How to Build Your Credit
Do you know your credit score? Do you know how your credit score can affect your everyday life? In the journey to building your credit, not only do you need to understand the basics of your credit score, you need to understand how it is affected simply by the kind of loan you might decide to use.
In this series we are going to explore the basics of what a credit score is, reasons why having a good credit score is important, and tips for building a good score and avoiding mistakes that can harm your score.
Build Your Credit: Credit Basics Transcript
Part 1: Build Your Credit: Credit BasicsVideo
Idaho Assistive Technology Project (IATP)
Do you know your credit score? Do you know how your credit score can affect your everyday life? In this module we are going to explore the basics of what a credit score is, reasons why having a good credit score is important, and tips for building a good score and avoiding mistakes that can harm your score.
You have learned about how to build a partnership with your money:
- What your money personality is;
- SMART goals and;
- How to make a contract with your money.
You also learned about building a financial success plan:
- The difference between needs and wants and;
- How to create a spending and savings plan.
Now we're going to talk about the basics of credit.
In this presentation, you will learn some of the myths about credit, why credit is important, and what a FICO score is and how it is used in obtaining credit to make purchases.
Information about credit and credit scores seems to be everywhere. There is often a lot of misinformation as well. We are going to begin by busting some of the myths you may have heard!
Myth #1: You have to carry a balance from month to month in order to build credit on a credit card. This is not true, because the best way to build credit is by using a credit card and paying off the balance every month which also avoids any interest charges.
Myth #2: Getting an auto loan is the best way to build credit. No, there are other options that build credit faster and cheaper.
Myth #3: Payday lenders don’t do credit checks, so they are great places to get a first loan. No, payday lenders will not build your credit, and are very expensive.
Myth #4: I will need many different types of loans in order to build a good credit score. No, while a perfect score is only attained by a combination of loan types, by using only inexpensive revolving loans, you can still build a strong credit score.
We have taken some of the myths out of credit, now let’s take away the confusion that seems to surround credit scores with credit score 101.
As we review the basics about credit scores we will also discuss reasons why they are important.
While there are many types of credit scores out there, there is only one type of score that is used almost universally throughout the United States. FICO, which stands for Fair Isaac Corporation, is the company that calculates this score. It is called a FICO score. This is THE score used in about the vast majority of all professional credit score checks. Any other score that you may get on a bank statement, or from a website, is just a guess and can be misleading.
To calculate your scores, FICO uses information from the three major credit bureaus that collect and share your borrowing history. These companies are Experian, Equifax, and TransUnion.
FICO scores range between 300 and 850; the higher the score the better. And those with less than perfect scores will pay an increasing amount of money for things like loans and auto insurance premiums.
There are five factors that make up your FICO score; types of credit used, new credit, length of credit history, payment history and amounts owed. Each of these factors affects your score in some way.
“Types of Credit Used” measures which types of loans you currently have in use. This affects your overall credit score by 10%. The choices you make on which type of credit to use can positively or negatively affect this factor. We will talk about this more in later modules.
“New Credit” measures how many times you have had your credit checked, and how many loans you have opened in the last year. This factor also affects your overall score by 10% percent. Every time you open new accounts, this factor in your credit score will drop. After 12 months the account will no longer be considered new and will no longer negatively impact your score.
“Length of Credit History” is the factor that looks at the age of each account, or how long the account has been open and actively used. This makes up a total of 15% of your overall credit score. This factor is positively affected when your credit accounts have been open for a long time, and it is negatively affected by newer loans.
“Payment History” is the factor that measures whether or not loan payments are made on time. It affects your overall score by 35%. If you do not make your payments on time, your credit score will drop significantly.
“Amounts Owed” is the factor that compares your loan balance to your maximum loan limit, or beginning balance. This factor will affect your credit score by 30%. The closer your loan balance is to the maximum loan limit or beginning balance of the loan the more your credit score will drop.
Trying to understand how credit scores work can be challenging; but understanding how they are used and why they are important to you may help make credit scores a little easier to understand.
Do you know what your credit score is today? Do you know how to check your credit score?
This is the point where some people might say, “Why bother with a credit score at all? I don’t plan on borrowing money, so why should I even worry about my score?"
These are excellent questions, because it is very wise to avoid borrowing and going into debt; however, using that as an excuse to not build your credit can be a very costly mistake, especially considering that you don’t actually have to go into debt to build a score—if you do it correctly.
The most important thing to remember is that in the world today, credit scores are used for much, much more than just borrowing. In addition to loans, your credit score can be used to determine your eligibility and costs for apartment rentals; home, auto, and life insurance policies; utility services such as cell phones; elective medical services; private schools; and last but not least, employment and promotion with a growing number of employers.
Slide 17: (Interactive)
Now let's review what you've learned about credit scores. Click on the questions and the answers.
[Question #1] Which is the best possible FICO score?
[Answer] The best possible FICO credit score is a) 850.
[Question #2] Which of the following are benefits of having a good credit score?
a) Better employment options
b) Less expensive insurance premiums
c) Less expensive borrowing options
d) Fewer checking account fees
[Answer] Better employment options, less expensive insurance premiums, and less expensive borrowing options are all benefits of having a good credit score.
You have now learned the basics on credit scores. In the next three modules we will explore the main types of loans, and how they can affect your credit score.
Thank you for watching this presentation. A special thanks to the UI Extension office for their content expertise.