Feb 27, 2020 11:16 AM EST
The Credit Building Basics for Newbies
Theoretically, your credit score sums up your ability to manage debt. The higher your credit score, the more interest rates will go in your favor when you're weighing up financing options for your home, car, or business. It will also determine your eligibility for not just loans and financing, but also certain types of insurance, the premiums for which may also be lowered by a high credit score. If you're a total newbie to the world of credit, this is your basic guide to building credit from scratch.
Understanding the FICO Rating
Your journey starts with knowing the organization behind the credit score. Also known as the Fair Isaac Corporation, FICO is the primary source of credit score calculations and parameters for more than 90% of businesses. Ranging from 300 to the perfect score of 800, your credit is based on five main factors.
35% or the biggest factor is your payment history — you can keep this up by never missing any due dates for any type of recorded debt.
30% or the next biggest factor is utilization ratio — this number represents how much you owe divided by your total credit limit.
15% is the length of credit history — or in the case of newbies, zero.
10% represents hard credit inquiries from new credit — every time you agree for a lender to make a hard inquiry on your credit history, it can deal five to ten points of damage to your score.
10% is credit variety — the more different credit cards and other credit avenues you're able to manage, the more reliable you are as a borrower.
There are many other alternative calculations for credit scores. However, FICO's remains the standard even today.
Always Pay on Time
The oldest credit score building strategy is also the most reliable: pay your bills on time.
This statement is as valid today as when we discussed this five years ago in a post on Money Times. After checking your credit report, finding out your actual score, and getting a full list of all your unpaid debts, mark all those due dates on a calendar and make sure to never miss a payment again. Remember that payment history makes up 35% of your total score.
Surviving Being New-to-Credit
The length of your credit history is, of course, a different problem. Only time can let you build this 15% part of your score. The problem is that lenders and the entire credit system itself can be quite unforgiving to those with zero credit history. And without any credit history to speak of, it's even harder to find lenders with which you can build other factors that comprise your score. This is where disruptive new fintech credit options enter the picture. For instance, The Petal Card is an option designed for credit newbies who need financing and savings account options. With literally zero annual and hidden fees, it can be a way for people still building credit to avoid the high interest rates and other limited, unfavorable options typically available to people at the bottom of the credit rating system. These new and alternative fintech models are out to disrupt the credit system, and they can be highly useful for those new to credit.
Keep Your Utilization Ratio Low
Whether you go with a traditional or an alternative credit card provider, keeping your utilization ratio low greatly reduces your chances of defaulting on loans in the eyes of lenders. This means never spending beyond or even near your credit limit. CNBC advises taking advantage of the alerts that credit card issuers use to notify users whenever they're close to exceeding predetermined amounts. The lower your utilization rate, the less hard inquiries future lenders will require, and the more credit variety will be available to you.
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