Financial literacy is a vital skill for any adult to learn. Being able to keep an eye on your finances, to understand how much is coming in, where it’s going out, and what you can do to improve your long-term financial situation is one of the keys to money independence in the long run. However, even those with a good handle on their money often don’t put as much effort into understanding their credit or how to effectively manage it. Here, we’re going to look at how you can become credit literate, too.
What, Exactly, Is Credit?
To start with the most basic point, credit is the system that allows you to borrow money with the understanding that you’re going to repay it later, typically with interest. In both score and report form, it’s used by lenders to assess your trustworthiness and can influence many of the financial milestones in your life. For instance, if you buy a car, take out a mortgage, a personal loan, or even a business loan, credit often plays a major factor in determining what loans, interest rates, and agreement terms (such as loan length) are available to you. It can even affect your ability to rent a place to live, to sign up for a cell phone plan, and to secure employment in some industries.
About Your Credit Score
There are multiple ways that you can read and assess the strength of your credit. The simplest of the two main metrics is your credit score, a direct numeric representation of your creditworthiness, typically read between 300 and 850. It’s influenced by a host of factors, including your payment history, credit utilization, types of credit, and recent credit inquiries. Typically, a score that’s above 670 is considered “good”, while scores above 740 are considered “very good” to “excellent.” Some institutions will directly lay out which loans, interest rates, and financial services are available to specific credit score levels. Your credit score can change, so it’s important to check it monthly and to think about any recent drops that might have occurred so you can rectify them.
The Importance Of A Credit Report
The credit score should be considered a helpful tool to help you gauge, overall, how credit providers view your credit history and use. However, for more detail, getting a credit report is the preferred approach. This goes into much more detail, listing your open accounts, balances, payment history, closed accounts, as well as any black marks such as late payments or collections processes. Some lenders will look at specific markers of credit health beyond your score, and reviewing your report allows you to see what they see. It also allows you to ensure that your reports are accurate, to dispute any errors on them, and even to potentially catch signs of identity theft early.
Don’t Trust One Report Alone
Each of the major credit reporting agencies is obligated to provide a free credit report every year. Beyond that, there are third-party providers, such as Credit Karma, that use reporting models like VantageScore to provide their own free reports. However, while such providers can be helpful, Credit Karma isn’t always accurate. Although certainly a legitimate provider of credit reports, it’s not always an accurate representation of your creditworthiness, as it often doesn’t use the same metrics that lenders do. For instance, Credit Karma uses VantageScore, while most lenders use FiCO. Apart from that, updates from your report can take time to show up, while FICO reports used by lenders may differ in what they show. As such, it’s wise to use at least two credit report services to get a more accurate picture.
Understand Your Types Of Credit
There are multiple forms of credit that can each have their own use, and knowing the difference is vital. For instance, revolving credit is the term used to describe open lines of credit and credit cards, which allow you to borrow and repay repeatedly up to a certain limit. Installment credit, on the other hand, like auto loans and mortgages, involves fixed payments over a fixed period. Each type of credit affects your score differently and should be managed in different ways. For instance, credit cards should be used and then paid in full routinely, whereas attempting to repay installment loans in full ahead of time can actually be a neutral or even negative mark on your credit score, rather than a positive one, because those agreements are made with the understanding that long-term repayments will be made to the lender.
Managing Credit Utilization
Many of the factors that affect your credit score, such as whether you make repayments on time and how many open credit lines you have, are easy to understand. Many trip over credit utilization, however. Effectively, it’s a measure of the percentage of the credit limits that you’re currently using. It’s one of the most influential factors in your credit score, as most lenders prefer working with those with credit utilization rates under 30%, though others name 10% as being an even better aim. A high utilization rate is an indicator of potential financial strain, even if you pay on time. As such, it’s important to avoid letting your credit balances get close to their limit, even if you find that level of utilization manageable.
Start Improving Your Credit Today
Getting to know your credit position is vital, as it’s the first step of improving your credit, rather than simply treating it like a mystery. Start by tracking your credit score and getting a credit rating, making note of any negative marks you can begin to address. You can start by paying bills on time, lowering your credit utilization rate, and disputing any inaccuracies in your reports. However, improving your credit can go even further by building it actively, like diversifying your credit type use or even registering to vote in your area.
Your credit can be a stronger indicator of your overall financial health than you might realize. With the tips above, ensure that you know your current credit position, what it affords you access to, and what you can do to improve it.
Daniel is a Cinnamon Hollow author passionate about house and home, renovations, homesteading and DIY.