In recent SquareOne Financial Foundations blogs, we reviewed topics focused on saving for emergencies and retirement, but now let’s shift gears and dig into one of the most critical yet most misunderstood components of your financial life—credit.
What is credit anyway?
Simply put, credit is one’s capacity to borrow money or gain access to goods and services with the understanding that you will pay later. It’s made up of payment history, length of credit history, new credit, amounts owed, and type of credit used. There are four types of credit:
Borrowers are given a maximum dollar amount to borrow and must make a minimum payment each month, up to the total amount borrowed in each period, usually a month. If you don’t pay the entire amount borrowed, you carry forward the remaining debt to the next month. Credit cards are the most common form of revolving credit.
Like credit cards, borrowers are given a maximum amount of availability to borrow each month, but you must pay off the balance in full every month. Charge cards are less common than revolving credit cards.
Utility companies and cellular providers use the service credit model. Users pay for services provided by companies after the fact.
Installment credit is a loan for a specific dollar amount that you agree to repay plus interest in a series of equal monthly payments. Installment credit includes car loans and mortgages.
So why do you need credit?
Is it possible to pay for everything in cash and never borrow money? Unfortunately, it’s not that simple. Both your credit report and score are reviewed by landlords and leasing agents if you’re renting, by insurance companies when determining rates for your home and auto insurance, and even employers when making hiring decisions. Establishing and maintaining a good credit history is essential for being purposeful with your finances and working toward financial stability and independence.
If you are short on credit or don’t have any credit history, here are a few easy ways to establish credit and begin improving your credit score:
Secured credit card
A secured credit card is backed by a cash deposit you make upfront and is usually the same as your credit limits. Like any other credit card, you will use the card by purchasing items, services, or paying bills. The key is to make a payment for the balance (in full) on or before the due date to avoid interest charges and establish a good payment history.
- TIP: Pick a bill you pay every month, like your internet, cell phone, or water bill, and instead of paying your provider directly with cash or check, set up an autopay on the secured card. Be sure to pay off the balance on your secured credit card each month to avoid interest charges. Consistent payments on the card will show responsible use of credit over time and help build your track record of using credit responsibly.
Secured cards are not meant to be used forever but are intended to build enough credit history to qualify for a traditional credit card.
Credit Builder Product or Secured Loan
These products function as a form of a forced savings program. The service program will report your monthly payments to the credit bureaus to help boost your credit history.
Use of a Co-Signer
Co-signing a loan or credit card is a widespread practice, but your co-signer needs to understand the risk they are taking. Co-signers on any debt are equally responsible for paying the debt back, so this is not a decision to be made lightly.
Suppose you have a parent, family member, or significant other willing to add you as an authorized signer on their credit card, and they have a good credit history. In that case, the association can help you build your credit. Adding you as an authorized user adds that card’s payment history to your credit file. A bonus for the individual adding you as an authorized user is that you do not need access to the card to see the benefits. However, you’ll want to make sure that the card issuer reports authorized user activities to credit bureaus.
Now that you have some tools to help you start building credit history, we’ll focus on how your credit score is calculated and more tips for using credit responsibly in the next SquareOne blog.
SquareOne: A Financial Foundations Blog is a personal finance series from The Welch Group created to help provide readers with the foundational knowledge to be purposeful with money by identifying key financial concepts to help them control their financial future. Foundation topics include personal savings strategies, debt consolidation and reduction, life planning, retirement planning methods, and beginner essentials of investing and taxes.
Callie Jowers, CFP ®, is an Advisor at The Welch Group, LLC, specializing in providing Fee-Only investment management and financial advice to families throughout the United States. Callie is a graduate of the University of Alabama, is currently pursuing a Master of Accounting at the University of Alabama at Birmingham, and is a Certified Financial PlannerTM.
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