Establishing good credit is an important step towards forming trust in the adult world. It is difficult to rent a vehicle, purchase a home, or do any of a number of other things without a credit card or a good credit score. In order to attain either of those, you will need to learn how to build and manage credit correctly.
Remember that in addition to the benefits, credit also comes with risks. It is easy to overextend your use of credit or to find yourself in a situation in which you cannot pay it back when the bill comes. A first line of credit can be both a blessing and a burden, which is why we are going to discuss ways to make sure that the credit history that you establish keeps you on the positive side of that equation.
What is Credit?
Credit allows you to obtain goods or services before payment is made. This is based on a promise that you will pay the money later. However, a credit agreement is generally not free and is likely to come with minimum monthly payments, interest rates and other fees. In the long run, what you purchase on credit is very likely to cost you more than what you could have paid for it with cash on the day that you made the purchase.
To learn more visit:
- Alma College’s Sallie Mae paper on Understanding Credit
- Lesson Plan for Teachers from PracticalMoneySkills.com
- Understanding Credit (PDF) from Sallie Mae and FICO
The History of Credit Bureaus
How did we end up in a world in which something as simple as a credit card purchase can affect our ability to rent or buy a house?
How the credit industry began
Borrowing has been a part of our lives for generations, but traditionally it has been reserved for necessities such as homes and farms. It wasn’t until the mid-1900s that the consumer credit industry began officially with the Diner’s Club card in 1949. Just two short years after that, the cards that would later become MasterCard and Visa were born. It was a slow start and many people were hesitant to adopt these new lines of credit, but over the decades, they have become more pervasive.
To learn more, visit:
- Mesa Community College’s When Were Credit Cards Invented? A Complete History
- PBS Frontline: Secret History of the Credit Card (Video)
- Harvard Business School: A brief History of US Consumer Finance
The consumer credit industry today
Today it would be hard to imagine a world without the familiar Visa and MasterCard logos. Our lives and credit ratings are intrinsically linked with a consumer society in which the amount of debt we carry can often directly translate to the level of trust that companies and lenders have for us.
The major credit bureaus
Before credit cards were created, the first US credit bureau, Equifax, was established in 1899. The next bureau, TransUnion, opened its doors in 1968. Today, under the Fair Credit Reporting Act, these credit bureaus are now known legally as consumer reporting agencies. The agencies are for-profit businesses and are independent of the United States government. There are four traditional agencies: Experian, Equifax, TransUnion, and the lesser-known Innovis. In 2002, an alternative agency, PRBC, was created to allow consumers to get involved in growing their own good credit history by self-reporting bills, such as rent, that are not traditionally found on credit reports.
To learn more, visit:
- Time’s The Long Twisted History of Your Credit Score
- The Federal Deposit Insurance Corporation’s Credit Reporting Agencies Page
Understanding Your Credit
We all know that the goal is to establish good credit, but what does that mean?
Good versus bad credit
Credit scores are based on an analysis of your credit history in order to determine your creditworthiness and the likelihood that you will pay your bills. While it varies from agency to agency, your FICO score in generally made up of the following:
- Payment history: 35% of your score
- Debt burden: 30%
- Length of credit history: 15%
- Types of credit used: 10%
- Recent credit searches and inquiries: 10%
The classic FICO score has a range from 300-850.
- A score of 300-599 is very bad
- 600-649 is poor
- 650-699 is fair
- 700-749 is good
- 750-799 is very good
- 800-850 is excellent
To learn more, visit:
- Duke’s What is a Credit Score and Why Does it Matter?
- Credit Reporting and Consumer Credit Scoring FAQ
- Consumer Federation of America: Your Credit Scores (PDF)
- Colorado State University: Credit Scores
Why is this important and what does it affect?
Your credit score can affect your ability to get a good interest rate and to qualify for a multitude of things including:
- Student loans
- Credit cards
- Cell phones
- Car insurance
- Personal loans
- Car loans
- Home loans
- Some jobs
To learn more about how your credit score can influence your borrowing abilities and living, visit:
- Consumer.gov: Using Credit explains all about credit and how its used
- Harvard College’s Credit page on setting up your financial success by understanding credit reports and scores
How to Build Your Credit
Building credit is a slow process that requires maintaining a healthy debt to credit ratio (Do not max out those cards!), using credit wisely, and creating a history of on time payments.
Establishing Credit History
The first step is establishing your original line of credit or reportable billing. It may seem like an insurmountable goal, but there are some relatively painless ways to get started.
