I was about 22 when I asked myself this question. Then I found out that it's actually not a very well understood topic, nobody seems to know what it's really good for, and what it can do for you. I learned a lot since then, so here is the deal....
You have to build credit to have a good score. If you simply avoid signing contracts or getting credit card, you won't have much on your credit report at all. That's not too bad as long as you are young, but when you get into your twenties and beyond, and your credit score barely has anything on it at all, it looks suspicious, like maybe someone else handled your money for you (and you have no idea how to handle it yourself), or maybe you are trying a fake identity or something shady like that. A bare credit report is not horrible, but it does not inspire anyone to trust you with a loan. The better way is to start as young as you can, and start small, and slowly build it up. By the time you are in your mid twenties, and possibly looking to buy something very expensive (Brand new car? House? Yacht?), you will need a solid credit report, and a high credit score. Trust me on this one!
As you know, Big Brother is always watching. Another fact of life. That means that someone is tracking how you use your money, what you buy, if you make your payments on time, and if you spend every penny the second you make it without any control over yourself. 3 'Someones', actually. Their names are Experian, EquiFax, and TransUnion. These are the 3 major Credit Reporting Agencies that each give you a Credit Score, and compile a Credit Report on you. I'm sure there are more of them out there, but these are the three you should mainly concern yourself about.
A Credit Score is a numeric grading system based on how you use your money, and it says a lot about how responsible you are with paying your debts, your bills, etc.(you thought grades would end with school? Think again!) Your score (grade) changes over time, as you learn to handle your money more efficiently. You will have a Credit Score for your whole life, and banks and other creditors will look at it when they are making decisions about lending you money. Some employers might check it, too. You Credit Score usually covers your previous 7 years, but some events such as filing bankruptcy may stay on your credit report for up to 12 years.
Your Credit Score plays a huge role regarding what sort of interest rates you can get on loans. A high score can get you a much lower interest rate, which means you won't pay nearly as much over time. You don't have to be rich to get a good score, you only have to be consistently reliable and responsible in how you deal with your money. That's right, people who know how to work the money the right way don't pay as much for cars, student loans, home loans, etc.
The highest credit score you can get (last time I checked in 2013) is 900. Anything over 700 is considered pretty good. 600 is about average. When I started studying all this stuff, I had a score of around 200. Ten years after I started actually doing the stuff I'm teaching you about, my score is 890 or higher in all 3 reports (Experian, Equifax, TransUnion). This is the only proof I can offer that this stuff works, but in my opinion, it's pretty good proof. Sorry, I'm not posting my report online, it contains WAYYYYY too much personal data! =)
A Credit Report is a list of all your credit-related activities that were reported, both good and bad, for the previous 7 years. It lists every 'official' debt that you have, whether you pay it on time every month, which months you missed and were late on, previous addresses, your full name, any aliases that you might use officially, and a lot of other personal data.
You can order your Credit Score and Credit Report from each of the 3 credit agencies, usually for just a few dollars. Do it once per year. Watch how it changes over time, year after year. Keep your old credit reports for 7 to 10 years, you may need them someday. Get yourself a file box to keep this stuff in, you don't want to lose it or misplace it!
Here are the links to order your reports directly from the credit companies:
What sorts of things impact a credit score?
Well, pretty much anything financial that is not a cash deal. If you buy a used computer from your friend for twenty bucks in cash, nobody is recording that.
If you buy a car from a dealer for $2,000.00, and you set up monthly payments on it, that will get reported. The dealership reports it to the credit unions. You don't get a say in the matter. Same goes for school loans, personal loans, or any other type of loan that is done through a bank, dealership, or other lending institution. Every time you make a payment on time per your agreement, your score goes up just a little bit. Every time you make a late payment, it goes down a lot. That's right, you get a small reward for doing a good job, and a huge penalty every single time you mess up. Late payments stick out like bold type on a credit report, and every creditor that looks at it for the next 7 years will be looking for your mistakes first. Sad, but still a fact.
Any time you sign any sort of contract saying that you will pay money, either as a one-time payment or as a monthly payment, it can be reported to the credit agency if you fail to make a payment, or pay late. This is why it is SO important to actually read all the agreements that you sign. Rent, car payments, household utilities, student loans, any sort of loan, credit cards, and a ton of other options that I can't think of right now, they can ALL report to the credit agencies. Don't ever give them any reason to report anything bad!
Credit Card Basics, and how that works with your credit report:
If you sign up for a credit card, that is called Revolving Credit. It works a little differently. With Revolving Credit, every time you buy something with the card (say, a pack of gum), it's like taking out a tiny loan from the bank. Yes, they will charge you compound interest on it, too. When you pay some amount back, it's like paying off that tiny loan that you took out to buy a pack of gum. The interest is usually computed monthly, which means that if you pay off the entire balance of your credit card every month, you don't end up paying any interest on it. Well, at least some cards work like that. There are probably some out there that charge interest daily. Avoid those! Read the entire card agreement before you sign up for any sort of charge card, and make sure you understand it.
