How to establish credit, understand your report, and maintain a score that lenders want to see
It’s no secret that the last year has left many Americans feeling uneasy about their financial health. Between the demands of work (or looking for work), and the stressors found at home as a result of social distancing, health concerns, and virtual learning, Americans barely have time to cope with their present, let alone address their future. A May 2020 Investments Study on Market Sentiment by Fidelity confirmed it: roughly half of the people surveyed said they were concerned about their finances, but didn’t have time to focus on financial planning.
However, that is beginning to change. In a new year with new hope, Americans are beginning to focus on a much more optimistic future; and with that, the health of their wealth. While the Fidelity study showed that people were indeed struggling, it also brought to light that the challenges of the pandemic were encouraging some to rethink how they managed their money. And staying on top of your credit report is one important tool to help do that. Your credit report contains information about your payment and credit history, and it’s what creditors, lenders, even other businesses use when they consider you for a line of credit or a loan.
For those of you who have not yet established credit, there are some tried-and-true ways to get started. When you’re new to the world of borrowing, one way to get a toehold is to apply for a secured credit card. It is called secured because it is backed by the cash that you deposit upfront as security. That deposit amount—typically a minimum of $200—becomes your credit limit, or the total amount you are allowed to charge to your card. You can use your card just as you would any other: for retail purchases, to make payments, and to pay bills. Secured credit cards aren’t meant to be used forever, rather to build your credit enough to qualify for an unsecured card—a card without a deposit and with better benefits.
When selecting a secured card, be sure to choose one with a low annual fee and make sure it reports payment data to all three national credit bureaus: Equifax, Experian and TransUnion. These agencies provide information about your credit use to lenders. The reports are used to build your credit score. Cards that report to all three bureaus allow you to build a more comprehensive credit history.
That’s not the only way to establish credit, though. You can also apply for a loan or a credit card using a co-signer. Often a parent or sibling, your co-signer must be a person with good credit because they are guaranteeing the lender that you will make prompt payments on your loan or card, and if you don’t, your co-signer will assume that responsibility. There are downsides to this approach, however. Although banks will often write co-signed loans, most major credit card issuers don’t issue cards with co-signers.
Perhaps a simpler and more palatable option is having a family member or significant other add you as an authorized user on their card. Doing so adds that card’s payment history to your credit files, so you’ll want a primary user who has a long history of paying on time. Being added as an authorized user can reduce the amount of time it takes to generate a credit score. You don’t have to use—or even possess—the credit card at all in order to benefit from being an authorized user.
A credit card, secured or unsecured, falls into the category of revolving credit, a line of credit that is being extended by the lender with no determined end time. The balance due increases with use and is due at a set time each month. If the entire balance is paid at that time, no interest is charged on that balance. You only accrue interest on the balance if you don’t make a current balance payment by your due date.
There is a second kind of credit you will likely run into which is installment credit, which takes the form of a loan that offers the borrower a fixed, or finite, amount of money over a specified period of time. Think student loans, auto loans, and mortgages. Unlike revolving credit, you know at the outset how many monthly payments, or installments, you will need to make and how much each payment will be.
Both types of credit impact your credit score. Lenders like to see that you have both, as it demonstrates that you can manage the many different obligations that come with borrowing. However, one type is a bit more impactful, says Jason Holliman, President of Citizen’s National Bank. “While, as a community bank we’ll consider a number of factors, we are interested in revolving credit and seeing that a customer can manage their money effectively, making payments of various amounts at different times.”
While installment credit shows that you can pay back borrowed money consistently over time, revolving credit does more; it shows that you can take out varying amounts of money every month and manage your personal cash flow to pay it back. And that is what lenders are most interested in seeing. It’s the most direct route to establishing good credit and the ability to borrow.
Sandra Parsons, branch manager with Bank of England Mortgage of Knoxville, says that equally important to payments are balances. “Keeping card balances low contributes to keeping credit scores up,” Parsons says. “When we’re looking at mortgage applications, we like to see card balances under 50 percent of the credit limit. Under 25 percent is even better.”
Once you’ve established some credit, your focus should be on maintaining a good score. If you hope to emerge on the other end of this pandemic and downturn with a credit score that will serve you well, make every effort to make even minimum payments on time. Credit scores are greatly impacted by late or missed payments.
Next, prioritize your debt. If for any reason, you are having difficulty meeting your monthly debts, contact your lenders and see if they are open to making some type of payment accommodation. If you can pay some of your bills but not all of them, prioritize your debts based on their two different types: secured and unsecured. Paying secured debts, or debts secured by an asset such as mortgage and auto, first ensures that you do not lose your home or vehicle. Unsecured debts are not tied to any particular asset, though lenders can take other actions to get you to pay, such as sending it to a collections agency to handle. Keep in mind that collections remain on your credit report for a minimum of seven years.
This leads right in to the final suggestion that you monitor your credit closely. It became a little easier this past year to monitor your score, as the three national credit reporting agencies have made weekly access to monitor your credit report free through April. These reports are available through AnnualCreditReport.com. Your report will start with a summary of your accounts, the type of accounts (installment or revolving), and a quick overview that includes your oldest and most recent accounts, the average age of your accounts, your length of credit history, and your credit filing status. It will also tell you how many credit inquiries you’ve had, public records, and collections recorded. Your report then takes you into your specific accounts, balances, payment history by month, delinquent payments, if any, and your outstanding balances. Along with each account, you’ll also be provided that lender’s contact information.
Should you find any inaccurate information in your report—information such as accounts that were really closed but show open with balances, or credit inquiries that you’ve not made and could perhaps point to potential fraud or identity theft—you can take action in a timely manner and limit your exposure. Check for errors such as misspelled names and addresses or other inaccurate information as these could indicate someone else’s information was accidentally entered into your report, or again be a sign of fraud. Monitoring your report might also bring to your attention any collections you missed, and if you feel the information to be inaccurate, you can dispute it. Generally, dispute directions can be found right at the top of your report in the form or a phone number, website or mailing address.
Credit scores usually range from 300 to 850, and contrary to popular belief, you don’t have just one. That’s because lenders can report to any or all of the major credit bureaus, so each might have different information about you in their credit reports. As a result, each report can generate a different score. When you apply for credit, lenders need a fast and consistent way to decide whether or not to loan you money. And in most cases, they’ll look at what is known as your FICO Score.
Calculated by the data analytics company, Fair Isaac Corporation, FICO scores help lenders make smarter, quicker decisions about who they loan money to. They also help borrowers get fair and fast access to credit when they need it. According to a 2018 study by the Mercator Advisory Group, more than 90 percent of lending decisions are made using FICO scores. So be sure to monitor this score, too.
Put simply, credit scores matter. They determine the loans available to you and the interest rates you pay. They are used by insurers to set auto and homeowners insurance premiums; landlords use them to select tenants; service providers use them to determine deposit amounts. But you have the ability to influence your score by paying bills on time, not carrying too much debt, and making smart credit choices.
Which brings us to our final important point, which is that where you go for credit matters. “What community banks can offer is their relationships in the community,” Holliman says. “While we offer the convenience of online banking, our relationships with our customers are what we focus on. If a customer is having trouble managing their debt, or doesn’t have a perfect credit score, we’re here to work with them.” Parsons echoes the sentiment. “I’ve been doing this for 20 years now. Sometimes I’ll work with a client for up to two years, advising them and guiding them, before they can get into a home. It’s what we community bankers do.“ Find a place you trust.
Less-than-stellar credit isn’t always a deal breaker. But paying cash isn’t always an option, either. In those instances, if you’re smart about how you borrow, you can make the most of the money you have, as well as protect the future health of your wealth.