As you go through life and build your business, you’ll hear a lot about “credit” when referring to purchasing things and how much you can borrow. It’s one of the key factors in how much and how quickly you’ll be able to grow your business, and we can’t overstate its importance. Let’s take a look at what credit is, why you need it, and perhaps most importantly, how you get it.
What is credit?
Experian, one of the three major credit reporting companies in the U.S., defines credit as “borrowed money that you can use to purchase goods and services when you need them. You get credit from a credit grantor, whom you agree to pay back the amount you spent, plus applicable finance charges, at an agreed-upon time.” In other words, credit is money in the bank, which can become money in your pocket.
It comes in the form of credit cards, payment agreements with vendors or other service providers, and banks or other lenders.
How much credit any of them will extend you depends, in large part, on your credit rating—how trustworthy you have been judged to be regarding money, and what kind of risk you are in paying it back.
When people talk about building credit, they’re basically talking about establishing and shoring up their credit rating, making it easier and cheaper to borrow money. Generally speaking, the better your credit rating, the greater your borrowing capacity, and the less it will cost you.
What is a credit score?
Your credit rating is based on your credit report, which contains information such as your income, how long you’ve lived at your present address, how long you’ve had your current job, how much money you have in the bank, and how you have handled credit in the past.
In the U.S., the three big companies that compile credit reports are Experian, Equifax, and TransUnion. Each credit bureau has its own formula for calculating your credit score, but all gather information and data from various sources and providers. The Fair Credit Reporting Act regulates what kind of information they use and who they can release it to.
Your credit report contains a lot of information that would be demanding for a bank or other lender to wade through, so it gets summarized into a credit score: a three-digit number generated by compiling and weighting the information in your credit report.
Various lenders have different benchmarks for that score that tell them which type of loan and how much you will qualify for. While there are a number of models for credit scores around, the FICO score is the one most often used. According to the website for its developer, 90% of all financial institutions in the U.S. use FICO scores in their decision-making process.
So, what goes into your FICO score? Your payment history is the single most important piece of the puzzle (35%), followed by how much you owe (30%), the length of your credit history (15%), how much new credit you have (10%), and the types of credit used (10%).
Why do you need credit?
Unless you have a bunch of spare thousands tucked under your mattress, you will most likely need to borrow money to make a major purchase. On a personal level, that might mean a car or a home. For your business, it could mean equipment or a building. Without credit, it will be more difficult to make a big purchase.
Companies that are in the business of lending money try their best to ensure they will get paid back. And unfortunately, your being a swell person just isn’t enough of an assurance for them to go out on a financial limb for you. They really need to look at your track record to see how you’ve handled money in the past. For many lenders, your credit history is the single biggest factor they’ll take into consideration when deciding whether to approve your funding request for a loan and for how much.
It doesn’t stop there, though. People with good credit are often seen as more trustworthy in other areas. Frequently, employers or landlords will check your credit information as part of their selection and decision-making process.
By law, you are entitled to receive a free copy of your credit report from each of the three big credit bureaus once per year. To do so, you can visit the central credit report website they set up for this purpose or call toll-free 1-877-322-8228. You can order from all three at the same time or one at a time.
To keep a good handle on your credit score, think about ordering one from each of the companies every four months. That would give you a good year-round picture of what your credit looks like. You are also entitled a free copy of your report if you are turned down for a credit card or loan.
How do you get credit?
You get it—having good credit is extremely important. So, how do you get it??
Getting started with credit may seem a little tricky because, as we’ve learned, you generally need to have it to borrow money or get a credit card. There are ways to begin, however.
- Establish that you are a reliable payer. This can be as simple as having a series of canceled checks or paid receipts for rent or utilities. It’s helpful for the apartment and utility accounts to be in your name.
- Get and use a secured credit card. With this kind of card, you can only spend up to the amount of cash you have as collateral in a linked account. Making card payments on time helps demonstrate a pattern of responsibility. This is one of the most popular ways of establishing credit, and some institutions will offer an unsecured card just a year after you begin with a secured card.