Teens under 18
If you are under 18, there isn’t a whole lot that can be done to establish credit because you cannot sign a contract on your own until you turn 18, however, that doesn’t mean that you can’t prepare for the day when you can, or get a co-signer in the meantime. If you have an adult co-signer on a contract, they will be fully responsible for any debt that you incur, so be careful!
- Open a bank account so that you can have a way to pay bills and begin adding money to that account
- Have a parent or guardian cosign on a prepaid credit card
- When you can drive, get a car loan with an adult cosigner
- Have a household or mobile phone bill put in your name, if possible
To learn more about your options, visit:
- FDIC.gov has a doucment Credit Cards: How to Avoid Costly Mistakes (pdf) on page 4
- USCourts.gov: First Credit Card Confusion: Read the Fine Print
- US News How to Help Your Teenager Build Credit Responsibly tips for parents
Once you are 18, there are multiple of ways to begin to establish a credit history in addition to those listed above.
- Open a secured credit card account by using your savings
- Establish bills in your name
- Look into student credit cards that generally have very few requirements
- Add overdraft protection to your bank account – overdraft protection is reported to consumer credit agencies
- If you have a verifiable income such as from a job, look into getting a car loan without a cosigner
- Apply for a credit-builder loan
To learn more, visit:
- The Mint’s Your Credit History for some practical advice for young adults
- Teens Guide to Money’s Credit History and FICO Score article on credit score and credit card tips for young adults
Finding and Monitoring Your Credit Score
Each of the major credit reporting agencies offer a free annual credit report. Beyond that, you can pay to access your credit report on an as-needed basis or via a regular subscription service.
- To learn more about retrieving your credit history, visit the Federal Trade Commission’s Free Credit Reports section for a report on how to access your credit report while avoiding fraudulent websites.
- To view all three of your free annual credit reports, visit AnnualCreditReport.com to apply in one location. You must be located in the US to access this service.
Managing Your Credit
Some basic steps can be taken to maintain and increase your credit score.
- Make a budget and stick to it.
- Do not apply for credit that you cannot afford. Make sure that you can handle the monthly minimums even if emergencies come up.
- Shop around. Compare the rates on various options before choosing a line of credit.
- Stay within your credit limits.
- Always pay on time and pay more than the minimum.
- Have emergency funds or insurance available to cover your payments if you become incapacitated or fall on hard times.
- Always check your statements to look for overspending and unauthorized purchases.
To learn more about how to manage your credit, visit:
- Ashton College’s has an article on Credit Card Usage for more advice on what you can do to make sure that your debt does not get out of control.
- Mass.gov’s Managing Credit and Debit page on additional steps that you can make including correcting credit reports.
Getting Out of Debt
Sometimes even the best plans go wrong. What can you do if you end up in debt?
- Stop borrowing money.
- Create a budget that includes realistic expectations.
- Make some cut backs at home to increase the amount of money in your budget.
- Start an emergency fund to avoid any future pitfalls.
- Spend any extra money on your debt.
- Organize your debt and figure out which bills need the most of your attention first.
- Work on your career goals to increase your income.
- Use a balance transfer card to cut the cost of interest.
- Contact your creditors to negotiate a better payment arrangement.
To learn more about what to do, visit:
- The University of Georgia’s How to Get Out of Debt pamphlet offering practical and in-depth solutions for paying off excessive debt.
- USA.gov’s Dealing with Debt page to read about further action you can take including credit counseling, debt consolidation and bankruptcy.
Credit Management Education for Kids and Teens
- ClearPoint’s Teaching Teens Money Management Basics offers an A-C guide on the basics of accounting, budgeting, and credit.
- Ipl2’s Money Management for Kids and Teens has multiple links and resources for getting started.
- Links to games that teach kids about money – Washington State Department of Financial Institutions
- Money Skills for Teens @ UCLA Extension
Credit Management Education for College Students and Young Adults
- Michigan.gov’s Debt Management Resources suggests links for debt management information and calculators for college students.
- Massachusetts’s Institute of Technology’s Manage your Money page goes in depth about budgeting, credit cards, checking accounts and student loans.
- Ten Sound Money Management Principles for Students (Powerpoint) from Utah State University
- Credit Management Advice from Investor.gov
- Hands on Banking – Instructional Resources – The Hands on Banking program offers all the basic money tools, skills, and information you need