My parents provided a great life for me and my siblings, but they rarely discussed good financial practices with us (something I want to do often with my kids). However, they did preach one very important thing the moment I turned 18. Building good credit is essential. And they were right.
Good credit lets lenders know that you are reliable and able to pay off your debts. But good credit is worth much more to you than a lower interest rate on a loan. Consider this partial list of times when our credit score has mattered:
- Renting an apartment – our application could have been rejected or the landlord could have required a higher security deposit if our credit was poor.
- Buying our home – on a $200K mortgage the difference between a 3% loan and a 5% loan is $230 per month.
- Applying for credit cards – the best cards with the most perks and lowest APRs are only available to “prime” customers with lower risk of default.
- Purchasing a car with financing
- Getting a job
- Utility companies
- Insurance premiums
- Cell phone companies
The approval of every item on this list is not fully dependent on good credit. But each of these is influenced by your credit and can affect its affordability.
Take insurance premiums for example. You likely won’t be declined a policy if your credit is poor. But insurance companies may use your credit score to assess risk because lower scores tend to correlate with higher frequency of claims.
The Perk$ of Good Credit
My favorite reason for building strong credit is all the perks that come with responsible use of credit — especially rewards credit cards. This topic deserves a blog post of its own, which I plan to do in the future. For now, let me summarize what rewards credit cards have done for us.
- Cash rewards between 1-10% on every purchase
- Discover It – 5% cash back categories that change each quarter plus double rewards for the first year after sign up.
- Chase Freedom – 5% cash back categories that change each quarter or 1.5% cash back on all purchases with the Chase Freedom Unlimited card.
- Citi Double Cash – 2% cash back (1% when you purchase, 1% when you make a payment).
- Travel rewards + sign up bonuses
- Citi AAdvantage Platinum Select – frequent 50,000 bonus mile offers.
- Southwest Rapid Rewards Visa – 50,000 bonus mile offers.
- Marriott Rewards Premier Credit Card – up to 80,000 bonus mile offers.
And this is just a small sampling of all the great rewards available through credit cards. And if you have good credit and use credit cards responsibly (pay off balances each month to avoid interest and fees), there’s no reason you can’t take advantage of these deals.
As I will chronicle in future blog posts, my wife and I enjoyed the most amazing vacation of our lives in 2016 in Hawaii. Using a combination of credit card rewards accumulated over a long period of time, we were able to enjoy this extravagent vacation on a fairly modest budget.
How We Keep Strong Credit
Contrary to many beliefs, keeping track of your credit score does NOT hurt your credit and it is essential nowadays. If you have a smart phone, download the Credit Sesame app and sign up for their free services. Both apps give you a free look at your credit score and the factors that cause your score to increase or decrease. You can also review your credit report and find any discrepancies in their reporting.
My wife and I monitor our scores, but only to make sure there isn’t inconsistent information on any of the bureaus (there are three — TransUnion, Equifax and Experian). Our spend patterns and timely payments keep our scores high.
Your FICO credit score is made up of five components, with the first two carrying the most weight.
- History of Payments (35%): this one is easy. Make your payments on time! With credit card companies, they generally won’t report you as delinquent to the bureau until you are 30+ days delinquent, meaning missing a payment by a couple days shouldn’t hurt your credit. But it will likely raise your credit card interest rates and cause a late fee. So be on time — we set up autopay on many of our accounts to make this one a breeze.
- Credit Utilization (30%): this is big. Your credit utilization is the ratio of balances to total credit limits. The lower your utilization is, the better. Under 10% is best, but under 30% will help you keep a strong mark in this category. Because credit utilization is so important, it doesn’t hurt to have multiple open credit cards even if you don’t use them all. But make sure you don’t leave credit cards with annual fees open and unused.
- Length of Credit History (15%): this is why you want to start early. Length of credit history can only be improved with age. Another tip that my wife and I live by — keep your oldest accounts open, even if you don’t use them anymore. I have an old college account with a crazy high APR and no rewards, but the 12 years of history is helping my credit score even though the card remains inactive.
- New Credit (10%): how many recently opened accounts you have. If you open a lot of new accounts in a short period of time, it will have some impact on your credit score. Thinking of it from the bureau’s perspective, someone applying for lots of credit is more likely to be in desperate need of credit — maybe due to job loss or unexpected expenses. A person with these stresses is more likely to default, and therefore has a lower credit score. My wife and I do open a couple new accounts each year to take advantage of new reward opportunities, but the credit hit is typically a few points and falls off within a couple months.
- Types of Credit Used (10%): diversify. Though this is another small piece of the credit puzzle, the bureaus like to see credit in multiple areas because it shows them you are reliable on multiple fronts. A mortgage is a good example of “good” credit because you can establish a strong payment history. But by no means does this mean you should go take out an extra car or personal loan just to help your debt. My wife and I only have a mortgage and credit cards we pay off monthly, yet our credit scores are well over 800.
Other less common derogatory marks like bankruptcy, foreclosures or collections can also dramatically lower your credit score. Learning good financial sense goes a long way toward avoiding these!
There you have it. Credit and why we take ours so seriously. If you don’t know your credit score or have not checked in awhile, sign up for Credit Sesame and get more connected with your finances today!
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