you are interested in getting started with a secured card, here is a link to a credit builder card that will report immediately. Typically, as long as you deposit your $200 security and are not in an active bankruptcy, then you should get a quick approval and card within 2-3 weeks. Again, try to keep the spending to $10 a month initially and pay it off monthly. You will thank yourself that you won’t pay any interest and you will give yourself an opportunity to get a high score.
Kelly Byrne Lee
Home Mortgage Consultant
502-523-3323