Set Yourself Up for Financial Success
Credit is the lifeblood of a modern economy. If you have a credit card and take the time to learn about credit and how to manage it, you can come out of school with a stellar credit score that will make it possible for you to rent an apartment without hassle or finance a car with the most favorable terms.
Credit Report vs. Credit Score
A credit report is a detailed report of your credit history. It has your personal information, employment history, and a list of both open and closed credit accounts. You can get a free copy of your credit report three times per year, once from each credit reporting agency, at www.annualcreditreport.com. It’s a good idea to review your report at least once per year to ensure accuracy and check for fraud. If someone were to fraudulently open a line of credit in your name, you might not find out without checking your report.
A credit score (aka FICO score) is a snapshot of your credit risk at a point in time. It is based off of your credit report and was designed as a time saving measure to avoid lenders having to review your credit report in detail. FICO scores range from 300-850 with the majority of Americans coming in between 600-800. The higher the score, the lower the chance of a default (failure to fulfill your financial obligation).
- Lenders know that 15% of people with a credit score of 580 will likely default on their debt, but, of those with a score of 800, there is a less than 1% chance they will default. Lenders will often charge higher interest rates when taking on higher risk of default.
If you plan ahead and build a solid credit history, you can pay lower costs on all sorts of credit products like private graduate school loans, credit cards, insurance, and auto loans.
Components of Your Credit Score
- Payment History: 35% - Are you making your credit card payments on time? Payment history makes up the largest component of your credit score so the best way for you to improve your credit score is by making consistent on time payments. If you are more than 30 days late even once, that record will remain on your credit report for 7 years and could result in a drop of 90+ points in your credit score.
- Amount of Debt: 30% -How much debt you have relative to how much credit you have makes up 30% of your score. Keep your debt utilization ratio (amounts owed / total credit limit) below 30%. Let’s say you have two credit cards and both have a limit of $500. To stay within 30% you can spend up to $150 on each card or $300 on one card and $0 on the other.
- Length of Credit History: 15% - Lenders like to see that you have long relationships with other lenders. The easiest thing you can do to start building credit history is to open a no annual fee credit card, charge a few dollars, then pay it off every month. If you manage credit responsibly, you can still get a high credit score with a short credit history.
- New Credit: 10% - Anytime you apply for a line of credit, be it a store credit card or a consumer loan, your credit score drops by 2-5 points. This isn’t a huge deal as new credit makes up just 10% of your score but this is helpful to remember the next time you are at a clothing store and they ask you if you want to save 10% by applying for their store credit card. This information remains on your credit report for 2 years.
- Credit Mix: 10%- Types of credit in use or your “credit mix” is not something you need to worry about as a student. Lenders like to see a variety of credit accounts because it tells them that you are a responsible borrower. A person who is making monthly payments on a credit card, an auto loan, and a student loan is deemed to be less risky which is why this component makes up 10% of your score.
Are You Ready for a Credit Card?
Do a simple experiment and track your spending for 2 weeks. You might want to use this weekly tracking sheet to help you.
- Do you give in to impulse buying often?
- Are you spending more per week than you earn per week from a part-time job?
If your answer is yes to either of these questions, then getting a credit card may not be right for you until you are able to get your spending under control. While having a good credit score is important, you can’t be successful if you are not responsible with money. Your goal should be to pay off your credit card in full every month. If you can do that, you can reap the rewards, not have to pay any interest, and most important, build your credit history.