There seems to be a huge misconception about credit that has more than a few people confused. Many hard-working, bill paying, by-the-book individuals are discovering that the good credit that they assumed they had simply does not exist. Is it because they were late on payments, or maybe had too many credit cards that were maxed out? The answer is no, and the reason why may surprise some people.
Good credit, in fact, any credit, is only established when people borrow money from lenders and repay it in a responsible fashion. It’s likely that some people assume that we all start out with good credit that deteriorates a little with each new loan we take out or credit card account we open. While it’s true that having too many accounts can have a negative impact on your credit score, the fact is, it takes borrowing money to make lenders want to loan you money.
A Blank Page
Sound confusing? Think of it this way; we all start with a blank page when it comes to credit. When we go to apply for a mortgage or other large loan, the lender doesn't really have a lot of information about our borrowing and repaying habits, just a blank page with no real indicator of whether or not we are reliable borrowers. In order to show them we are good for the money, we need to fill that page in, or establish a good credit score.
Lenders want to see certain things on our 'page', or credit report. They want to see a good mix of installment and revolving credit accounts. Installment accounts are accounts such as a mortgage or monthly car payment that has a fixed monthly payment, while revolving lines include credit cards and store cards.
Filling Up Your Page
If your page starts off blank, how do you fill it up? It can be tricky getting the right information on the page, but not impossible. The easiest way to start building credit is to apply for a secure credit card. These generally have a higher interest rate and lower credit limit, but they are just a first step in the credit building process.
The next step is to use that shiny new card, but beware! The goal is to put good information on our page, so you want to use the card, and then pay the balance off in full. That means no maxing out the credit card every month, then paying only the minimum. That paints a picture of irresponsible borrowing that lenders will be wary of.
Don't Wipe out Information
As your credit score improves, it can be tempting to close old accounts, especially if you’ve moved up to credit cards with lower interest rates or higher credit limits. That would be a bad idea; it’s essentially taking information off of your page that can show lenders how responsible you were in the past. It can also lower your credit score, so keep old accounts open, and use them from time to time to keep them active.
In summary, the phrase 'it takes money to make money' would be a fitting way to describe the path to a good credit score. You have to borrow money and repay it responsibly in order to build a credit score that will make lenders want to loan you more, bigger amounts of money. Just remember:
- Lenders want to see both revolving lines of credit and installment loans, so aim for getting a mix of these on your credit report.
- Closed or inactive accounts won't do you any good; make a purchase from time to time, and pay the balance off in full each month.
- Never miss a payment or pay late! This is a big red flag to lenders that screams 'this person is irresponsible with money!'
It may seem frustrating to have only high interest credit cards to start with, but remember that as your credit score rises you will be able to apply for ones with lower interest rates and other loans with low rates. The key to getting access to the 'big money' is to manage spending the 'little money' responsibly, and building a good credit score in the process.