Chapter 3: How to Build & Maintain Excellent Credit

The average American has a FICO score of 695, which means they have some room for improvement.

A low credit score can cause you to pay more money on loans and new accounts. It can also make it harder for you to get a job or rent an apartment.

You need to read this if you want to build or maintain excellent credit. Because, the truth is that there are many things that negatively affect your credit score, including late payments and high balances on your existing cards.

This chapter covers everything from improving your current situation to creating a plan for future success in order to help prevent these problems from occurring again in the future.

Now that you understand how the credit system works and the importance of data in your credit reports, you have a foundation to build on for more advanced credit concepts.

In this section, over multiple chapters, you’ll learn specifics on building and maintaining excellent credit. 

5 main factors affect your credit scores. 

Think of them as 5 knobs you can turn to move your credit scores up or down. So, there are factors you can control right away, and others take more time. 

Some factors affect your credit more than others because they are weighted more heavily in credit score calculations. 

So, in this chapter, we’ll start with your payment history’s most important factor.

3.1. Your Account Payments

Whether you pay your credit account on time or positively, about, installment 36% of the typical credit score. 

That’s the highest factor percentage which means it’s critical to pay all your bills on time with no exceptions. Hands down, your payment history influences your credit scores the most. 

And it makes sense that if you show a history of no late payments, you’re responsible with your finances and are a low credit risk. 

On accounts that require a minimum monthly payment, such as credit cards and lines of credit, you just need to make the minimum payment on time to help your score. 

Paying off your full balance each month is great for your finances because you avoid all interest charges, but I want you to know that building a great payment history is not required. 

In other words, you don’t get extra credit for paying more than the minimum. 

If you have had an account for many years and only have one late payment, it still dings your credit scores but not as much as if you have multiple late payments. 

Scores focus on 3 factors:

  1. Frequency– how often you pay late.
  2. Recency– how recently you were late. As time passes, the less a negative mark counts against you.
  3. Severity-how late you were. For instance, having one payment 30 days late isn’t as serious as 120 days past due or being in collections. You learned in a previous chapter that your credit reports also include negative public records such as bankruptcies, foreclosures, lawsuits, liens, judgments, and wage garnishments. Having any of these black marks or an account in collections on your report will significantly lower your scores.

In the next chapter, we’ll cover the second most important factor for your scores. Your available credit.

3.2. Your Available Credit

In this chapter, you’ll learn how to use your available credit to build your credit scores. It makes up 30% of the typical credit score, the second-highest amount after your payment history, covered in the previous chapter.

And by the way, if you’re just getting started building credit, and you haven’t qualified for a credit account yet, or you’ve been turned down for credit because you have poor credit, I’ll show you a full-proof way to get approved in an upcoming chapter. 

But continue with this chapter so you’ll know how to manage accounts the right way when you do get approved for them.

Credit scoring models analyze the total amount of debt you owe on all your accounts. Plus, for your revolving accounts, scoring models look at something called available credit. 

Let me explain; there are two main types of credit accounts; 

  1. Revolving accounts
  2. Installment accounts.

Revolving accounts are the ones that stay open indefinitely, such as credit cards and lines of credit. They don’t have a set maturity or pay-off date, but they give you a set credit line to spend. 

As long as you make monthly minimum payments on time, you can continue to use revolving accounts forever. 

But installment loans have a set ending date such as a 30-year mortgage or a 3-year car loan. They don’t have a credit limit, just an original loan amount that you pay off over time. When you pay off the balance to zero, the account is closed.

A key formula that is used to calculate your credit scores is called your Credit Utilization Ratio. It’s used only on revolving accounts to compare credit limits to your outstanding balances. 

This ratio shows how much of your available credit that you’re using. But let me repeat that credit utilization does not apply to fixed loans, instalment loans, like the kind you get for a car or home that have an ending date and do not come with the credit limit. 

Credit utilization is a very simple formula: =Total Account Balance/ Total Credit Limit.

