People often say that you should try to stay away from credit as much as possible so that you don’t end up in lots of debt. But the fact is that it’s impossible to stay away from credit in the United States. If you stay away from credit forever, it’ll have other adverse effects that will hurt you down the road. Therefore, it’s important to be smart with credit so that things will be easier later in life and you won’t be drowning in debt.
The whole point of using credit responsibly is to improve your credit score. What does this magical number mean and do for you? I’ll explain all of that and how to improve it.
Disclaimer: I’ve done quite a bit of research and the tips I provide is a combination of my research and personal experience. I am not an expert/professional and am not responsible for any potential damages.
What is a Credit Score?
Your credit score is simply a number that tells lenders and creditors how well you use credit that’s available to you. This number ranges from 300 to 850, where 850 means that you’re the ideal credit user while 300 means you’re the worst credit user imaginable.
A high credit score is important because it makes it easier to get loans at lower interest rates (such as car loans, mortgages, or personal loans), meaning you pay less money back throughout the life of the loan. It also has lots of other uses. Utility and cable/internet companies often check your credit score and ask for deposit if your credit score is too low for their liking. Even most employers now include credit checks when screening candidates — a low credit score can show that you could be financially irresponsible, and that could translate into the workplace as well.
Simply put, a credit score is very important in your life and you need to check it regularly. If you want to get technical about it, you could go through life without a credit score (or with a bad one), but then you’ll have to pay for large items immediately; most people don’t have that much money saved up at the time when they want to make such purchases.
How to Improve it — Credit Cards
So, the easiest way to improve your credit score is through credit cards. A lot of people say that they’re evil and should be avoided at all costs, but they’re only bad if you use them incorrectly. Otherwise, they can actually be very beneficial to you because they help you improve your credit score and also give you rewards points.
The only things that you have to do — as far as debt is concerned — is to spend within your means (if you get $2,000 a month but have a $5,000 credit limit, spend $2,000 but not $5,000) and to pay your balance in full every month to avoid interest charges. Interest only starts accumulating on any remaining balance from your previous statement. So if you get a statement for $200, and you only pay $150, then the following month will include interest charges for the remaining $50. But if you pay in full every month, you’ll never get any interest charges.
If you’re worried about losing track of how much you can actually spend with your credit card since it doesn’t automatically take money out of your checking account, you can use any budgeting tool you’d like — such as Mint.com or various tools on Google Drive — to help you out. With such tools, you can easily tell it how much income you expect and start budgeting all of your expenses. You can easily revisit the site to check on how much of your budget is left in each category to track your progress. The great thing about Mint.com is that it’ll connect with your bank accounts and credit cards so it’ll automatically track your expenses and categorize them appropriately.
What Cards to Get
If you’re in college, start early! You can often get a college credit card from a bank. As long as you have a small side job to provide some sort of income, these cards are easy to obtain despite having no credit. They will have a very low credit limit (my first one was just $500), but it’s all you need to get started.
If you aren’t in college or you have bad credit, then your only option is to get a secured credit card. These are cards that can affect your credit score, but you basically have to provide a deposit that ultimately becomes your credit line. So if you pay a $500 deposit, your secured credit card’s credit line is $500. This simply eliminates risk for the bank because if you use up your credit limit and then refuse to pay any money back (which will destroy your credit score), at least the bank hasn’t lost any of their own money. However, if you use the card responsibly, your credit score will go up and eventually you can upgrade to a regular credit card that isn’t secured and therefore doesn’t require a deposit.
Don’t apply for too many credit cards all at once. I’d recommend applying to up to two, and if you get denied for both, then go for a secured credit card because you won’t get denied for that one. When it comes to starting and/or improving your credit score, the earlier the better.
Tries to apply for credit card. Gets denied for not having enough credit activity. HOW DO I GET LOTS OF CREDIT ACTIVITY WITHOUT THE CARD?!?
— Jason Boucouras (@JasonBoucouras) May 10, 2015
If you need help to search for credit cards — whether it’s a college/secured card or better cards once your credit score improves — there are plenty of online help. Credit Karma can give you plenty of suggested choices for credit cards (although some of them are sponsored), and there’s also NerdWallet which asks you a few questions before suggesting some cards to you. Heck, even Google has a credit card comparison tool. You should most certainly be able to find a credit card using any of these tools. You just have to be honest when answering any questions it asks you. It does nothing but hurt you if you apply for cards that require higher credit scores because you told it that your credit score was better than it actually is.
Pay Before Your Cycle Ends
So, let’s quickly review. The steps so far are to get a credit card, spend money using it (within your means) because it gets you rewards, and then pay in full every month to avoid accumulating interest.
