As a student, you spend most of your time thinking about your classes and friends. It’s not until later in your life when you focus on credit and savings. Yet, this is also when you will struggle the most to repair your credit. You can maintain a strong credit report and a good credit score, you just need to learn how!
It’s shameful, so many students are oblivious to the truths of their credit report. Yet, it is also something that we have all observed for a long time. The brunt of it comes from looking at how students handle credit in their first place:
- 96% of graduates use credit cards.
- 15% know the interest rates of their cards.
- Under 10% know their interest rates AND fees.
The issue is twofold: students do not know how to read their credit reports, and they are not well educated when they take on new credit. But, these two factors have a serious impact on your credit score. For many students, any school loans will carry enough of a burden. It’s worth focusing on good credit today, to avoid further credit troubles down the road.
Start Working on Your Credit Now!
Increasing your credit score as a new borrower should not be tough. Yet, most students make the mistake of tying up too much debt. By doing this, you get evaluated by the credit report bureaus with a high utilization rate. Your utilization rate is the ratio of credit available to debt owed. As your FICO score factors 30% of its calculation by your use rate, this is something that must stay low.
An astonishing 56% of students admit to not knowing well enough how to improve their credit rating. If you are a part of that statistic, you probably did not know how impacting your credit utilization was on your FICO score. So, now you know one thing you might need to do to improve your credit. But, there are dozens of things you still need to know, so do not stop reading here!
Patience is Your Best Friend!
Time can heal all wounds. If your credit score is low, it will come back to life down the road. It’s just a matter of how long you have to “wait it out” for before things turn positive. The worst case scenario is you file for bankruptcy, and you endure around 10 years of a weakened credit score.
Yet, as a student you have the power to use patience for the good. Your credit is not yet at the point of no return, so you can let time play into your hands. Be a good borrower every month, take on credit limit increases, diversify your loan types, etc. The quality actions will pay for themselves.
If you have debt, start paying it down. You can always re-borrow if an emergency comes up. It is better to get your use rate reported as low as possible. This improves your credit rating, as long as you have real activity on the card.
What’s even better is the effects that time can have on your credit accessibility. Being a good borrower for five to ten years will make it easy for you to get a low interest loan. You might even get invitations for different cashback rewards and no-interest credit cards. If you want to finance a home, your interest costs also just dropped by ten’s of thousands of dollars.
Your efforts now will pay off in the future!
This is what you need to never fail to realize. Too many students procrastinate, and wait to build their credit once they find out their score is low. It is well worth the effort to “fill the portrait” of a trusted borrower now. You will have much better credit access later on, and the terms will work more in your favor.
This is what time can do:
- Building out aged accounts will contribute towards a higher average age for your credit accounts. As this factors towards 15% of your FICO score calculation, it matters.
- Filing for chapter 7 bankruptcy will mean a whole 10 years of your credit report getting held down. Yet, a bankruptcy judgment will stick on your report for 7 years.
- Avoiding taxes and student loan debts can run on for a long time, but the effects on your report will stop. These things tend to drop off your report 7 years after you default.
The age of your credit blemishes can play a role in how big of an impact they have on your credit score. For example, payment delinquencies on a credit card from 2010 will not have a serious impact today. If you kept consistent after those few late payments, you should not see your credit score kept lower as a result.
The biggest tell of time’s power comes from bankruptcy cases. Borrowers have the chance to take an “easy out” by bypassing their debt repayment. The United States makes this a great place to go bankrupt, as you can structure it to keep your car, your home, and more. Plus, you can establish new credit within just a few years, and a quality credit score is not out of the question.
As a college student, you do not want to look forward to the small advantages of going bankrupt. It is much better to focus on building your credit the right way. And, there’s no better time to do that than now!
Build Credit as a Student
As a college student, you are lucky. This is the prime time to start your credit growth, and to plan for the future. This is when all the financing offers start flowing in, and credit limit increases get offered like they are going out of style. All you need to do is get a few credit cards, and maybe take on an installment debt, like a student loan. These are typical credit uses for a college student, anyway. With diligent repayments, you will fast become a quality borrower on paper.