For example, if you have a credit card with a balance of $1000, so you’ve made $1000 in purchases, and you’ve got a credit limit of $2000, your Utilization limit would be 50%, and here’s how I calculated that:

$1000 (balance) / $2000 (available credit limit) = 0.5 = 50%

Keeping a low utilization such as below 20% is optimal for good credit. 

So, by paying down your balance on the car to $400, you could reduce your utilization ratio from 50% down to 20%. 

So, the 20% ratio is calculated by:

$400 (new balance) / $2000 (available credit limit) = 0.2 = 20%

Getting it down to that level would boost your credit scores. Again, the lower your credit utilization ratio, the better. A low ratio tells potential lenders and merchants that you’re using credit responsibly. 

On the other hand, a high ratio says you’re maxed out, and you may even be getting close to missing a payment. To maintain the best credit possible, never let your utilization ratio exceed 20%, maybe up to 25% at the most.

A common misunderstanding about credit utilization is that it doesn’t matter how much you charge, as long as you pay off your entire balance by the monthly statement due date.

While I’m a huge advocate of paying off your credit card in full every month, so you stay out of debt and avoid all interest charges on a card, charging too much on a card can still hurt your credit even when you pay it off in full. 

Here’s why: Credit cards report your payment information and account balance to the credit agencies on a given day each month, and you probably won’t know what day that is. This day typically is not the same as your statement due date. 

It doesn’t matter whether you paid your balance off in full by the due date. The balance you owe on the reporting day is what shows up on your credit report. So, even if you always pay off your balance in full, you can still have an outstanding balance on your credit reports, and that could give you a high utilization ratio. 

If you remember anything about credit utilization, the takeaway from this chapter should be that when you want to build credit, always keep your credit balances below 20%-25% of each card’s limit even if you plan to pay it off right away. 

Otherwise, charging more than that amount on the card could appear on your credit report and give you a larger than expected credit utilization ratio which could drag down your credit scores.

Suppose you use credit cards responsibly but still charge more than 20% of your available limit. In that case, one solution is to apply for a credit limit increase using your online account or by calling the credit card company. 

For instance, if your credit card limit was raised from $2000 to $4000 and you still owe $1000 on the card, that drops your utilization instantly from 50% down to 25%, which is way better for your credit scores.

Another strategy to increase your credit scores is to use multiple credit cards, so you spread out your usage and balances, so you never go over 20% of your credit limits. It’s much better to have 2 credit cards that have a balance below 20% of your credit limits than to have one card with a 40% utilization ratio. Getting additional credit and spreading out your credit card balances can improve your credit scores quickly. 

Also, know that credit scores factor in your ratio on individual revolving accounts and the total of all your revolving accounts. So, both matter.

3.3. Closing Credit Account

In the previous chapter, you learned that your credit gets penalized with a high utilization ratio because it’s a red flag to creditors. They figure that if you can’t pay down your balances, you must be spending too much and have a high credit risk. 

You learn that if you increase your available credit by asking for a credit limit increase on a credit card or by getting an additional credit card, it cuts your utilization ratio and boosts your credit. Likewise, the opposite is true. 

Closing accounts and reducing your available credit hurts your credit scores. Many people mistakenly believe that getting rid of their credit cards will automatically improve their credit. 

The surprising truth is that cancelling credit accounts can work against you and damage your credit. You might be thinking, “how can that happen if you don’t have more debt.” 

The problem is that canceling a credit card causes your available credit on the account to plummet to zero. That means your total balances become a higher percentage of your total credit limits, making you look riskier even if you aren’t. 

Your utilization ratio spikes and your credit scores can drop right away. 