Sounds easy enough, right? Let me add one more tip to that: pay off most of your balance before the statement cycle ends. 30% of your credit score is determined by how much of your credit limit you’re using. If you’re using a high percentage of your total available credit limit, then your credit score will decrease dramatically. The ideal number is to keep your credit utilization at 10% or less. So if your credit limit is say $1,000, then ideally your reported balance should be $100 or less.
Credit card companies charge an interest rate of 20% per year, which means a an unpaid $1000 debt turns into $40,000 in 20 years.
— WoW Shocking Facts (@eyeopenngfacts) May 11, 2015
The great thing is that the balance is only reported at the end of the statement cycle and you’re able to pay toward your credit card before the statement cycle ends. So if your cycle ends on the 15th and your current balance is $800 (out of a $1,000 credit limit), then you could pay $750 on the 12th to give it enough time for the payment to be processed and then the statement balance will only be $50. That is what is then reported to the credit bureaus. And this is an important tip, because it truly lets you spend however much you want (again, within your means) without having to worry about the problems that come with high credit utilization.
Again, there’s no need to worry about interest charges. Let’s ignore the credit limit for a moment. If you have a statement balance of $200, spend an extra $800 on your card, and then pay $600 back, then $200 of those $600 will always go towards paying off your statement balance first, and then the remaining $400 go towards paying off your new purchases. So you still won’t have any interest charges in such a scenario. If, however, if you had a statement balance of $200, spend an extra $800, and then only pay $150, then you’d accumulate interest charges on the remaining $50 from the last statement, plus you’ll have all those new purchases to pay for as well.
Let Time Do Its Thing
So let’s review again! Get a card, use it within your means to get rewards, and then pay a few days before your statement cycle ends to reduce your credit utilization to under 10%, while making sure that you’re paying at least the full balance of the last statement.
Now here comes the hardest part — waiting. You’ll need to be satisfied with your current card for at least two years. It may take even longer if you already had bad credit rather than starting with no credit. You can now use a service such as Credit Karma to check your progress on your credit score. If you’d rather use something else, you can use the government’s official website to get your full free credit report. While extremely descriptive, you can only get it once a year for free. If you don’t mind paying, Wells Fargo offers a service that pulls the full credit reports from all three reporting bureaus monthly.
Credit Karma is free, allows you to check for updates weekly (for TransUnion and Equifax only), and provides its own scores that are similar but maybe not exactly what score the bureaus would give you. It also uses the information it collects on it to suggest you cards, loans, and more, but that information never reaches those companies — it stays with Credit Karma. My recommendation is that you should wait until your score reaches at least 700 before you consider applying for a better credit card (but not one of the premier ones — 700 is still too low of a score for those).
If You Already Have Credit Cards
If you already have credit cards and your credit score is bad, then applying this strategy (if possible) will start getting you on the right track. There’s no need to get another card if you already have one. Chances are that if you have a bad credit score in this scenario, you have large balances on your card(s). Before you start applying this strategy, you’ll need to pay off your balance(s).
Put the check my mom gave me in savings or pay off credit card bill…#reallifedecisions
— Kylie (@kylie_lil) May 11, 2015
If you have multiple balances, it’s usually advisable to focus your payments on the card that has the highest interest rate so that you’re not unnecessarily having to pay extra money. Don’t forget to also try to reduce your expenses to help make payments on your cards. Once your balances slowly go away, you’ll see relief. For more information on getting rid of your debt, check out our How to Get Rich guide.
It can seem like an impossible task — improving your credit score to something that you can be proud of. It’s simply a bit test of financial responsibility and patience.
The gist of the whole strategy I outlined is to simply show that you have credit, and you use it, but seemingly little of it. Creditors love seeing you having credit and using it, but only in small amounts (which shows responsibility and no dire need to actually use all of it). If you don’t meet all of that, then that’s something to improve. If you have no credit, then you need to find a way to start. If you use all of your credit, you need to find a way to pay off all your balances. That’s what it simply boils down to. Just keep faith and work hard at it and you’ll eventually reach your goal.
If you have any questions about improving your credit score, just ask and I’ll try my best to answer! Perhaps you’ve got some tips to pass on other readers? Or maybe you’ve hauled yourself out of bad credit and now have an exemplary score? We’d love to hear your stories and opinions.
Finally, don’t forget that there are also plenty of other great resources, such as Reddit’s /r/personalfinance.
Image Credit: Credit report via Shutterstock, Credit report with score on a desk via Shutterstock, Luis Ramos, businessman counts money via Shutterstock, Loving couple looking at their dream house via Shutterstock