The process of building credit can be daunting, especially if you’ve never used credit before. But, by familiarizing yourself with the various factors that influence your credit score, you can start off on the right foot.
What is a Credit Score?
It may be hard to believe, but people have not always had to worry about maintaining a good credit score. The current industry standard credit scoring system, FICO, was only established in 1989. So before that date, lenders did not have a uniform way of determining the creditworthiness of borrowers. Now, your credit score impacts your ability to acquire loans—especially at competitive interest rates, rent apartments, get deals on insurance premiums, and more. But how do you begin to build a high credit score?
Where Does Your Credit Score Start?
If you are brand new to building credit, you may be worried you will have to start from scratch. Luckily, you will never have to start at zero, because credit scores only range from 300-850. As soon as you open your first line of credit, be it for a credit card or student loan, your credit journey begins. But before even qualifying for a score, you need at least one credit account that has been open for at least six months and at least one credit account that has been reported to a bureau within the past six months. So, don’t expect to receive a credit score the month after opening your first line of credit.
How is Your Credit Score Calculated?
After opening a line of credit, the lender will begin to report your activity to the three major credit bureaus: Equifax, Experian, and TransUnion. These three bureaus look at five factors, all weighted differently, to calculate your score:
- Payment history (35%) - The most important factor in calculating your credit score is your ability to make your payments on time. All kinds of accounts, including car loans and mortgages, can influence your payment history. Making late payments, defaulting on loans, and declaring bankruptcy will negatively impact your score.
- Credit utilization (30%) - Credit utilization, also known as amounts owed, refers to how much you owe in relation to your available credit. It is important to familiarize yourself with your credit utilization ratio. Just because you have available credit, does not mean you should be maxing it out. In fact, to achieve and maintain a high credit score you want to only use around 30% of the credit limit on any of your credit cards.
- Length of credit history (15%) - The length of your credit history allows lenders to understand how well you use credit. The longer your history, the higher your score. Before closing old or unused credit cards, remember doing so will bring down your credit score. Unless there is a large annual fee you wish to avoid, it’s probably better to keep the account open.
- Credit mix (10%) - Credit mix is simply the different types of accounts that make up your credit report, such as student loans, auto loans, credit card accounts, personal loans, and mortgages. It is seen as more trustworthy when you simultaneously manage different types of credit.
- New credit (10%) - Finally, bureaus look at how many times you have applied for new lines of credit. Applying for new credit triggers what is called “hard inquiries”, which cause your overall credit score to drop. You should generally avoid applying for numerous loans or new credit cards in the same year.
How to Create Good Credit
Creating and maintaining excellent credit may feel overwhelming. However, there are several strategies you can use early in your credit journey to get you started on the right foot. You can start by applying for a secured credit card with TDECU, taking out a credit-builder loan, or becoming an authorized user on a family member’s account. It’s also a good idea to monitor your own credit report and take advantage of the free credit reports provided by the major credit bureaus. Most importantly, remember building credit is a long process. If you are looking for more support at the beginning of your credit journey, contact a TDECU Wealth Advisor, and learn how to make your money work for you.
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