5 Basic Concepts of Credit

Credit.

Everyone has an opinion on it. Some people love it. Some hate it. One thing is for sure, you have to live with it.

I cannot count how many times I have seen on Facebook people chose having a perfect credit score as a top pick on a wish list on post like this:

There is so much conflicting information about it credit. It can be overwhelming. If you have bad credit or no credit I am here to tell you, you can fix your credit situation. First things first. Here are the basics:

1. don't max out your credit cards, but don't pay it off every month either

Keep your credit balance below 30% of your limit. It is a myth that you should use your credit card then pay it off every month. Let me clarify…. That is responsible but not necessarily helpful for building credit. Credit is built by showing you are responsible for making your payments on time, not maxing out your lines, and the longevity of the line of credit.

For example: If you have a $1,000 credit card don’t hold a balance over $300. This will show you can use credit responsibly. Don’t like to hold a balance because of interest? Then carry a very small balance of like $10.

2. Request your credit report

Many people believe Credit Karma and other sites can accurately tell you your credit score however they can be slapped in the face when they go to apply for a loan and discover that the score they thought they had was not accurate. Did you know you can request a free credit score from each credit bureau once a year? Experian, Equifax and TransUnion are obligated to provide you with a report. Why not go straight to the source. You can go directly to each bureau website to get your report or you can request one by going to https://www.annualcreditreport.com/index.action.

3. Dispute errors

If you feel what is reported on your credit report is wrong tell ’em! You can dispute any error on your credit report. This is why it is so important to know what your score is. Get a report at least once a year. If you do have errors disputing it could help improve your score. I will not lie disputing can be labor-intensive but worth it.

4. Understanding Types of Debt

Unsecure Debt

This is money that you borrowed with no collateral. With poor credit, this will be difficult to receive without a high rate of interest. An unsecured loan is typically a credit card but can be unsecured loan for cash.

Revolving Debt

Revolving debt can be paid off and charged and paid off again. This can be collateralized or unsecured. Depending on the loan type.

Fixed Debt

Fixed is a home loan or car loan. These have long terms and usually higher payments. However, if not handled responsibly it could be damaging to your credit.

Having a healthy mix of different debts can help your credit score. However, don’t over-leverage yourself. Be mindful of your debt to income ratio. This ratio is scrutinized for larger purchases such as buying a home or vehicle.

5. Don’t Close Credit Lines!

Let’s say you have 5 credit cards and you are trying to reduce the temptation to use all of them. They all have a limit of $1,000. That is a total of a $5,000 limit. Say your total balance adding them all together is $2,000. This means you are using 40% of your debt limit.

You have 2 out of the 5 cards paid off. You are contemplating closing the cards to help you build credit and reduce temptation.

This theory is only half true. Closing 2 of the cards will reduce your credit compacity to only $3,000. You would then be at 67% credit utilization. To a credit reporting agency, this looks worse.

In short, remember the number of lines is not as important as the balances. As stated, before you only want to utilize 30% of your limit.

6. Use it or lose it

Last but most important. Don’t let your hard work be in vain. Once you have reputable credit established don’t let it wither to zero. Many people think never buying things on credit is a good thing. I concur. Using credit irresponsible is horrible but credit is not the enemy.

You need credit to buy a home which is a goal for most. Use credit wisely and purposefully. It is a tool to work for you not against you.

If you never have credit or do not nurture it, it will disappear. Then you have to start from ground zero.

Aim to not need credit for everyday purposes but never view it as the enemy. An enemy is described as a thing that harms or weakens something else. I don’t remember any of my enemies vouching on my behave when I needed a loan for my car or house. Both those purchases have drastically improved my quality of life. Credit did that.

In short, credit is your financial reputation collected in one place. Be mindful of it. Cultivate it, water it, pull the weeds, and use it. You control it. Don’t let it control you.