It is never too early to begin your financial education and that of your children. By the time I was 26, I had an $80,000 credit limit with an 803 credit score, and I had never made more than $14,000 a year up to that point in time. I am proof that anyone can achieve the trust of financial lenders without having a high paying job or a fat savings account. Financial responsibility is all that is needed.
Opening a line of credit through a credit card is the most common method used to begin building your credit score. Although credit card providers require applicants to be at least 18 years old and provide proof of independent income, it is possible to begin building your child’s credit score even earlier by making your child an authorized user of your credit card. Most credit card providers do not have a minimum age for authorized users because they are not contractually obligated for any debt incurred, the primary card account holder is solely responsible. However, the authorized users’ credit score is affected.
Being an authorized user on another’s credit card does not carry a huge impact to your credit score; however, if you have no credit history, becoming an authorized user on another person’s account will allow you to establish a credit score.
What is a credit score?
A credit score, also referred to as a FICO score , as a calculated scoring methodology used by financial institutions to rate the creditworthiness of an individual seeking to borrow money. In essence, your credit score helps lenders assess the risk probability associated with loaning money to consumers. From a bank’s perspective the lower a borrower’s credit score and greater the loan amount, the greater the risk of the loan not being paid back in full. You can check your credit score for free using Credit Karma. They have a very intuitive phone app which makes checking your credit score quick and easy.
How is your credit score calculated?
The FICO scoring method develops by Fair, Isaac, and Company, was developed in 1989 and is the primary credit scoring model used the financial institutions in the United States. There are three credit bureaus in the U.S. that provide consumer credit ratings, TransUnion, Equifax, and Experian.
FICO and the credit bureaus do not share the exact calculation methodology used to calculate your credit score, but they do publish what criteria is used to determine your credit score: payment history, current outstanding debt, length of credit history, recent hard credit inquiries, derogatory marks and number of credit accounts. Credit scores usually range from 300 to 850, scores are designated as bad (less than 550), poor (550-649), fair (650-699), good (700-749) and excellent (750 or above). The average credit score rating in the U.S. is 687 at the time of this writing.
Payment history is the most heavily weighted factor in a credit score. It calculates the percentage of on-time payments made by the consumer over several years.
Tips for breaking 800: 1. Pay your bills in full each month, not just the minimum amount due. 2. Pay your credit card on bi-weekly basis, whenever you receive your paycheck, rather than waiting for the monthly bill to come due. 3. Set up electronic payment methods for each of your accounts so you can pay your bills with a few swipes of your phone.
Current outstanding debt is the second most important factor and looks at how much outstanding debt you have at the current time compared to your total line of credit to determine your credit utilization. For example, if you have three credit cards with credit limits of $1,000, $5,000, and $15,000, your total available credit is $21,000. If you currently have $326 of outstanding debt on your credit card your credit utilization would be 1.55% (326/21000 = 0.0155. The lower your credit utilization the higher your credit score will be.
Tips for breaking 800: 4. Keeping your credit limits high and request credit limit increases every six months to a year. When you pay your bills on time and in full, lessors are more inclined to grant your requests. 5. Keep your credit utilization under 5% and never go above 10% unless you have money in the bank to pay it off in full the very next day. Experian data shows that consumers with credit scores over 800 averaged 7% utilization of their total credit. Be better than the average and you will accelerate yourself into the 800+ club. It is my personal preference to keep my utilization below 2% unless I am making a very large purchase to take advantage of rewards points.
Length of credit history is the third most important factor, which looks at the average age of all lines of credit currently held. This includes open credit cards, student loans, mortgages, etc. Some credit bureaus also look at how old your oldest line of credit is. Financial institutes like seeing a long credit history, in their minds it proves you have been able to manage your credit successfully for a long period of time and it also gives them a greater sample of records to review when determining your creditworthiness. The most important thing to keep in mind regarding this cost element is how your credit score may be affected by closing out old credit cards or paying off long multi-year loans like student loans or a mortgage. For this reason, it is usually not advised to close old credit cards that are more than 5 years old, especially if there is no annual fee to keep the credit card open. Just simply cut up the car or store it in a secure place if you do not plan to use it. I have closed credit cards that are less than 5 years old and although they affected my credit score, my score never declined more than 2 points. So don’t be afraid to close out old cards if it makes financial sense to do so.
Tips for breaking 800: 6. Avoid closing out old credit card accounts unless it makes financial senses, in such cases ask the provider what options are available. If you are paying an annual fee on a card you haven’t used in over a year it may be worth closing out the account, however, you can most likely downgrade the card to a no-fee alternative. For example, I recently downgraded my Chase Sapphire Preferred card, which carried an annual fee of $95, to the Chase Freedom with no annual fees.
