If you’re looking to build or improve your credit, here is a quick guide on the importance of credit and how you can start building it today.
Why is credit important?
Not only do you need credit to get a mortgage or car loan, but it also factors into other areas. Here’s a list of additional reasons why credit is important that you may not have considered:
- It can affect your insurance rates.
- It can affect your ability to rent an apartment.
- You may need it to set up utilities.
- You’ll need it to apply for a business loan.
- In some cases, prospective employers may check your credit, which can affect your chances of getting a new job.
What affects your credit score?
Payment history has the largest effect on your credit score (35%)
Amounts owed has the second largest effect (30%)
Length of credit history (15%)
New credit inquiries and the amount of new credit (10%)
Types of credit (i.e. installment loans, credit card debt, etc.) (10%)
How can you build credit?
Here are a few guidelines on building and improving credit:
Pay bills on time. Late payments can negatively affect your credit score.
Keep old accounts open rather than close them. Keeping old accounts open ensures that your available credit stays high, which means your utilization ratio can be lower than it would be if you closed your old accounts.
- This can also be beneficial for length of credit history.
Monitor your credit report for any errors as well as accounts you did not open.
When shopping for new credit, minimize inquiries by shopping within the shortest period of time possible.
Don’t open new accounts if you don’t need them and already have credit.
How does credit affect your mortgage?
Credit has an impact on the rate you qualify for. The higher the score, the lower your mortgage rate can potentially be.
Your credit score also affects the Loan Level Price Adjustment fees (LLPAs) paid on your loan.
- LLPAs can potentially add thousands to the upfront cost of your loan.
Credit can affect the loan program you qualify for. For example, conventional loans require a minimum 620 credit score.
Credit isn’t the only factor considered–other factors are taken into account, too, such as the amount of your down payment and the type of home.
Avoiding late mortgage payments
One late mortgage payment can cause your credit score to drop by over 100 points. This may sound dramatic, but it’s true. A single 30-day late mortgage payment can cause your score to drop drastically, and it can take months to years to recover.
Late payments have hidden costs. In the long run, a late payment can cost you more than a late fee. If you apply for credit in the future, you may not qualify for as low of a rate as you otherwise could.
Missed payments are often unexpected. Oftentimes, when we miss a payment, it’s due to unforeseen circumstances such as illness, job loss, accident, or another issue.
What can you do?
Maintain an emergency fund. Save up a cash reserve equal to at least 3 months of living expenses.
Automate. Set up automatic payments through your checking account or put a reminder on your phone.
If you’ve missed a mortgage payment, only time and good financial habits will help you recover your score.
Final thoughts on building and improving credit
Credit has many uses these days, and it’s worth building, even if you’re not planning to make any major purchases soon. There are steps you can take to strengthen your credit and build it over time, which can play a key part in reaching your long-term financial goals.
