Understanding Credit for Beginners
Do you understand how credit works? This post will help you figure out how to understand your credit score and begin building credit for your future.
Credit is important because it is used to determine whether lenders will work with you. Yet, often credit is something most of us don’t want to be bothered with until it comes time to buy a new house or car. If you are in need of a loan at some point in your life, it is best to keep a close eye on your credit. You can use free sites such as Credit Karma to help you keep track of your credit.
Did you know you can get a free credit report once a year? By ordering a free annual credit report you can get an actual breakdown of your credit score and FICO score that is accurate. Why is this important? As mentioned, this score is used to determine if Lenders will work with you or not. In short, can you get a loan?
What is credit?
Simply put, credit is a trust system used to determine whether an individual will be likely to pay off a loan given, usually with interest. If good, your credit score will help you get a loan when you need one.
Banks are usually where most people go to get a loan, but you will see credit scores used in other applications including housing at times.
How is credit checked?
Your credit report will show your credit score. This report shows how you have borrowed money in the past and how you have made repayments. Your credit report shows your credit score and also contains records of borrowing and repayment activity that may be in a public record.
This information is collected by the three main credit bureaus, so financial institutions can determine if you are a good candidate for a loan. Obviously, they do not want to take the risk of borrowing money that will not be paid back. Yet, if you display good repayment history, they will be willing to lend money (and make money on interest) which benefits both parties.
Hence, you can afford your car/house, etc. and the lender makes money as well. It seems like a win-win, right? Yet, if you don’t have good credit, your loan could be denied.
What is a credit score?
A credit score is directly linked to the details of your credit report. This score helps lenders decide if you are a good candidate for a loan because they can predict if you will pay your loan back. In fact, 800 is the highest credit score and if you are in the 700 to 800 range, you are more likely to get a loan because the higher the number, the more likely you are to pay back your loan on time.
If you need help repairing your credit score, click here.
How are FICO scores calculated?
Keep in mind, there are positive as well as negative factors on your credit report. Your FICO is based on both. Other things that come into factor are as follows:
- marital status
- child/family obligations
Nonetheless, FICO looks at payment history. If you have missed payments on credit cards or loans, your FICO will be affected. Also, how much you owe on other loans is a consideration.
How to Build Credit for the First Time
If you are looking to build credit at age 18, you can start by getting a credit card in your name. How much you will be able to borrow will be determined by your income. Once you start using your card, make sure not to charge it to the maximum, keeping some credit open. Also, pay your bill on time and in full each month. This is the easiest way to start building credit.
You can also take out a car loan, if needed, and again, make sure to buy something within your means and make your payments.
Is your credit already bad? Check Credit Saint here and learn how to improve your credit…
Five credit factors
Often people wonder what makes your credit score go up or down. By learning about the five factors that affect your credit, you can understand how credit works and how long it takes to repair it.
FICO credit score makeup:
⦁ 35% = payment history
⦁ 30% = amounts owed
⦁ 15% = credit history
⦁ 10% = credit mix
⦁ 10% = new credit
As you can see above, the biggest factor in determining a credit score is your payment history. Do you pay your bills/loans on time and in full? Do you have outstanding balances and missed payments? This will make up 35% of your credit score.
Unfortunately, if you have fallen behind on payments, your score most likely will reflect this and has gone down. Make sure to pay bills on time and keep a bill tracker to make sure you are paying the minimum (at least) and on time. It will take time, but it is possible to build your credit back up so don’t worry.
It also helps to check your credit score and get a free credit report annually. This helps, especially with fraudulent charges and identity theft on the rise. If this happens to you, you can catch it and report it so your credit is not further ruined.
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The next heavily weighted towards your credit score is the amount you owe. This is a percentage of how much credit you are using. For example, if you have a credit card with a $10,000 limit and you have borrowed $8,000 toward that card, you are using 80% of your credit. If you want your score to go up, try staying under 15% of your allotted credit. Also, pay off those cards until you reach a 15% utilization.
Make sure to set alerts as to when your bills are due and also alert yourself when you reach your credit utilization amount. Moreover, you can keep better track and a high utilization amount will not creep up on you. You can use a budget to help keep track of this, but the most basic of basics here is to start writing down your earnings and your spending.
Now that I have the means, I pay off my credit card each month. If you can’t afford to do this, it is best to come up with a debt payment plan.
You can use these freebies to help you stay on track: Click here
Length of credit history
The next factor is the length you have had your credit card which is weighted to 15% of your credit score. You can earn a long credit history length by keeping cards open, even if you are not using them. This could mean a difference of a 750 -800 score.
I have a card I no longer use, but I keep it because I have had it for over 15 years. This helps the “length of credit” portion of my credit score.
Do you know your credit mix? This is a mix of the loans, retail accounts, and credit cards you have in your name. Some do not have all of the available credits, but 10% of your credit score is determined by the credits you have. These are often viewed by lenders to see if you are able to pay on multiple accounts each month.
You will be considered a “high-risk” borrower if you have opened up multiple credit accounts or loans in a short time, usually in the course of a year. It is best not to open more accounts than needed if your goal is to grow your credit. Not to mention, each time you open a new credit card or take out a new loan, your credit history/length goes down.
When I was younger, I didn’t understand how credit worked and I opened up credit cards while in college, so I could get free gifts. Although, not th best idea, since I always paid my credit card bill, it actually helped me earn a high credit score over the years.
Types of credit
Did you know there are two types of credit that affect your credit score? First, you have revolving credit which consists of credit cards, lines of credit, and revolving accounts. Secondly, you have installment accounts including car loans, personal loans, student loans, and mortgage accounts.
According to Chase Bank, revolving credit is renewed as the debt is paid ( once you pay off the amount, you can borrow the said paid amount again.) Yet, installment credit is a fixed payment that is paid each month until your full amount is paid.
While building credit, don’t worry about increasing your credit limit. Although it can help build credit, it is normal to have a low limit while building credit. In fact, even a small credit card can have a bit of an impact on a larger loan, so make sure you are paying even your small credit card bills on time.
Understanding Credit for Beginners Final Thoughts…
Credit can seem confusing and frustrating. Yet, once you start paying more attention to your credit score, you will understand how it works and you can begin to work on repairing your credit or building credit if you are new. Keep in mind that missing payments, using too much of your allotted credit, and opening up multiple accounts can have a huge impact on your credit score.
Yet, keeping a mix of credit, and paying bills on time will build your credit. However, missing payments will do the opposite, You can always stay on top of your credit, but use sites like Credit Karma to check your annual credit report.
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