Learning About Your Credit Score and Ways to Make it Better (Or Establish It!)

So today's post isn't really about saving or making money per se, but it is an important topic when talking about finances that I think many people have misconceptions about and that's your credit score.

What is your credit score?  Put simply, it shows how worthy you are of borrowing money.  Meaning, the higher your credit score, the more people are willing to lend you because you have a good history of paying back money you borrowed.

I think the biggest mistake made when concerning credit, is not establishing any.  Many people are afraid of credit cards or taking out loans because they are afraid they will go into debt.  It's smart not to try and buy things that you cannot afford, but it is not smart to be afraid of using credit as long as you use it wisely.  It's important to establish credit as soon as you can so you can build a long history of good credit.  Why is this important?  Because when the time comes in your life to be making a big purchase that you have to have a loan for, like a house, you have to have credit established to not only get a loan but to get a good one with better rates.

So how do you establish credit?  There are two big ways to establish credit: through credit cards and through loans.

Credit Cards
I have already talked about using credit cards to your advantage to make money, see Make Money With Credit Cards, and I briefly talked how to manage credit cards so they don't lower your credit score -- that is . . . . paying off your bill every month!  As I said in that blog, don't be afraid of credit cards.  As long as you spend with it just like you would a debit card, only buy what you actually have money to pay for, you shouldn't run into any problems paying your bill.  And paying your bill in full on time means paying no interest or fees.

Paying your bill also means helping your credit score.  As long as you keep paying your bill, your credit score will go up.  This also increases the amount of money you are able to "borrow" each day from the credit card company.  Like I said, the more you pay off, the more you can borrow on credit.

An important thing to note, if you have multiple credit cards open that's fine!  DON'T EVER CLOSE A CREDIT CARD ACCOUNT!  This affects your score negatively.  Many people after going into debt and then eventually paying it off, want to close their accounts so their not tempted to use it anymore.  DON'T.  Cut up your card and don't use it, but keep the account open.  Why?  Because an open account, even if the bill is $0, you pay $0, you are paying off your bill.  That helps your credit score.  Closing an account even if you always paid your bills on time will negatively affect your credit score because banks and such see that as a cry for help, that you do not have money to pay things off.  So even if you want to open a credit card account and not use it, it could still help your credit score, though very slightly.

Loans
The other way to establish credit is through loans.  I remember my economics teacher in high school saying, never get a loan to buy a car, you should have enough money to pay it off right away.  That always stuck with me but now I see that getting loans is important to establishing credit, though there is still truth in what he said.  It's important to understand when you should be getting a loan to help your credit and when you should be getting a loan just because it's a big purchase and you have to have a loan.

What do I mean by this?  Well take the car example he used.  The idea that you should have enough money to pay for the car is still true.  It does not make sense to purchase a car that you cannot afford even though you can get a loan which makes it easier to buy.  Why?  Well first of all, in the scheme of all things in life, purchasing a car is a relatively small purchase compared to other things like education, houses, property, etc.  Second of all (and something more people will take to heart), cars depreciate in value where as most other things you need loans for increase in value -- houses and property if well taken care of and improved over time increase in value and even investing in an education means that you will be able to make more money in the future.

So why do I believe now that you should possibly still get a loan?  Well, just like credit cards, you can get a loan just to establish credit even if you have all the money to pay it off (as you should).  You can pay off the loan in full and not have to deal with interest.  It's just like paying for it with cash or a check, but you help your credit score while you're at it.  This can also be done with smaller large purchases (that sounds strange) like an engagement ring or other vehicles.

Really the only types of loans that you shouldn't be able to pay off right away or shortly after are: education, housing, and property loans.  Obviously these are are in the tens and hundreds of thousands (or millions) of dollars and most people cannot afford to pay for that right away, and rightfully so!  But to be able to get a loan for these things, you need to already have credit!

Important tips about loans:
1. If you can pay more than your monthly payment, do it.  Just because you have a loan for 30 years doesn't mean you have to take that long to pay it off.  The sooner you pay it off, the less interest you have to pay!
2. Don't get behind on payments, not only does that hurt your credit score, but the interest and fees that accumulate become insanely hard to pay off.  That's how people go into extreme debt.  If your financial situation changes, talk to the bank or company that has your loan and discuss different options.  Especially with long-term loans, there is generally a solution that both parties can agree upon that doesn't hurt you as much.


If you feel there's anything I forgot or if there's still something you don't understand, feel free to comment below!