Let’s say you have two credit cards, and on each one, you’ve got $1000 of available credit. If you owe $500 on card A and $0 on card B, your total available credit is $2000, and the amount that you owe is $500

So, making that calculation, you’ll take:

$500 / $2000 = 0.25 = 25% (Utilization Ratio)

If you cancel card B because, well, let’s say you just paid it off, or maybe you don’t like it, you still owe $500 on card A, but now your available credit shrinks to $1000. Canceling the cad shoots your Utilization Ratio up from 25% to 50%, so now the calculation looks like this:

$500(Amount that you owe) / $1000(Available credit limit) = 50% (Utilization)- too high!

So, even if you have the same amount of debt, your Utilization ratio makes you appear less creditworthy because it’s a larger percentage of your Available Credit Limit, and your credit scores will go down. 

For this reason, I strongly recommend keeping all your existing credit cards open, especially if your goal is to build credit or you’ve got plans to finance a big purchase like a house or car in the next year or so. 

Jeopardizing your credit could ruin your chances of getting a low-interest loan and cause you to overpay interest for decades.

Never cancel a credit card with negative information like late payments or being in the collection, thinking it will just disappear from your credit file. Remember that credit accounts generally stay on your credit report for 7 years from the date you became delinquent. 

If you have cards that you are not using, you could just file them away in a locked filing cabinet. Alternatively, use them strategically by occasionally making small charges that you pay off in full to keep the account active.

However, I don’t recommend keeping a credit card if it tempts you to overspend and you’re not using it responsibly. Taking a temporary hit to your credit might be worth it to prevent bigger problems in your financial life.

If you decide to close a credit card, choosing one with a higher credit limit causes more of a threat than getting rid of one with a smaller limit. Space out multiple cancellations over many months for minimum impacts. 

You might wait 6 months between the time that you closed two accounts, for instance. You might be wondering how many credit cards you should have. Well, there is not an exact number you need to build or maintain excellent credit. 

But, you may need a low-rate card for times when you just carry a balance and a higher rate rewards card for charges that you always pay off each month. 

No annual fee cards are best, but some of the best rewards cards may charge a fee. It may be worth it, depending on the benefits you get from each card. 

You need at least one credit card to maintain good credit history, especially when you’re just starting or rebuilding your credit. 

In the next chapter, you’ll learn how to use a special type of card, a secure credit card, as a secret weapon to build credit when you can’t get approved for a regular credit card.

3.4. Using A Secured Credit Card

Building credit is an important part of having a healthy financial life, but it’s challenging when you’re just starting. When you’re recovering from a financial hardship or when you’re a new or returning resident in the United States. 

In this section, you’ll learn how a secure credit card works and why it’s a foolproof tool that anyone can use at any time in their life to build credit. But, the key is choosing the right card and using it in the right way.

You must have credit accounts and use them responsibly to have good credit, but it can seem like a catch 22. You can’t build a credit history without a loan or credit card, but you can’t get one without having a good credit history.

Unfortunately, having no credit is the same as having bad credit. A “thin” credit history means you don’t have enough data in your file even to generate a credit score. Without a credit score, lenders and merchants have no way of evaluating how likely you are to repay your debts and are likely to deny you credit.

Fortunately, using a secured credit card the right way is an easy way to build credit. And by the way, credit scores in the United States are tracked by your Social Security number. That means any resident who qualifies for a social security number and has credit accounts can build credit in the United States.

First, I’ll cover what a secured card is and then explain how to use one strategy to build credit as quickly as possible. A secured card is similar to a regular, unsecured credit card in many ways. 

They look the same; they can be used to make purchases at the very same stores, they require a minimum monthly payment on balances. They charge interest if you don’t pay off your balance in full by the statement due date.

They may charge an annual fee; they may offer a variety of benefits such as fraud protection, price protection, extended warranty, or travel accident insurance. 

Although you can use a secured card as a regular one, it’s a different financial tool. The main difference is that you’re required to put up a refundable security deposit that becomes your credit limit. 

With a regular credit card, you never have to make a security deposit once you’re approved. You automatically receive a credit limit based on various factors such as your credit rating, income, history with the issuers, and the type of card you choose. 