The trick with credit cards is that they will try to lure you in with 'Point rewards'. They offer this nifty deal where every dollar you spend with the card gets you points of some sort, which you can eventually trade in for stuff or travel. This will make you want to use the card a lot, to get the 'free stuff'. This is where the self control part comes in.... Credit cards are not necessarily bad, if you use them wisely.
1) NEVER charge more on your card than what you know you can pay off every month.
2) ALWAYS pay off the entire balance on your card, and MAKE SURE you pay it before the due date. This way you never actually pay interest on it, but you still get the points.
3) Don't sign up for cards that you don't intend to use regularly. If you have a card in your name, and you don't use it, it will put a bad mark on your credit score. Go figure.
4) Do not sign up for a card that has an annual fee. Your bank can probably offer you one with no annual fees, plus, if it's linked to your bank, it's easy to make online payments from your main account every month. You can even do it from a Smartphone. There's an App for that! You should make sure that your agreement allows you to raise the credit limit, however. Also, make sure that it has a feature called 'Daily Limit', so you can set how much the card can be used in one day. That way if it gets stolen, the thief can't max it out all at once. Pick a limit that accommodates your daily needs, but not more. You can call your bank and have them approve an exception if you know you will be making a large charge to the card. That's how I got my first computer. Make sure your card has protection against theft: That's where the bank pays you back if the card is stolen or used without your permission. Since you will have it for a long time, make sure it can be used internationally, in case you go on vacation. After all, someday you will be able to afford that trip to Paris!
5) Every time you complete a year of making payments on time with your card, pay it off and call your bank. Ask them if they will raise the credit limit by $500 or $1000. If you have just completed a year of perfect payments, and have no balance on the card at the time that you call, most banks will happily raise the limit for you. You see, when people over-spend on their cards, and end up carrying balances from month to month, that's when the banks make money in the form of interest. So it makes sense that they want you to have a high spending limit, in the hopes that you will run up a bill that you cannot pay off in a month, because that's when they gouge you. On the flip side...
6) NEVER use more than 1/3 the total amount of your spending limit on any card. It looks bad on a credit report, and raises a red flag with the bank too(OK, a small red flag, but they probably won't grant you a limit raise at the end of the year if you do it too often!). When people start living off a credit card and running up big monthly credit card bills, it usually means they are either unemployed, or have suddenly stopped caring about their finances for some reason. Nobody wants to lend you money if you are jobless, or might not bother to pay it back. It's the appearance that matters here. The bank does not know if you lose your job, unless it becomes reflected in your finances. As long as you still look good on paper, nobody will be the wiser. This is also where that Savings Account comes into play (from my previous essay), as it can be used to pay off a credit card and provide the appearance (at least on paper) that everything is fine. They don't have to know that you are surviving off of Ramen and carrots from the neighbor's garden! As you grow older, and keep asking them to raise your limit every year, you will eventually end up with one of those nifty Platinum Cards, with a really high spending limit. The higher the spending limit is, the more you can spend before you reach the 1/3 mark, but by then you will be making enough money (hopefully) to pay it off every month anyway. It's a slow process, and you have to start small, but if you keep at it, that's how you go from Broke to Well Off, at least in regards to credit cards.
7)Avoid getting more than one credit card, it looks bad on a credit report. It looks like you are desperate to spend money that you have not even earned yet. More credit cards DOES NOT make you look more responsible. It makes you look like you have some sort of compulsion to sign every offer you get in the mail. Which brings me to...
***WARNING*** You WILL get a billion credit card offers in the mail as soon as you show any improvement on your credit ratings. DO NOT accept any of them. Tear them in half or burn them so nobody can accept the card in your name, without you knowing about it...which will destroy your credit BTW. The only credit card companies that send out mailers all charge yearly fees, have high interest rates, and are basically bad deals. If you want a credit card, go to your bank, shop around a bit, there are better deals out there!
So.. I'm confused now...How do I actually get GOOD credit?You earn it. Over many years, little by little. There is no quick way to get good credit, but the basics are pretty simple, really:
- Keep your word: If you agree to make payments, do everything you can to make them on time, every time, like your life depends on it. This should be common sense, I hope.
- Pay attention to your money. Know how much you have, how much you expect to make every year, month, week. Know what you spend it on. Know it well enough that you can immediately tell if any goes missing. (keep your mind on your money and your money on your mind)
- Build your credit: Take out loans that you know you can pay on time. Get a credit card and learn to buy a few small things with it every month, and practice paying it off on time like it's your new religion.
- Track your credit report and credit score every year. Study it. Treasure it. Snuggle with it, if that's what it takes. Know it by heart.
- If you see any mistakes on your credit report, contact the credit agency immediately and start a dispute. If you have the misfortune of having your identity stolen, you could end up with a lot of false reports on your credit report. It takes a long time to get that stuff fixed, but it helps if you get right on it promptly. Your future mansion with the rooftop pool depends on you now, and how closely you keep an eye on this report!
Basically, that's it. That's the basics of how to establish credit, make it good credit, and build on it from there. Even if you have bad credit already, you can still follow all these steps, and in about 7 years your credit will be a whole lot better. If you want to take it further, there are a ton of books on the topic, just check out your library.
Good luck!
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