We live in an economy built on credit. When we apply for a new car loan, buy a new house, borrow to star a new business or even apply for a new job, good credits will go a long way to save you money and help landing you that new job!
So how does credit work and what makes good credit?
Credit is a measure of your financial strength and trustworthiness. It helps the banks who want your business getting to know you a little, at least your finances, and decide how risky it is that they might loose the money they loan you. Over the years the banks have done business with enough people and they’ve done the research on what risky behaviors that lead to a default look like. Exactly how they turn those metrics into a credit “score” is proprietary and here are some basics.
History of on-time payments tells the bank that you take your trustworthiness seriously and if they lend you money they are very likely to get the money back plus interests. Score!
Types of the credit also tell a story of your financial well-being. Routine payments to utilities like telephone, cable TV, gas, water garbage and electricity bills will add to your credit worthiness. School loans, car loans and credit cards issued by major financial institutions are also good. However credit cards issued by retails stores can suggest an excessive spending habit. Too many of these trade lines can weight on your credit score.
Length of each trade line also makes a difference. The longer you have maintained an account open in good standing the better it is for your credit.
Routine spending close to your credit line limit can suggest that your life style might exceed your affordability and therefore raises the risk of default and will bring down your credit score. Switch to another card for your daily spending if you purchased a big ticket item.
Never ever be late for a payment. Live within your means. If you must carry a balance on your credit cards look for ways to pay more than the minimum payment. If you are going to consolidate your credit cards keep the oldest cards with no annual fee open and close out your newer ones, especially if they charge a fee. Your credit card from college doesn’t know that you now have a hot shot career so call to update your income record and they’ll raise your limit. Note that some credit research company will actually bring down your score for each credit line limit increase request though this is quickly recovered by good payment history.
Stay below 30% - 50% of your credit card limit. Set up utilities bills under your name and then collect from your (trustworthy) roommates each month. If you are prone to over-spending do not set up automatic payment. Instead, set up a calendar reminder to pay your credit card each month. This will bring clarity to your spending habits and help prevent over-spending. Building good credit takes intended effort and time. Start early. Ask for help! If you are in debt seek help from a financial advisor or engage a debt relief company. Good luck and remember, life is good.
This article was written by Peter Mu, CFP®
Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS) 20 Bicentennial Circle, Suite 100, Sacramento, CA 95826 Securities products & services and advisory services offered through PAS, member FINRA, SIPC. Financial Representative, The Guardian Life Insurance Company of America (Guardian), New York, NY. PAS is an indirect, wholly-owned subsidiary of Guardian. Guardian, its subsidiaries, agents, and employees do not give tax or legal advice. You should consult your tax or legal advisor regarding your individual situation.
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