Wednesday, September 5, 2012

Establishing and Maintaining Good Credit

By: Megan

You've probably heard at least a little bit about the importance of establishing credit and keeping your credit history clean. If you ever take out a loan, your credit score will play a big part in what interest rate the bank will charge you. This is especially important when it comes to buying a home. In this day and age, it's a good idea to have a credit card.

I know I used to have a lot of questions about credit cards: is it best to carry a small balance on your card or to pay it off each month? Should I get those credit cards from stores when they tell me that opening one will save me 15% on my purchase?!

For starters, let's look at what credit evaluation companies are looking at when they give you a credit score:

Payment history: The largest chunk of your score is based on your payment history. For this reason, you do not want to carry a balance. Paying off your card in full shows that you aren't using your credit card to make purchases that you can't really afford.

Use of credit limit: The next biggest chunk is based on how much of your credit limit you use each month. The closer you get to your limit, the more nervous the banks get. Are you using your credit card to buy things you can't afford? Will you be able to pay them back? To be safe, don't use more than 30% of your credit limit each month- to be really safe, don't use more than 20%.

Credit history: How long have you had a credit card? This component is why it is important to get a credit card as soon as you feel ready for one. Even if you never use it, having the account open says a lot. Also, when you get a new credit card, never close your old credit cards. Doing so shortens the length of your credit history. You can cut the card up or put it somewhere safe, but leave the account open.

Application history: this refers to how frequently you are applying for new cards. A good rule of thumb is to not apply for new debt (a new credit card, new mortgage, refinance, etc) within one year of each other. If you are applying for credit too often, the banks get nervous about what you need all of that credit for. Only get a new credit card if you really need one or if it really makes sense.

Credit mix: this is the last category, and is very small. This refers to the fact that you shouldn't have a Kohl's, Nordstrom, JC Penny, and Sears card. This category also refers to the different types of debt. One website says, "A good mix of credit would include a mortgage, a car loan, a couple of major credit cards, and one or two department store or gas credit cards." But remember, this element of your credit score is small. Don't go out and open a bunch of credit cards because you feel like you need a good mix, especially if you feel like you won't be responsible with them.

If you don't have a credit card or are looking for a better one, I'll do another post about choosing a good credit card!

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