A Beginner’s Guide to Borrowing Smartly
If you’re a young adult who has just started building your credit, trusting that you’re getting the right advice can feel a bit overwhelming and leave you with questions. How do you get a loan if you don’t have any credit? How can you build your credit if you don’t have a loan? How do you avoid bad credit?
Building credit is a journey, but with the correct information and focused determination, you can set yourself firmly on the path to financial success. In this blog, we’ll discuss ways to build and maintain good credit, which is essential if you want to borrow at lower interest rates that will save you money.
Understanding Credit
Before diving into tips on improving your credit, it’s essential to understand what credit is and why it matters. Your credit score is a numerical representation of your creditworthiness, with a range from 300 to 850. Lenders use this score to determine their level of risk to lend you money.
A higher score indicates a lower lending risk, making it easier to get approved for loans, credit cards and even other things such as rental agreements. Also, a high credit score gives you access to lower interest rates that can save you money over the life of the loan. There are several factors that will affect your credit score, according to Bankrate.com. They are:
- Credit Age: The longevity of your credit/loan accounts plays a role in your credit score. By keeping older credit accounts open, it can help improve your score.
- Inquiries: When you apply for a loan, your credit history and credit score are obtained by the lender in what’s known as a credit pull or hard inquiry. This inquiry appears on your credit report and temporarily reduces your credit score by a few points each time it’s done. A good practice is to avoid applying for multiple loans in a short period of time because too many hard inquiries will lower your score.
- Overall Debt: Your outstanding balances and credit utilization directly impact your score. Keeping your lines of credit open under a certain percentage lest you maintain your credit score.
- Payment History: Payment history is also an important factor to your credit score because it lets lenders see how likely you are to repay the loan. By making payments on time, you can build a positive payment history and raise your score.
How to Build Credit
If you currently don’t have any credit or don’t know where to begin to build your credit, a secured credit card is a solid place to start. Unlike a traditional credit card, a secured card requires a cash deposit as collateral to cover the amount of credit extended to you. For example, to have a credit line of $500 you need to have $500 on deposit.
Using a secured credit card helps teach you how to spend smartly with low risk to the bank or credit union you open it with. Try to pay off your outstanding balance in full each month. Also, try not to use more than 30% of your credit line so it doesn’t impact your credit.
Similarly, a secured loan helps to build or rebuild credit. The borrower provides their own funds that are held in a savings account as a requirement of the loan. Monthly payments are made until the loan is paid off and the frozen funds in the savings are then released. The lender reports your on-time payments to the credit bureaus, helping you establish a positive payment history.
Here are other tips to help you build your credit:
- Make Payments on Time: Your payment history is the most significant factor in your credit score, accounting for 35% of your score, according to CNBC.com. Building good credit requires always paying your bills on time. Even a single late payment can negatively impact your score. Set up automatic payments and calendar alerts to ensure you never miss a payment. Paying bills on time also helps you avoid late payment fees.
- Keep Your Credit Utilization Low: As discussed, credit utilization is the ratio of your credit card balance to your credit limit. It’s recommended to keep this ratio below 30%, meaning if you have a $1,000 credit limit, try not to carry a balance of more than $300. A lower utilization rate shows lenders that you’re responsible with your credit and not exceeding your limit.
- Avoid Applying for Too Much Credit at Once: When applying for credit, a hard inquiry is made on your credit report, which can temporarily lower your score. This happens when a lender checks your credit score to determine if you are eligible for a loan. To build credit wisely, avoid applying for multiple credit cards or loans in a short period. Instead, focus on maintaining a few accounts responsibly and allowing your credit score to grow gradually.
A great way to avoid hard inquiries is to pre-qualify for loans. Some lenders, including Travis Credit Union, will let you get pre-qualified for an auto loan. TCU also will let you see if you have any loan or credit card offers on file without a hard pull on your credit record.
- Monitor Your Credit Report Regularly: It’s essential to review your report regularly to ensure there are no errors or fraudulent activities. You can receive a free credit report every year from each of the three major credit bureaus (Equifax, Experian and TransUnion) at annualcreditreport.com.
- Keep Old Accounts: The length of your credit history accounts for 15% so keep old accounts active and in good standing. Old credit card accounts increase the average age of your credit accounts, which is a good thing. Be sure there are no annual fees associated with keeping the account open. Use your older credit accounts occasionally to show activity to lenders, which indicates you still need the account.
- Be Patient and Consistent: Building credit doesn’t happen overnight. It takes time, consistency and responsible borrowing. Focus on making smart financial decisions that improve your score over time. Your credit score reflects your financial health, so practice good habits now to set yourself up for financial success in the future.
Building credit doesn’t have to be daunting. By understanding how credit works and following these tips, you can establish a strong credit foundation. Borrow wisely, make payments on time and keep your credit utilization low. With patience and persistence, you’ll see your credit score grow, opening doors to better financial opportunities.
How TCU Can Help
Travis Credit Union is focused on your financial wellness and that includes providing resources to help you improve your credit. For example, our shared secured credit card lets you start building your credit, while our partnership with Experian Boost lets you increase your credit score automatically. Our digital banking platform allows you to stay in touch with your accounts at any time and our automatic bill payment system lets you schedule payments so you don’t miss a beat.
You can also check your offers to see if you’re pre-qualified for a loan. Travis has been rooted in our communities for more than 70 years. Learn more about us at traviscu.org.