Understanding credit seems like an impossible task. Terms like “credit utilization, interest, credit history, and line of credit” can be confusing. My goal is to give you a basic understanding of how credit works and give you some simple tips to help you start your journey to establishing a strong credit history.
First of all, what is credit? Credit is the money you borrow from a financial institution, such as a bank, credit union, finance center, credit card company, and so on. A “line” of credit is simply the vehicle through which your credit is extended, such as a credit card, mortgage, car loan, signature loan, GEM loan, and more. Every time you borrow money (“take out credit”), the company from which you borrowed the money from (for example: JPMorgan Chase Bank) reports that information to the 3 credit bureaus (1- TransUnion 2- Equifax 3- Experian). These credit bureaus store all of your history with credit, such as the amount of late payments you have made, the outstanding balance(s) you owe, your credit limits, and so on. Every time you go to a new financial institution to get more credit, they will check with the credit bureaus to see what your credit history looks like to make sure that you are a responsible person to whom they can lend credit. Your credit history is measured using a number called a “credit score” that ranges from about 450-820, with a higher score being better than a lower score.
So, what do credit companies like to see?
Keep credit card(s) for as long as possible. If you are constantly opening and closing lines of credit, then your average credit history will be incredibly short. Your credit history is computed using this equation: sum of total months you have had all of your lines of credit / amount of lines of credit that are currently open. If you have six credit cards, but each have only been open for 1 year, then your average history would be 12 months. You want to have as long of a credit history as possible, so you (generally) never want to close your oldest credit card.
Pay on time. Ideally, you pay your entire credit balance (or monthly payment) in full to avoid paying as much interest as possible, but even if you can only make the minimum payment on your credit card every month, that’s still better than not paying at all.
Take out as much credit as you can “to build credit.” This would make your average credit history extremely low.
Use all of your credit. Credit card companies have what’s called a “credit utilization rate” which is the percentage of credit that you’re using. So, for example, if you have a $1,000 credit card and you spend $900 of it, then your utilization rate is 90%. This makes lenders uneasy because you’re using a lot of their money. Typically, companies and institutions like to see no more than 30% utilization. Utilization will be reviewed on the individual cards as well as the sum of your credit cards. For example, if you have three credit cards, each with a $1,000 limit, then spending $900 would only be 30% of your total utilization.
Although credit is much more dynamic and complex than these simple tips, this information should lay a solid foundation for positive credit habits and behavior. If you have any questions about credit or want help with your unique credit situation, feel free to make an appointment with a NEXUS Financial Coach!