Credit: Your Financial Power

Recently, I had an interesting conversation with a person who works at Visa in the area of credit for over a decade. The intriguing moment was their mention that a person who has frequently needed to borrow money and successfully paid off their credit has a better credit rating (and hence a chance of receiving a future loan) than someone who has always planned for and had enough money so they never needed to borrow.

It was this conversation that sparked my interest in credit rating, and here’s what you need to know.

With a debit card, during a transaction money is taken from your checking account in real-time. A credit card, however, provides the flexibility to get something now and pay for it later, giving you the luxury of time. At first thoughts, debit sounds much simpler, cleaner, and perhaps safer and I guess this is why most people in our generation like to stay away from credit. But credit matters, and here’s why.

What Is Credit?

Credit allows you to purchase things now based on your promise to pay later. There are broadly two types :

1. An Installment Loan is a fixed amount of money loaned for a specific purpose, like a student loan.

2. Revolving Credit is a line of credit through which could can make infinite purchases within the set credit limit as long as you continue paying down the balance. This is the system a credit card works on.

Credit has several advantages, the most prominent being immediate access to cash flow during an expensive, unexpected emergency, like being stranded in another city for a couple of days more than anticipated.

And it has additional perks such as itemizing monthly expenditures, giving budgeting a new convenience. As a kid, I was most exposed to the pluses of credit cards because of their rewards program for benefits like travel and bookings, which my family would try to max.

Speaking of which, the main disadvantage of using credit is that the absolute amount you need to pay for a certain cost is higher because of the interest and fees associated with credit. Wise use of credit means optimizing those costs and acting accordingly.

But we’re not here to talk about the small perks such as discounts while booking hotels - there's a real significance to taking on credit, even if you don’t need to borrow money, and that is to build a good credit score.

What Is A Credit Score?

A credit score is a grade that indicates to institutions a borrower's ability to repay a future financial obligation based on their current income and past repayment histories. It helps lenders understand their risks before approving a loan.

A credit score is a three-digit number you can find on your credit report representing your creditworthiness. Credit reporting agencies (CRAs) collect information from your current credit habits that makes up your credit reports. It is based on how much money, property, and debt a borrower has and on how well they have paid past debts.

But of course, this score can be created only if it has something to score you on! And that’s why it's important to take credit. It helps you build a credit score that organizations can look at in the future and helps you qualify for credit when you need it.

Why Is It Important?

Having a high credit score gives you creditworthiness that financial organizations rely on. This can save you massive amounts of money that far outweigh any credit interests you may have to spend.

1. Lower Interest Rates

You most probably will have to apply for a loan at some point in your life. A money lender typically uses your credit score to determine the interest rate you will have to pay on the loan. The better your credit score, the lower your interest rate. Even more basic, a good score gives you better odds of qualifying for a loan in the first place (even though it is not the only factor lenders take into consideration).

2. Career Advice

At this time when we're thinking of potential future careers, it’s important to keep in mind that some jobs, especially security clearance positions, do a personal credit check. Even in government positions, this check demonstrates your capability of handling finances and even goes to show that you’re not vulnerable to say bribery because of financial problems.

3. Larger Credit Limits

Unlike a high school GPA, your credit score follows you lifelong and constantly gives you better opportunities. You could get better loans and a higher limit, allowing you to upgrade to high-cost-of-living areas.

4. Easier Approval for Rental Properties

Even if you never plan on buying a house, you’ll still need a good credit score. Many people don’t realize it, but your credit score is a factor that landlords take into consideration with your rental application. If you have a good credit score, you’re more likely to be approved as a tenant since a history of on-time payment behavior is likely to be more attractive to a landlord than someone with multiple delinquencies. If not, then you may have to pay a higher deposit, agree to a short-term lease, or even be denied housing outright.

5. Lower Insurance Rates

Good credit also can save money on your insurance. Insurance companies use your credit score when deciding whether to accept you as a customer and how much to charge you, even though some officials think this practice is unfair. According to an insurance quotes study, people with fair credit (a FICO score of 580-669) paid 39% more on their auto insurance premiums. People with poor credit (A FICO score under 580) had it even worse, paying 103% more.

Using Credit To Your Strength

Responsibly managing a mix of credits is integral to achieving a high score. On the other hand, missed payments, defaults, and major setbacks such as foreclosure or bankruptcy can indicate to lenders that you're a risky borrower and make it harder for you to qualify for credit in the future.

Here are four critical tips for managing credit responsibly:

Your payment history matters. Making on-time payments at least the minimum payment on a credit card or installment loan is essential for building and maintaining credit. Late payments can stay on your credit report for seven years and affect your score the entire time they appear. To ensure you never miss a payment, consider setting up autopay or creating reminders for yourself. How often you make payments on time gives lenders insight into how likely you are to repay your debts as agreed.

Don't spend more than you can afford to repay. Using credit cards to live beyond your means can lead to a high balance you can't afford to pay off. If you carry a balance over time, the interest you accrue can make it even harder to pay down your debt. If you're overwhelmed by credit card debt, you can get free help from a certified credit counselor.

Having a low Credit utilization: Your credit utilization is the amount of revolving debt (credit card debt, for instance) that you carry divided by your total revolving credit limit. For example, if you have just one credit card with a $3,000 credit limit and a balance of $300, your credit utilization is 10%. As far as your credit score is concerned, experts often recommend keeping your utilization below 30%, but the lower, the better.

Use credit cards to build credit. One smart way to avoid incurring debt while building credit with a credit card is to exclusively use your credit card for regular, small expenses, such as utility and phone bills. Pay off your balance every month on time to avoid paying interest and carrying a balance.

Credit mix: A larger way of applying the previous point is diversification. Using a diverse mix of credit products, such as credit cards, a mortgage, student loans or auto loans, indicates to lenders that you have experience managing a wide variety of credit products.

Start now! Keep old accounts open. The average age of your credit accounts has an impact on your score, so it's often in your best interest to leave your oldest accounts open. Doing so can also keep your credit utilization low, as you'll have a higher amount of available credit, and help you to avoid having a thin credit file. You shouldn't unnecessarily keep an account open if it has a high annual fee that's impacting your finances, though.

Length of credit history: The length of your credit history is a measure of how long you've been using credit products. Generally speaking, lengthier credit history can help you achieve a higher credit score.

Keep in mind. New credit: The credit check associated with an application for new debt can result in a hard inquiry on your credit report, which can cause a slight, temporary dip in your score. The appearance of new debt can also affect your score. If you know you have a planned large credit purchase, be careful of any new credit.

Working to improve your credit helps ensure you'll qualify for loans when you need them.

The Essence

Building and maintaining a strong credit profile is crucial as your credit score plays a key role in most lending decisions. If you happen to have a low credit score, take the time to improve your credit score to prepare for any future loan or rental applications. And how do you do that? Stay tuned to the Visible Guide for a future article covering different ways of getting into credit as well as ways to improve a low credit score.

I hope the takeaway from this for you is to start thinking about credit and how or when it could feature in your financial journey.

This ability to borrow and reborrow as needed allows you to do things like buy a car, or finance college when you do not have that kind of money in hand at the moment, but there are healthy practices that you should know before you start to take on debt.

Budgeting (read more here) comes in handy now because keeping track of your spending will help you ensure that you can repay your credit bill on time and in full.