Understanding How to Build Credit
A friend recently told me he couldn’t make sense out of his credit. I asked why, and he told me he had just recently paid off a $13,500 credit card balance only to watch his credit score drop a few points. My friend was convinced it was impossible to understand how building credit works. “Shouldn’t paying off my debt mean I look better to lenders?” He grumbled.
Yes and no. Truth be told, there’s more to credit reports and credit scores than simply showing an ability to pay your debts on time. Normal folks with good paying jobs and responsible financial habits are still vulnerable to low scores and high interest. The many stories posted on the creditrepair.com Youtube channel and similar testimonials attest to this surprising reality.
Good credit comes down to demonstrating an appreciation for the responsibility at-hand, as well as an ability to borrow and pay consistently. Sound a little weird? Allow me to explain further:
Understanding What’s at Stake
Getting offers for loans and credit cards in the mail can make you feel all grown-up. Clearly these institutions wouldn’t be willing to let me use their lines of credit if they didn’t think I was a responsible adult capable of fulfilling my end of of the bargain, right?
Yes and no. Those first round of high-interest low-credit cards are offered to young people as both a way to simply net new customers and to test the waters. Since they’re sure to get their money one way or another, credit card companies in particular don’t see a $1,000 line of credit given to a 19-year-old as a risk as much as an experiment.
Lenders want to see whether or not you’re able to resist spending sprees on a regular basis. It’s easier said than done. If you’re able to manage it, maintaining charge cards without maxing out is a great way to build good credit. If you take the responsibility for granted, overwhelming debt and reduced credit score will follow.
Understanding What Lenders Want
Okay so you’ve mastered the art of resisting spending every dollar you’re able to borrow via credit card. Good. But hopefully that doesn’t mean you’ve decided to lock your credit cards up for good, because that’s almost worse if the goal is to acquire good credit.
Similar to the credit score tribulations of my friend mentioned earlier, simply opting to deny lenders your business is going to hurt your score not help it. Of course it’s good to be able to pay off a credit card and maintain a zero balance, but only for peace of mind. In matters of determining someone’s credit score a lack of activity on active accounts sends red flags to lenders.
How? For one it demonstrates that the card holder doubts their own ability to responsibly handle debt. Secondly, an absence of credit usage is, by its very nature, going to result in no credit history appearing on your record. If there’s no history then how can a score be ascertained?
Ultimately, however, the reason a lack of a credit balance leads to a lower score is because credit card companies only make money when people, responsible or not, charge their expenses to their cards. It doesn’t do a for-profit company like Visa any good if you’ve paid off your debts completely and aren’t spending with a charge card anymore.
Building up your credit can seem like a wacky and unpredictable process. But there’s an art and a science to it. You essentially want to convey responsible spending habits and a never-ending activity history if your goal is to build credit. The simple way to do this? Take two credit cards out and use them to pay for gas or utilities. Pay the majority of the balance off at the end of the month with a little left over.
I recently got in touch with my friend after suggesting the aforementioned tips. His news? The score went up! Go figure…