Perseverance: Creditworthiness- Build and Maintain Strong Credit
By: Julio Garcia
“How trustworthy are you?”
Credibility is defined as “the quality of being trusted and believed in.” When it comes to personal financial management this is critically important, As simply stated as it can be, credit is based on trust. How can we measure how much we can trust someone financially? If only there were something to do that… oh yes credit scores. This is the way I like to think about credit scores and what that number tells you. It tells you on a scale from 300 (worst) to 850 (best) how trustworthy you are with your monetary obligations. Something that I have always wondered about is the 300-850 scale but that could be a topic for another day.
A good credit score is important for more aspects of life than just finance- for example, a credit score is pulled in background checks which ultimately impacts other endeavors you may have (such as applying for a job). Creditworthiness is particularly important for your financial health because it can first off determine if you get approved and then what kind of rate a bank can offer you for financing things like a car, home, or credit card. The credit bureaus are the ones who are responsible for assigning your credit score based on several factors. Credit bureaus are another topic for a different day but back to those factors and weighting within the scores. Below are the factors that go into a FICO credit score, a popular score referenced by lenders in the US.
Now that we hopefully have a little better understanding of what those scores mean, let’s focus on one of the primary reasons most people’s scores are used- credit cards. If you’ve ever heard the saying “use a credit card for emergencies only” you can do yourself a favor and throw that out. While that may be a good rule of thumb and help prevent people from racking up a lot of credit card debt, that is a very conservative view and for people who don’t have a lot of discipline. Credit cards are meant to be used for your everyday purchases from something as small as buying a water bottle from vending machine to as big as buying a new laptop. People sometimes mistake credit cards as extension of their monthly income instead, think of a credit card as a replacement of the money you have budgeted for that month. For example, if you receive $2,500 a month but spend $1,900 on bills and $100 to savings, you’re left with $500. You should spend a maximum of $500 on your credit card so by the time that the billing cycle ends you can pay the balance in full. Another reason you want to use your credit card for everyday purchases is because of the rewards financial institutions offer. Some will give you cash back on purchases and others will give you a certain amount of points for every dollar you spend. If you are already planning on spending the $500 on your debit card why not spend the same amount on a credit card and receive extra benefits.
The previous example is perfect for explaining what it means to live within your means. Credit cards will test how responsible you are. Financial institutions will grant you a certain amount of credit but it’s important to budget yourself to only spend what you have. If a bank grants you $1k on a credit card but your income only allows you $400 to spend then you can only spend $400 on your credit card. Over using you credit limit can result in negative impacts on your score and put you in high interest debt which is a hard cycle to get out of. As mentioned above, there are a number of factors that go into your credit score and utilization is an important one (falls into amounts owed category which is 30% weighting). If you spend $400 on your $1k card then you have used up 40% of your credit card limit. If your limit used has reached above 30% it CAN negatively impact your credit. Always try and stay within that sweet spot of 0%-29%.
How hard is it to build credit? Have you ever tried to apply for a credit card and get declined because of insufficient credit history but you need a credit card to build credit? Like what? You want me to build credit but in order to do that I have to get a credit card that I need to have established creditworthiness for? Makes sense. A great resource for understanding what your credit score looks like before you have credit is https://www.creditsesame.com/blog/credit-score/what-credit-score-do-you-start-with/#:~:text=. Building credit seems easy huh? Fret not, there are ways to do this and here are a few:
1. Paying your bills on time (when you start paying bills, that is)
2. Get a secured credit card which is tied to an account where you have some amount of cash deposited in. For example- a $300 account with your cash in it that is tied to the credit card. Then you use the credit card for purchases and pay it down as you use it. This does tie up the $300 meaning you can’t use that money but this is a great alternative for people who need to build credit all on their own.
3. If you’re lucky enough to have someone who has established credit and they are willing to let you on their account(s) as an authorized user, that is another way to help build credit early on.
Retail cards like Macy’s or Walmart can also help you build credit and have a higher tolerance for lesser credit scores. Those companies will give you a low credit limit and you’re only allowed to use those cards at their stores but it still creates credit history and it still builds credit. These are also credit cards that will typically have the higher interest rates, so be aware. After having them for at least a year or so and have made on-time payments you can graduate to some of the more exclusive credit clubs (financial institutions, credit card companies, etc.).
Once you have established your creditworthiness, you’ll still need to be vigilant on your credit. Monitoring and checking your scores daily, making payments on time, making sure your credit is secure, etc. Credit is a lifelong commitment
