By Charles L. Westmoreland | Southeast Living
Our world didn’t always revolve around credit. It used to be families could save their hard-earned dollars and pay cash for a new car, or sometimes even a house. Many of our parents and grandparents grew up learning that if you don’t have the cash to pay for something it means you shouldn’t buy it, period. But that was then.
Today everything involves credit in one way or another. To rent an apartment, get hired for certain jobs, or even to get car insurance you are required to have a positive credit score. The lessons of frugality by purchasing everything with cash is still important to learn, but in order to buy a car, house, boat and many other larger purchases establishing positive credit is a must.
“In a time when so many people struggle with their credit score, there are a lot who think closing out there accounts and paying cash is the way to go,” said Bethany Woods, a home mortgage consultant with Residential Mortgage in Juneau. “Ideally that sounds great, but our society is no longer set up that way. We built our society around a credit score and it’s essentially the only way to ensure your livelihood. Unless you want to walk to work and save money for 10 years to buy a new car you have to establish credit.”
Establishing credit takes time, Woods said, and trying to rush the process will cause more harm than good. At least three trade lines are necessary to maintain a positive score, but only two of those lines should be revolving credit such as credit cards and the third should be an installment loan, she said.
“If you don’t have three trade lines, usually one of the three major credit bureaus will inevitably say you don’t have enough credit to have a credit score,” she said.
Buyer beware: Part of what makes up a person’s credit score is the number of inquiries by lenders into their credit history. Lenders will be cautious if they see that a person has applied for a half dozen credit cards in a single month, fearing that person will quickly become burdened with debt and will be unable to make payments.
“Everyone starts with a blank canvass and can paint that picture however they want,” Woods said. “If you make a bunch of credit inquiries at once it will decrease your credit score. The rule of thumb is to not apply for more than three trade lines within 90 days. That way you can build a payment history.”
The four main components of a credit score are credit history, payment history, credit card balances and credit inquiries. Each item is assigned a value and the results are added up and configured into a number ranging from 300 to 850 (the higher the better).
Once someone has established credit the challenge becomes maintaining a good standing. Credit cards should never be maxed out. Experts suggest charging half of the available limit.
“I tell people that in the beginning they should use a credit card to pay for gas for one month,” Woods said. “It’s something they have already allotted money for. They should charge things that they would normally pay cash for, that way they can pay off the balance each month. It’s when people start charging for things they can’t afford that gets them in trouble.” You may be thinking, “What about the interest rate I have to pay each month?”
“That’s one of the necessary evils,” Woods said.
Source: Federal Reserve