Why Is Credit Important? | Credit Cards News2america

  • A good credit score can help you qualify for credit cards, mortgages and personal loans at low interest rates.
  • Used responsibly, credit cards can help you build – or rebuild – your credit score.
  • A credit report that shows you’ve successfully handled credit is viewed favorably by lenders.
  • A prospective employer isn’t allowed to ask for your credit score, but it may ask for permission to look at your credit report.

If you’re anti-credit score or just plain afraid of credit, you might want to rethink that stance. You’re hurting yourself financially in the long run.

There are many reasons why credit is important. Now, I admit that there are individuals who should avoid credit. For example, some people are compulsive shoppers. But if you think you can use cards responsibly, they can can help you attain a good score.

Types of Credit

There are three basic types of credit: revolving credit, installment loans and open credit. The FICO score considers your mix of credit, which is 10% of your score. It’s a plus if you’ve demonstrated that you can handle different types of credit.

  • Revolving credit definition: This is a line of credit that’s available for you to use. The best example is a credit card. You get a credit limit, and it’s up to you to decide how much of that limit you want to use. When you carry a balance from one month to the next, you’re revolving a balance and paying compound interest on purchases. Ideally, you want to pay your credit card balance in full and by the due date every month.
  • Installment loan definition: With this type of loan, you borrow money, perhaps to cover the cost of a purchase. You make a fixed monthly payment that includes interest over the life of the loan. When the loan is paid off, the account is closed. Examples include mortgages, car loans and student loans.
  • Open credit definition: With open credit, your monthly payment varies. For example, your utility bill is considered open credit. So is your cellphone bill and water bill. It’s a monthly obligation, but the amount can change from month to month.

Why Is a Credit Score Important?

Most lenders use a version of the FICO score to determine how creditworthy a credit applicant is. There are three minimum requirements to generate a FICO score. First (and my personal favorite), you need to have a credit file that doesn’t suggest you’re deceased. If you’re able to read this, you’re alive and kicking, so this requirement is a breeze, right?

Second, you must have at least one account open for six months or more. And third, you need to have at least one account that’s been reported to the credit bureaus. If you have zero or limited credit, you can satisfy the “at least one account” requirement with something as simple as a secured credit card or maybe a credit-building loan from your bank or credit union.

It’s possible a lender might use a VantageScore instead of a FICO score. Although it takes around six months to generate a FICO score, it only takes about two months to earn a VantageScore. The two types of scores are similar, but VantageScore puts less emphasis on age of credit history.

A credit score represents your creditworthiness. The higher your score, the better. Here are the FICO score ranges:

  • Exceptional: 800 and above.
  • Very good: 740 to 799.
  • Good: 670 to 739.
  • Fair: 580 to 669.
  • Poor: 579 and lower.

A good credit score offers you many financial benefits. A good score helps you get a low interest rate on a credit card, mortgage, car loan and more.

Benefits of Good Credit

Now that you understand why you need a credit score, let’s dive into the importance of having at least a good credit score. Here are six reasons why having a good credit score helps you become independent, a little bit richer and even more employable:

When you want to rent an apartment, the landlord or manager usually checks your credit report. Even without requesting your credit score, a landlord can tell from your report if you’re likely to be a tenant who pays on time.

If you don’t have a credit score, then your credit report probably looks like a ghost town. This situation tends to spook landlords.

There are ways to get around this, but it costs you. You can offer to pay a few months’ rent as a security deposit to show your good faith. If you’d had a good credit score, you’d probably get by with one month’s rent as a deposit.

Now, you also need utilities. Guess what? Utility companies want to look at your credit report, too. You’ll be asked to pay a deposit if the utility company thinks you’re a credit risk. You might be able to get by without a deposit if you can find someone who will agree to pay the utility bill in the event that you don’t pay. Unless your mom or dad is willing, I wouldn’t count on using this strategy.

If you don’t have a FICO score, it could be difficult to find a mortgage lender. And since it takes time to earn an excellent credit score, the longer you wait to start working on it, the more interest you will pay on a mortgage.

You don’t need a perfect FICO score to get the lowest interest rates on a mortgage, but you do need to have a score of at least 760, which is a very good credit score. Remember this: The lower your score, the higher the interest rate you’ll have to pay.

With a very good score, you can save thousands of dollars over the course of a 30-year mortgage. Wouldn’t it be nice to have all that extra cash for your child’s education savings or for building up a healthy rainy-day fund?

If you’re not in a rush to get a mortgage, take time to boost your credit score. Trust me, you’ll be glad you did.

