Good credit is the key to borrowing smart. It allows you to secure lower interest rates on a mortgage or auto loan, it gives you a larger pool of funds to borrow against for larger purchases or remodels, and can even help when you’re looking for a new job.
Why does credit history matter?
When looking at your credit history credit card companies and banks look at ALL your borrowing history. That means they look at your how long you’ve held an account, limits on the account, and payment history. They need to know if you’re going to be able to pay back your debts and by looking at your history they can instantly spot red flags like high balances, late payments, and accounts that are delinquent.
Why are credit scores important?
I’ve shared before how vital it is to track your credit score. This is the number that helps banks make a decision about your application based on your previous history. A higher score indicates someone who is responsible and able to pay off debts while a lower score can indicate accounts in default, bankruptcies, and foreclosures.
Tip: Discover provides FICO credit scores on all cardmember statements, which is pretty helpful to keep track of over time.
How to Establish Good Credit
If you don’t have credit (or much credit), the key is to building good credit is to start small. One credit card or small loan can get the ball rolling. Here are a few tips to help you establish good credit:
- Pay off your cards.
Pay the balance in full when the statement arrives. Pay your loans on time. If you can’t pay on time, call the bank or credit card company immediately.
Tip: Some credit companies allow you to pick your due date, so line it up with the day of the month that makes the most sense for your budget.
- Pay on time.
Pay your bills on time and you won’t be dinged with late payment fees or a ding to your credit score.
Tip: Set alerts in your phone or sign up for email or text alerts if your bank or credit card company offers them.
- Stay well below your credit limit.
Your credit score is calculated based on your credit available and the amount you’re using. If you have $10,000 in credit available with $8,000 in balances that’s an 80% usage—not good. You’ll be considered a riskier borrower so you’re less likely to get a low-interest rate or approval. If you were only using $1,000 of that same $10,000 that’s only 10% of your total credit available—you’re in good shape.
Tip: Most recommendations are to stay below 30% usage of total credit available.
- Read your credit report.
Negative information can damage your credit history and your credit score. Make sure your information is current and accurate will ensure that no clerical errors keep you from getting credit or best available terms on a loan.
Tip: If you find an error you can mail a letter to all three credit reporting agencies describing the error with documentation. I was able to do this for a false late report on a credit card account that had switched card numbers but updated the old account as ‘late’ even though it no longer existed! A small clerical error on their part, but a big hassle for us.
- Know what debit does.
Debit cards are popular since they act as credit cards and remove funds directly from your account. While there may be some benefit to directly withdrawing from your account, debit cards will not improve your credit history or credit score.
Tip: Check with your bank about fraud protection on your debit card. Debit cards don’t often offer the same protection as credit cards. If your debit card is stolen your bank may not have the same fraud alerts in place (check with your bank) and it may take days or WEEKS to get back the funds that are stolen. If your credit card number is stolen or used for potential fraudulent charges your credit card company will spot it quickly and you will not be liable for any charges.
- Focus on what you want.
Your credit history becomes critical when it’s time to make those big purchases, like a home or a car. At that point, a one percent difference in the interest rate on a loan will either cost you or save you thousands of dollars over the life of the loan.
Tip: It may be worth setting up credit monitoring during the time leading up to a large purchase.
Should You Use Credit?
In a word, yes. It doesn’t take much to keep your accounts active and good standing, and it has a huge impact on your credit score. You can even use a credit card to pay a regular monthly bill like your cell phone bill and set up an automated payment to pay it off each month.
What it comes down to is this: use credit wisely and spend within your means. If you need to borrow for a longer time be sure you can pay back those borrowed funds.
Disclosure: This post is sponsored by Discover. Find resources for understanding credit and more on Discover.com.