- Get a credit card with a low spending limit. Make a small charge each month, and then pay it off right away. College students may be eligible for credit cards with lower spending limits, so if you get an offer, consider accepting. If students don’t qualify on their own, a parent can co-sign. Credit builds for the student as the card is properly paid.
- Pay off an existing loan. Paying off student loans taken out in your name is a great way to build credit.
- Open checking and savings accounts. Lenders look at these accounts as a sign of financial stability.
How do you increase your credit score?
Once you’ve gotten a credit card, be careful and smart with it! Pay your bills on time—all of them, all the time. Even being a few days late can have a major impact on your credit score. Consider setting up automatic payments from your checking account so you know you’ll never be late. You can choose to pay the monthly minimum, pay the entire balance due, or pay a set amount each month.
Keep your debt low. Don’t go over your credit limit. Even better, try to keep your balance to less than 50% of your credit limit; 30% is even better for a more favorable rating, while 10% or less is ideal.
Pay at least the minimum amount due each month, but more if you can. Don’t overextend yourself. Don’t skip payments.
If you absolutely, positively have to miss a payment, choose carefully. Missing an auto loan or mortgage payment will hurt your credit much more than skipping a credit card payment. Always try to make at least the minimum payment due, however.
If you do mess up, you might be able to get a late or missed payment taken off your record. Call the company and ask. Sometimes a creditor will delete the information out of goodwill, especially if you’ve been a good customer for a while.
Keep an account open even if you don’t use that card anymore. Your credit score is calculated, in part, by how much you owe compared to how much credit you have available to you. A card that has no balance helps with this calculation. It also reflects well on you to have longstanding accounts, whether or not they are currently active.
Don’t open too many new accounts. This will lower your average account age, which is a negative.
Don’t use too many accounts. One of the factors in your credit score is how many of your cards have balances. Instead of spreading your purchases around between a few cards, concentrate on one (preferably the one with the lowest interest rate). Pay off any cards with small balances and get them out of the way.
Having and successfully paying off an installment loan (a loan paid in set installments over a particular period of time, such as a microloan or mortgage) will raise your credit score.
Don’t let past slipups mess you up going forward. Get current and stay current. Older problems don’t carry as much weight as your more recent history, so the longer you keep your track record clean, the higher your score will go.
Protect your personal information carefully to prevent identity theft, which can put your credit information in turmoil for a long time. Guard your Social Security number, your credit card numbers, and your bank account information. If someone is able to fraudulently open a credit card account in your name and then doesn’t pay the bills, the delinquent account will be reported as yours on your credit report. Getting your credit cleaned up and corrected can take considerable time and effort.
Keep track of your score by taking advantage of those free annual credit reports you’re entitled to, and make sure they don’t contain any wrong information that could hurt you.
What If I Find A Mistake On My Credit Report?
The Fair Credit Reporting Act says the credit bureau must correct inaccurate information in your report. To clear things up, you need to contact them and let them know what you think is wrong. You can do this in writing, over the phone, or online.
What issues might you come across? Dispute any accounts that aren’t yours or that you didn’t open. Dispute any payments listed as late that you paid on time. If you had a bankruptcy, it should no longer be listed after ten years. Other negative credit information should be gone after seven years.
The credit bureau must investigate, usually within thirty days, and forward all the relevant information you give them to the creditor that provided the information. After the dispute is filed, the creditor has to investigate and report the results back to the credit reporting company. If the information in question does turn out to be inaccurate, they must notify all three nationwide credit bureaus so your file can be corrected. When the investigation is complete, you’ll be provided with the results in writing.
If you still have a dispute after the investigation, you can ask that a statement of the dispute be included in your file and in future reports.
Give Credit Where It’s Due
As you can see, you are the one in control of your credit. Build it wisely and guard it carefully. Good credit will be a big help in building your business, while bad credit can make life much tougher and more expensive.