If you’re already making payments on your student loans, here’s your chance to build a credit score. Once you develop a good credit score, you can refinance your student loans and maybe get a better interest rate.

So, over the long haul, you’d be paying less interest on the loans. Don’t underestimate the power of a good credit score when you have student loan debt. It can help you create more room in your budget for savings.

If you’re ever unsure that you can make timely payments, contact your lender to discuss options. Paying off student loans can help you build credit, but it can also harm your score if you don’t pay as agreed.

If you’re a supporter of the anti-credit card crowd, I understand where you’re coming from. You worry about debt. I’m anti-credit card debt all the way.

But as long as you can use a credit card responsibly, you won’t get into debt. The key is keeping low balances and paying your bills in full by the due date.

A credit card is nice to have for emergencies or for renting a car. And using a credit card is the safest way to shop online. Sure, you can use your debit card online, but why would you want to do that? If your account number gets stolen, your checking account can be drained before you realize what’s happened.

And yes, you might get most or maybe even all of your money back. But in the meantime, how will you pay your bills while you wait for the bank to sort out this mess?

With a debit card, your losses range from zero to $500, depending on how quickly you report it. Under the Fair Credit Billing Act, if an unauthorized person uses your credit card, your maximum liability is $50, but most major issuers offer zero liability.

Here are some options for first-time credit card holders:

Student credit card. If you’re still enrolled in college, you might qualify for a student credit card. Not everyone is mature enough during the college years to handle this well. So make sure you’re ready to be self-disciplined before taking the plunge.

Secured credit card. A secured credit card works just like an unsecured card. The difference is that you put a deposit in a bank account to “secure” the card. You then get a credit card, and you use that to make purchases. Pay your bill promptly, and since the issuer will report your payment history to the bureaus, you can develop a credit score.

Authorized user. If you’re ready to build credit but can’t qualify for a secured card (this can happen), then ask a parent or close relative who has great credit if you can be an authorized user on one of their credit card accounts.

To be clear, a potential employer will not be looking at your credit score. But an employer might look at your credit report. And as already mentioned, if you don’t have a credit score, you’ll have a pretty bare credit report.

A desolate-looking credit report could make you appear a little suspect to an employer. When an employer sees that you can use credit responsibly, it sends a message that you’ll be responsible at work, too.

Is this fair? No, not really. But this is the reality you have to deal with.

This is less of an issue for someone who has just graduated school and only begun to build credit. But if you’re well into your 20s and 30s, then you may need more on your credit report than your student loans if you want to impress a prospective employer.

Surviving a Financial Emergency

Don’t ever have the mindset that a credit card is your new emergency fund. You need an emergency fund because life is unpredictable even during normal times. But during a crisis, such as losing a job, a good credit score is a safety net that helps you qualify for low rates on credit cards and loans.

Is using credit ideal? Of course not! But having a way to plug a hole in a sinking ship while you’re waiting for the storm to pass gives you time to properly fix the leak and get back on course.

How to Get Good Credit

As I mentioned, there are many different scores. But most of them look at similar factors, such as payment history and credit utilization. So if you work on the following factors that make up your FICO score, it’s a good bet that most of your scores will start going in a positive direction:

  • Payment history. This accounts for 35% of your FICO score. You can ace this factor by paying all of your bills on time every month. Just one payment that’s over 30 days late can make your score drop like a rock.
  • Credit utilization. This is also referred to as available credit, and it makes up 30% of your credit score. You have a credit utilization ratio, which is the amount of credit you’ve used compared with the amount of credit you have available. Keep your ratio under 30%. But to boost your score more quickly, keep it under 10%.
  • Length of credit history. Your credit history is 15% of your score. Unless you have a good reason, don’t close credit card accounts you’ve had for a long time. When you close a card, it also increases your credit utilization ratio, which then decreases your score.
  • Credit mix. This is 10% of your FICO score. You’ll have a better score if you show you can handle different types of credit, such as having a credit card, which is revolving credit, or a car loan, which is an installment loan. Over the course of your life, a mix of credit usually happens naturally, depending on your needs at the time. So, no, don’t buy an expensive car to satisfy this requirement!
  • New credit. When you apply for credit, a lender does a thorough review of your credit report. This is called a hard inquiry, and it can lower your score up to five points. This factor is 10% of your FICO score, so spread out applications for credit. There’s some good news, though. The negative impact on your credit score decreases after the first year, and the hard inquiry falls off your report after two years.

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