Hard credit inquiries are recorded anytime a financial institute checks your creditworthiness in response to an application for a loan or credit card. One hard credit inquiry will knock your credit score by 2 to 3 points. The hard inquiry will show on your report for 24 months but will only impact your credit score for the first 12 months, after which time your score will recover. If you apply for too many credit cards at once it is possible to drop your credit score by 5 to 8 points. On the other hand, if you apply for a loan with multiple financial institutions to compare offers the credit bureaus will usually take note and treat the inquiries as one. I recently purchased a new vehicle and shopped around by applying for auto loans with five different institutions, additionally, I had recently applied for the new Chase Sapphire Reserve credit card a week earlier. With all of these credit inquiries in a two-week period, I was worried that my credit score would drop significantly, but I was surprised to see it had only dropped two points.
Tips for breaking 800: 7. Do not apply for new credit cards more than once or twice a year. If you are seeking out a loan, shop around to compare rates with at least 5 financial institutions, but submit all applications within a 1 to 2 week period. The credit bureaus will most likely treat the multiple hard inquiries as one inquiry if all performed in a short period of time.
Derogatory marks are any accounts in collections, bankruptcies, or foreclosures from the past 10 years. Although not the most weighted criteria, lenders take derogatory marks very seriously as it shows that you have mismanaged your credit in the future and pose a high risk when it comes to paying back debt. Usually the more recent the derogatory mark the greater the probability of loan default.
Tips for breaking 800: 8. Pay your bills on time and avoid derogatory marks. If you do happen to find a derogatory mark on your credit report there are steps you can take to try and get it removed. It is not a guarantee that the mark will be removed, but ten minutes of effort to attempt to dispute a claim is worth the time.
- First send separate letters to each of the credit bureaus Transunion, Equifax and Experian. Include a copy of your drivers license, social security card and a recent utilities bill with the letter, mail the letter certified mail and request a signature.:
- Simultaneously, mail a second letter certified mail to the lender asking for documentation proving you were late on the payment or whatever the case may be.
- You should receive a copy of your credit report with the results of the investigation within 30 days.
Number of credit accounts does not heavily influence your credit score, but it may account for a few points. The scoring element looks at how many different lines of credit you have established; number of credit cards, mortgages, auto loans, etc. The more lines of credit you have the higher your credit score will be. You would think this would be seen as a risk, but from a bank’s perspective, it proves a track record of being able to manage multiple lines of credit responsibly because other financial institutions are also willing to trust you with their money. Although you may be tempted to open up several extra credit cards at low credit limits to help boost your score a few points, I do not suggest doing so. Lenders usually use this scoring element to review what types of credit you have. Lenders prefer to see a variety of credit types, both installment, and revolving. An installment line of credit has a fixed monthly amount due, such as student loans, auto loans, and mortgages. A revolving line of credit is one that has varying payments due each month, the most common types of revolving credit are credit cards and homeowner lines of credit (HELOC).
Tips for breaking 800: 9. This scoring element is the least weighted, and although it is preferable to have a mix of revolving and installment credit, it is even more preferable to have a very low credit utilization percentage and a strong ontime payment history. 10. Check your credit score at least once a month. It is free and there are many tools out there to help you. I have found CreditKarma to be the most useful and it is completely absolutely free.
Tips to build your credit:
The best way to build your credit is to focus on the top three most heavily weighted scoring criteria. Pay your bills in full and on time, paying the minimum amount due on a credit card is not going to help you. Keep your credit utilization low. You will see posts out there that say if you’re credit utilization is below 30% you are golden. I personally think that is bad advice. As a peer-to-peer lender on LendingClub, I do not finance any loan applications that have more than a 10% credit utilization. Those with the best credit scores utilize between 5% to 10% of their credit lines. I would challenge those looking to significantly increase their credit score to keep their utilization below 5% and preferably closer to 1%-2%. Start early and establish a long credit history. I would also suggest you start building your children’s credit history as early as possible. Ask your landlord to report your rent to the credit bureaus. If you rent from an individual landlord or property management company that does not report data, sign up for a rent payment service which will allow for the payment and collection of your rent electronically and automatically report your on-time payments to the credit bureaus. This is an easy way to quickly boost your credit score. Although I have not had to use this last strategy, I have met people who have claimed credit score increases anywhere from 15 to 80 points just by reporting their rental payments.
I became an authorized user on my parents’ credit card at the age of 13. The card was intended for use only in emergencies and I rarely ever carried the card with me on a day to day basis. One my 18th birthday I applied for my very own credit card from American Express and was quickly approved for a $2,000 line of credit. A few months later I was able to open a second credit card at a huge big box retail store to finance a laptop for college with 0% interest for the first 18 months. I paid off the laptop within a year and used by credits cards to pay for small purchases each month. I paid my bills on time, and every six months I would reach out to my credit card providers and ask for small credit increases of $100 to $500. I was never once rejected for a credit increase. By the age of 23, I a credit limit over $50,000 and a 780 credit score. As my credit grew I began seeking out credit cards with better rewards benefits, and by 26 my credit limit was over $80,000 with a score of 803. By that point in my life, I had only worked part-time jobs, had never made over $14,000 a year.