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You’ve heard the age-old question: Which came first, the chicken or the egg? You can’t have one without the other. It’s a little like establishing a strong credit score — it takes having a credit history … which can be tough to establish if you don’t have credit to begin with.
Mind blown? Not to worry.
Credit, Credit Score and Credit history can be a little confusing (and even overwhelming) at first — but understanding these topics is super important. Credit plays a huge role in your life and can impact several aspects of your finances, from the credit cards you qualify for to your eligibility to buy a car or a home.
Unlike the chicken and the egg, it’s not a mystery to find out how to keep your credit in the best shape possible. So, let’s start by cracking into these concepts.
What is credit?
Credit is your ability to obtain goods or services and repay at a later time — think credit cards, mortgages, student loans, etc. Not all credit is the same, though. Here are the four types.
Revolving credit: This is what credit cards typically are. With revolving credit, you have a maximum credit line (which is the most you can borrow at a time) and a periodic payment. You must pay at least the minimum required payment when your bill is due. If you make less than the minimum required payment, you may be charged additional interest or other fees
Charge cards: This is similar to a credit card, except you have to pay your full balance every month and cannot carry any charges over.
Service credit: This refers to things like utility bills and cell phone bills. With service credit, you are provided a service upfront (like your electricity or gym membership) and then are expected to pay for it at the end of the month or billing period.
Installment credit: Installment credit is a financing of a specific amount of money paid back in installments over an established period of time, such as auto financing or a home mortgage loan. You’ll likely also pay fees and interest, along with the borrowed amount.
What is a good credit score?
It’s hard to hit the mark when you don’t know what to aim for. When it comes to your credit score, your target range will depend on what scoring model you’re using — but the most commonly used scoring system is the Fair Isaac Corporation, or FICO score. This system ranges from 300 to 850. Typically, scores above 800 are considered excellent, those ranging from 740-799 are very good, and a score between 670-739 is good. Not sure what your FICO score is? Find out for free simply by logging into your Ally Auto account.
Another scoring system is VantageScore, a system created by the big three credit bureaus (Experian, Equifax and TransUnion). It ranges from 501 to 990.
Bottom line: No matter what scoring system you are looking at, the higher your score, the better.
How does your credit score impact your access to credit?
A strong credit history demonstrates to lenders you’ve been responsible with repaying debt in the past and likely will be again in the future. So, while your score isn’t the only factor lenders look at (and even a perfect score won’t always guarantee approval), a high credit score can increase your chances of being approved for various types of credit.
Another benefit of establishing and maintaining a good credit score? The higher your credit score, the lower your interest rate could be when applying for loans and credit cards. That means you can spend less on interest and finance charges and pay back debt faster.
If you’ve had some bumps in the road (late payments, high credit use on cards, too many cards, etc.), your credit can suffer, and lenders may be less likely to extend a line of credit to you. If you find yourself in this position, the good news is your credit score isn’t permanent. You can still build up your credit score, even if you’ve made a mistake in the past, missed a payment, or had to rely heavily on credit cards for a period of time.
How You Can Build Good Credit
Your credit score is calculated using models which weigh a number of different factors, including: payment history, utilization, recent applications for credit, outstanding debt, and length of credit history. To put it simply, in order to establish good credit, you need to build a credit history — which can be tricky at first. (Remember the chicken vs. egg conundrum?)
One way to begin building a credit history from the ground up is to get a secured credit card, where you place a security deposit in return for a credit line that’s often the same amount.
You can also start with a very low line of credit on one card and gradually increase your credit limit over time.
As you start to build your credit, it’s critical to make sure you pay your credit card bill on time, every month, as late payments can create a large chink in your credit armor.
Finally, you should aim to keep your credit utilization ratio low. This is the ratio of your outstanding credit card balancing to the total limit — and it can have a big impact on your credit score. It’s often recommended to keep your credit utilization below 30% on a credit card. For example, if your credit limit is $10,000, you’d want to aim to charge only up to $3,000.
Why Credit Monitoring Is Crucial
You work so hard to make sure your credit is the best it can be. You diligently pay each bill ahead of the due date each month. You keep your debt-to-credit ratio low. You’ve built a strong credit history for yourself, so why wouldn’t you want to make sure it accurately reflects your dedication and persistence?
Identity theft is a very real threat to consumers today and keeping your eyes on your credit report can help minimize any damage caused by such an intrusion.
Read more: A Roundup of Our Best Tips to Help Protect You From Cybercriminals
What’s more, errors or incomplete information on your credit report can impact your credit score and prevent you from getting credit when you need it. The three nationwide credit reporting services, Equifax, Experian, and TransUnion, recommend you check your credit report annually (at the very least). This allows you to catch possible errors and have them corrected, as well as understand where your credit stands and why.
According to the FTC, everyone in the U.S. is entitled to one free credit report annually from each of the previously mentioned credit reporting services. However, due to the financial implications of the coronavirus, Equifax, Experian, and TransUnion will offer free weekly credit reports until April 2021. Visit annualcreditreport.com to request yours.
By making all your payments on time, lowering your debt utilization ratio, keeping your credit card account open as long as you can to build your credit history, and monitoring your credit reports regularly, you can set your credit score on an upward trajectory.
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