Key Takeaways
Your credit score is crucial when it comes time to make big purchases in your life. Know how to correct discrepancies and measure your “credit utilization rate.”
It can be difficult to restore your rating if you are delinquent in payments.
Encourage teen or young adult kids to start building credit early. Make sure they understand what goes into a credit score, so they know how to optimize it.
Know the risks to your own credit before co-signing on a mortgage or apartment lease.
With the Holidays fast approaching, thoughts naturally turn to deals, steals and shopping for friends, family and yes, for ourselves. But this is also the time of year when I start thinking about credit scores. Ever since I was 18, I became very aware of my credit score. I knew I would likely have to take on some loans to pay for college, and while I certainly didn’t understand the ins-and-outs of credit, I learned that it’s very beneficial to get your “credit age” established as early as possible and to show the credit ratings agencies that you can manage debt responsibly.
I opened a starter credit card when I was 18 and used it for lots of small purchases (gas, groceries, textbooks and low-cost apparel, etc.) that I could easily pay off every month. With that discipline and foundation in place I was able to keep building my credit. It looks like those early steps will be paying off in spades as I enter a very competitive real estate market as a first-time buyer seeking a mortgage.
In college, I saw many students and friends nearly max out their parents’ credit cards, often on frivolous purchases. Not only was that likely to cause some uncomfortable conversations when they went home for the Holidays, but they weren’t building any of their own credit history up – and were potentially hurting their parents’ ratings.
I have shared those experiences with the high school and college-bound children of several of our clients. With our mostly affluent client base, the kids aren’t applying for financial aid or loans for school thanks to the parents’ assets and well-stocked 529 plans. In one sense, that removes a big burden for the families, but it deprives the kids of the discipline needed to build up a credit history. In effect, they come out of school four or five years behind their peers with loans in terms of their “credit age.”
Real World Example
A client’s young-adult child was shocked to learn he was turned down for an apartment lease despite having a great job lined up after college. He never had a credit card in his own name or any form of debt that he was personally responsible for, so there was no proof of credit worthiness when the landlord ran his credit report. Fortunately, his parents were willing to co-sign the lease, but that’s not always the end of the story. Just know that if you co-sign for a child’s or grandchild’s apartment and they walk out on their lease or lose their job and start missing payments, the landlord or management company can come after you. This situation could not only result in embarrassment, but it could also damage your credit rating.
Steps for Building and Repairing Credit
As mentioned above, the earlier your child or grandchild can start building their own credit history, the better. Again it starts with using credit cards (not debit cards) and with paying off the balance in full each month – even if that means cutting back on concerts, dining out, shoes and clothing purchases, etc. Credit Karma is a great free website for checking your credit score, for seeing how much credit you have available, how much credit you typically use, what your credit age is, and for getting a grasp on the impact of different variables toward your credit. Many credit cards, such as certain Capital One and American Express cards can also give you your credit score.
Most credit scores range from 300 - 850, and the scores you see on Credit Karma are as follows:
300-639 - Needs Work
640-699 - Fair
700-749 - Good
750-850 - Excellent
Improving your score from 725 to 775 won’t have much impact on your interest rate offers since both scores fall in the “very good” range. But moving your scores from 650 to 700 could mean getting lower interest rate offers and better loan terms. AnnualCreditReport.com will also give you one detailed credit report every year free of charge. This will let you know where you stand with the three main credit rating agencies: Experian, TransUnion and Equifax.
If you find a dispute or discrepancy your report, it’s very important to have that error corrected ASAP, especially if you are applying for a mortgage, a car loan, a business loan, an apartment lease or even a new credit card in the near future. If you do find a dispute, you’re not alone. About one in four U.S. consumers found errors that could affect their credit scores in one of their credit reports, according to a Federal Trade Commission study.
To dispute credit report errors, send a letter to the credit bureau that generated the report. Clearly describe the inaccuracy and explain what the error is. The bureau generally has up to 35 days to investigate and respond. Review the results of the investigation and then check for updates to your credit report. It can be a tedious process but protecting your credit score is certainly worth the effort.
Understand your credit utilization rate. This is calculated by dividing your total credit card balances by your total credit card limits. For instance, if you have $20,000 in credit available and you have an outstanding balance of $7,500, that means you are “utilizing” 35% of your available credit. Your utilization rate is one of the most important factors in determining your credit score. A higher credit utilization rate tells lenders that you may be carrying too much debt and may not be able to pay back your new loan or credit card balance. The Consumer Financial Protection Bureau recommends keeping your credit utilization ratio below 30%. This may not always be possible based on your overall credit profile and your short-term goals, but it’s a good benchmark to keep in mind.
Pay off balances. There’s no substitute for paying off your credit balances in full every month. But, when you have to carry a balance, make sure you pay far above the “minimum” on your monthly statement and if you have balances on multiple credit cards, makes sure you attack the balances on your highest interest rate card(s) first.
Conclusion Talk with your teens and young adult children or grandchildren about responsible use of credit. We’re happy to work with them as well and can help you freeze your credit (or a child’s) should the need arise. If you or a family member has questions or concerns about managing credit, please reach out any time. We’re happy to assist.
BRENDEN LEESE, CFP® is an Associate Wealth Advisor at Novi Wealth Partners