January 2, 2008 Comments

Building and Rebuilding Good Credit

When I was in college, I was often solicited around campus to sign up for credit cards to get free t-shirts and other goodies. I always avoided the temptation and never signed up for any credit cards. In my mind, credit cards were a bad thing to be avoided at all costs. Unfortunately, I didn’t realize by turning down those offers that I was also turning down the opportunity to begin building my credit history. Building credit is extremely important, especially if you plan on becoming a homeowner some day.

I remember the trouble I had of having no credit as I entered the workforce and how frustrating it was. I would often receive junk mail offers for credit cards with annual fees, but never signed up for any of them. I think it is rather ridiculous to pay an annual fee for the privilege of spending your own money. So what alternative is there to getting a credit card with an annual fee? I began building my credit history by opening a secured credit card with Bank of America.

Secured Credit Card
With a secured credit card, you give a deposit to the lender and they hold it for a certain period of time (I think mine was a year). The deposit held will earn a nominal amount of interest and is held as collateral for the credit line. The credit limit for the card is equal to the amount of the deposit made. Although it seems that Bank of America now charges an annual fee for their secured credit cards, I’m certain there must be others out there that will not charge an annual fee.

Automatic Payments
It may seem like stating the obvious, but you should always make your payments on time. It may also seem like an easy task, but it isn’t so easy for lazy people such as myself that don’t like to pay bills. The best thing you can do in regards to making your payments is to set up automatic payments. I know this was the best thing I ever did to build a good credit history and maintain my credit rating as high as possible.

A lot of credit card companies will allow you to set automatic payments online with their website. You can set up automatic payments to pay the balance in full or make the minimum payment. Also, you can probably use your bank’s online bill pay to automatically make your payments on credit cards as well. Check your banking online bill pay to see if your credit card company offers e-bills. Then you can set up your bill pay to either pay the balance in full or make the minimum payment.

I highly recommend you pay your entire credit card balance(s) each month if possible. Contrary to popular belief, carrying a balance DOES NOT help you to build credit. It only results in paying unnecessary interest and finances charges. The important thing is to make sure that you make the payments, not that you “are actually borrowing money.” Do not pay for anything you do not have the money to pay for. If you wish to buy something you can’t pay for now, save for it and then buy it when you’ve saved up enough money to do so.

I would also suggest setting up automatic payments for everything, such as credit cards, utilities, phone bills, insurance, auto loans, mortgages, etc. Although the payment history for non-credit accounts do not appear on your credit history, nonpayment of accounts do. So make sure to always pay your bills on time no matter what they are! If you’re ever really strapped for cash and you need to make a late payment on something, DO NOT pay any of your credit accounts late.

Making Late Payments
Delay a payment on a water bill, electricity bill, or phone bill before you ever make late payments on a loan or credit card. Late payments on non-credit accounts will not hit your credit report until they have been sent to a collection agency. Companies will attempt to collect late payments themselves before sending them to collection agencies. I would guess that most companies do not send their receivables to a collection agency until they are at least three months late, so being late a month or two on your phone bill probably won’t hurt your credit.

Another important tip if you ever have to pay any of your bills late: do not be late with insurance payments. Nonpayment of insurance premiums can result in cancellation of your policy. Heaven forbid you decide to pay your insurance premiums late and you need to file a claim. If the policy was canceled due to nonpayment, you will be SOL and will have to pay everything out of pocket. You could also have problems reinstating your policy, getting a new policy, and may end up paying higher premiums.

Buy a Car
Buying a car (if you need it) is another good way to build credit. Of course, if you can get a 0% financing deal, it’s the best way to pay for a car. If you have limited credit history, it may not be possible to get a 0% auto loan. It may not also be possible to get 0% if you decide to buy a premium model such as an S2000 (like I did). If you get a high rate on your auto loan, you could always refinance it on Prosper or some other lender. Be sure to set up automatic payments for your auto loan to keep your credit history pristine.

Credit Inquiries
Try to keep your credit inquiries to a minimum. If you have a lot of inquires, they will bring down your credit score. If you are trying to get a loan, ask for quotes based on your current credit score and income. Do not allow anyone to run a credit check until you’ve decided on what lender you will use. In other words, don’t give them your social security number until you know for sure that you will be borrowing from them.

It takes two years for an inquiry to be removed from your credit history. More recent inquiries (within the past 6 months) will have more impact on your credit score than older inquiries. If you have had very few inquires within the past two years and have held a credit card for some time, be sure to contact your credit card company and request an increase. It will help to improve your overall score, as it will lower your credit card utilization percentage.

Low Utilization
It is important you try to maintain a low balance in terms of your overall available credit. Of course, when you first start building your credit this may be difficult to do if you have low credit limits. Slowly but surely, your credit card limits will be raised. If you feel your credit limits are too low, you can always request credit line increases. I have even been able to request a couple of credit line increases on my Bank of America credit card without credit inquiries! They gave me the increases based on my excellent payment history.

A while back, I received a 0% offer on one of my cards with no balance transfer fee. I thought I would be clever and take out the maximum ($13,000), put it into a high interest account, and pay it back before the introductory period expired (6 months). Although I did make about $200 or so by doing so, it did come at a price. I saw my credit score drop from around 800 to around 730.

My score has gone up to around 750 since then, but it has taken some time to recover (over a year). I think a few credit line increases on some of my accounts have helped to bring it back up. It is important for me to note that I paid the entire balance in full and paid it on time. Therefore, the high balance must be affecting my score as well my current credit card utilization. Otherwise, as soon as I had paid off the balance, I would have seen my score jump back up to 800. Although I lowered my own credit score, I learned a valuable lesson: don’t max out your credit cards.

Keep Lines Open
Although canceling unused credit cards may sound like a good idea, it is actually more likely to lower your score. This goes along the same lines of maintaining low credit card utilization. Creditors like to see a credit card utilization ratio of around 30%-35%. If you cancel an unused credit card, your overall credit limit on all of your credit lines will go down. This will result in raising your credit card utilization and lowering your credit score.

So how many credit cards should you have? It is probably a good idea to have at least one credit card with each of the major credit card companies: Visa, Mastercard, Discover, and American Express. If you do get an American Express credit card, I’d recommend getting one with no annual fee (such as their Blue Cash card). You really shouldn’t need any more than one credit card with each of these companies. To increase your overall credit limit, rather than open new credit cards, ask for increases on your existing cards.

Once you’ve begun establishing/restablishing your credit history, if you make your payments on time, keep credit inquiries to a minimum, and keep your credit card utilization relatively low, you should be well on your way to building a good credit score.