A secured card asks for an upfront deposit to reduce the insured loss if you don’t pay your bill. They hold your deposit as collateral until you close the account and pay your balance in full or prove your creditworthiness and transition to one of the issuer’s unsecured cards. 

The minimum required security deposit varies depending on the secured card you choose. Some issuers may only require $50, but others may ask for several hundred. 

In some cases, you may be able to pay a deposit in installments over a certain period, such as 60-90 days before your card is issued. If you deposit $300 on a secured card, your total charges can never exceed that amount.

However, if the card has an annual fee, it may be taken out of your deposit. For instance, if you put up $300 and have a $50 annual fee, your credit limit becomes $250 for the first year, $200 for the second year, and so on as those fees get deducted. 

So, if you anticipate using a secured card for large purchases, such as airline tickets, electronics, or furniture, you’ll need to make a bigger initial deposit. If you want to increase your initial credit line, most secured cards allow you to make at least one additional deposit. 

The maximum deposit varies, but many are in the range of $3000-$5000. Now that you understand what a secured card is let’s cover exactly how it can help you build credit, no matter if you’re starting from scratch or rebuilding after going through financial hardship. 

The major benefit of a secured card is that it can be a real credit account similar to a regular credit card. Even though you spend your own money, some but not all secured cards report your payment data to one or more of the nationwide credit agencies, and we’ve covered them: Experian, Equifax, and TransUnion. 

So, your secret weapon to build credit is to apply for a secured card that reports your payment history to the credit bureaus. Do not spin your wheels with a secured card that doesn’t. 

Even if they’re just the minimum payments, a history of making on-time payments always builds credit. In a previous chapter, we covered credit utilization as a major factor in calculating your credit scores. As we mentioned, the lower your utilization, the better. 

I recommend never exceeding 20%-25% of your available credit limit on a regular credit card, and the same is true for a secured credit card. Remember that this could be a tiny amount if you make a small deposit. 

For instance, 20% of a $200 credit limit means you should never charge more than $40. If you want to charge higher amounts on a secured credit card and maintain a low utilization ratio, you can increase your security deposit so your credit limit goes up. 

If you use a secured card strategically by making payments on time and keeping your utilization low, you could see a substantial increase in your credit scores in just a few months. The result will be a positive credit history and higher credit scores that will eventually allow you to qualify for a regular unsecured credit card and loans at the best possible terms. 

If, for some reason, you can’t get approved for a secured card that reports to the credit bureaus, don’t let that stop you. Look for an issuer that converts secured accounts to regular ones after you demonstrate responsible use after a while such as 6-12 months. 

That’s another way to build credit. A secured credit card is like riding a bike with training wheels. It’s a great way to start but not a long-term solution. Your goal should be to get a regular unsecured card as quickly as possible since it allows you to build the strongest credit history and gives you the most conveniences for your purchases. 

In this chapter, you’ll find a resource with the best-secured cards that report payment information to credit agencies. In the upcoming chapters, you’ll learn the remaining three factors that affect your credit so you can use them to your advantage to build better credit.

3.5. Your Credit History

So far, we’ve covered 2/5 main factors that affect your credit scores. Factor #1, 35% of it comes from paying your accounts on time. Factor #2, 30%, is how much you owe and your credit utilization ratio. 

The third key factor in scoring is how long you’ve heard credit, making up 15% of a typical credit score. So, it carries less weight, but it still matters. 

You can have a good credit score even if you have a short history, but the longer you’ve had a credit account in your name, the better. Having a long history of using credit responsibly shows lenders and merchants that they can count on you to continue making payments on time in the future. 

Scoring models look at both the age of your oldest account and the average age of all your accounts. So, if you have credit accounts that you don’t use anymore, consider keeping them open since the length of time you have a credit history is important. 

In a previous chapter, I covered how closing a card can hurt your credit because you shrink your available credit, increasing your credit utilization ratio. Building a long credit history is just another reason not to cancel a credit card, especially one that you’ve had for a long time. 

If you’re just starting and you have a “thin” credit file, you simply have to let your account age. There isn’t a way to make accounts appear older than they are. 

Accounts that you own for longer periods, such as revolving accounts like credit cards and lines of credit, are great for building a long credit history because they stay open indefinitely as long as you handle them responsibly and make payments on time. 

3.6. Your Credit Inquiries

In this chapter, you’ll learn how credit inquiries or applications for new credit affect your credit scores. 

So, let’s recap the main credit factors we’ve covered up to this point. Factor #1 is paying accounts on time, which make up 35% of scores. Factor #2 is how much you owe your credit utilization ratio, which makes up 30% of the typical score, and factor #3 is how long you’ve had credit which makes up 15%. 

The fourth most important credit factor is new hard credit inquiries. The number of recent applications for new credit or new accounts can ding your scores. 

Especially if you apply for a lot of credit and a short period, every time you apply for a new line of credit, that application counts as a hard inquiry on your credit report. 

However, I want to emphasize that checking your credit report, even if you do it frequently, does not damage your credit scores in any way because it’s known as a soft inquiry. 

Also, credit inquiries on your report related to pre-approved offers for credit or insurance are known as a soft pull that does not count against you. 

Lots of hard inquiries make you appear too impulsive or eager for new credit, and they suggest that you’re about to take on more debt. 

One common situation when people get into trouble is when a store entices you to open a new credit account by offering discounts and promotions on your first credit purchase. 

Many people get talked into applying for store credit cards that they don’t want or think they are just signing up for a store promotion. Never give up any personal information to a store clerk unless you apply for a new credit account. 

Unfortunately, there’s no way to reverse a credit application. Even if you cancel a new credit card quickly, it shows up as an inquiry and a credit account on your credit history. However, inquiries have a relatively small impact on credit scores, just 10%. 

Also, hard inquiries typically get removed from your credit file after 2 years, and the negative effect decreases over that period. But what if you’re shopping for the best rate on a big loan, such as a mortgage or a car loan? There may be multiple inquiries as you apply with different, such as rent lenders for rate quotes. 

That’s actually not a problem because when you’re looking for one type of loan, multiple inquiries over a 2–3-week period only count as a single hard hit.

The credit scoring models are smart enough to know that you’re rate shopping if you apply with three different mortgage or auto lenders within a short period. 

You’re not trying to get three mortgages or three-car loans. So, remember that you should not apply for new credit cards, retail store cards, or any additional credit accounts unless it’s necessary.

3.7. Your Mix Of Credit

In this chapter, we’ll cover the fifth most important factor for your credit scores. 

Let’s review. We’ve got;

  • Factor #1, paying accounts on time at 35%. 
  • Factor #2, how much you owe and your credit utilization ratio at 30%.
  • Factor #3, how long you’ve had credit at 25%. 
  • Factor #4, new hard credit inquiries at 10%.
  • Factor #5, the number and types of accounts in your name which account for 10% of your credit scores. 

This is known as using a mix of credit types. 

Creditors want to see that you have a healthy mix of credit because that demonstrates that you can handle both revolving credit accounts such as credit cards and lines of credit and instalment accounts such as auto loans, personal loans, and mortgages. 

So, having more than one type of credit positively affects your scores. You don’t need to have an account of every possible type to have good credit scores, and as we covered in the previous chapter, you shouldn’t apply for new credit that you don’t need. 

I recommend having at least one major credit account in good standing. Bank cards such as visa, master cards, American Express, and Discover are typically better for your scores than a department store card installment or other finance company cards. 

Remember that there’s no need to carry debt on a credit card to build credit. Even making a small charge occasionally and paying the bill off in full each month allows you to build a history of positive payment transactions and avoid all interest charges on the card. 

And if you need an installment loan, such as a mortgage or a car loan, and pay it as agreed, that reflects very well on your credit.

What Next?

So, we’ve covered the five key factors that affect your credit scores. Let’s now look at some myths and FAQs in Chapter 4.

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