You can open new accounts now to increase your average account age. After time you can increase your credit limits. This gives an instant lift to your credit rating. This is because of the increase in credit availability, and the decrease in credit utilization. In the end, you can graduate school with an impressive FICO score. It should be close to what you need to finance a home, and more than enough to cover a financial crisis.
Plus, you never know what will happen if you do not keep an eye on your credit report. A company could place a fraudulent charge on your card, or an individual could even steal your identity. Yet, without tracking your credit report, it could take you years to find out. All these things can be devastating, not just to your credit score, but also to your bank account.
Do Not Get Lazy … Build Your Credit Now!
What would you do if your son was away on vacation, and needed emergency funds for a sudden surgery? If his life was at risk, even if you have a good job, you will struggle to get approved for financing. Yet, if you work on your credit profile today, you have insurance for the rest of your life.
It works like a rain day fund, and some would say it’s better than a savings account. The amount you do not pay in loan interest is more than what you would get paid in a savings account. That is clear as day when you look at the statistics below.
Credit.com reports $279,000 as the average interest paid in one’s lifetime. The total interest cost in your lifetime will vary depending on your credit score. If it’s below 550, you can expect to pay around $910,109 in your lifetime. Yet, you just need to pay $480,386 if your FICO score is 750 or higher.
High credit scores pay for themselves all the time!
Found a nice condo with a wicked rental price?
You might get disappointed when you find out you are not a qualified tenant. Many landlords will factor your credit score when deciding whether to let you rent off them. The same applies when looking into a rent-to-own agreement. You could even run into this problem when hooking up utilities at a new home.
Many types of insurance use your credit rating as a metric of trust. This means your score can influence your insurance premiums. So, you should work at improving your credit score today. As the years pass, your insurance costs will decrease as your credit rating gets higher. You will also have a better chance of getting a more lucrative offer from a competitor, once you reach renewal time.
How Can You Establish Perfect Credit?
As a student, you have the power to perfect your credit. If you do things right, there is nothing that will stop you from having an ever-increasing credit score. There will be times when it has small drops, such as from a flurry of hard inquiries. But, you can continue the uptrend for as long as you stay determined.
It all comes down to how you take on new credit lines, and what you do with them to influence your FICO rating to improve. This is not as complex as you think, and there are many services available to help you.
For example, most students are new borrowers with thin credit files. If this is you, then Credit Karma’s “thin file service” is an incredible tool to use. Not only does it help to track credit, but you will also get a custom list of credit offers that work based on your profile. As you take on new offers, you can continue to track your credit report (for free!) and see how your score changes.
Of course, you do not need any fancy software or live help to reach perfect credit status. It is just a matter of continuing onward with your positive actions. There are things you can do to maximize your score increases, and to cushion any blows. Take a look below for a more in-depth, step-by-step analysis on how to improve your credit as a student.
You Must Establish a Credit File
You cannot look like a good borrower if you have no borrowing history. Even if you have to start off with a secured credit card, get something on your report!
While building new credit lines, remember these points:
- Avoid getting too many cards
It is always nice to see a new credit card offer come in the mail. If the terms are a bit better, or the limit is higher, it could be easy to convince yourself to apply for the card. After a while, you will find yourself with a high volume of low quality credit cards. At this point, you will debate which ones to close, while watching your score drop due to a jump in use rate and a drop in average credit age.
- Get more than one new card
To contradict the point above, it is important to open more than one account at once. The only downfall is if you are getting bad terms on your new credit cards. For example, securing two different cards for $1,000 each is senseless. You could secure one, wait for a limit increase, then apply elsewhere for a partially secured card. If you can get unsecured cards, start building your average credit age now by getting approved for two separate cards.
- Be careful with secured cards
The trick about secured credit cards is not the fact that you pay high interest, and annual fees on money that you already own. The trick is that money you used to secure the card might never come back to you. The terms might stipulate that it gets returned when the card closes. You should avoid this, as it lowers average card age. Even worse, some secured cards cannot get converted to unsecured. You could get forced into paying the card fees just to keep the card active on your report.
- Don’t stick to one credit type
The way you diversify your credit has an impact on the strength of your credit score. 10% of the FICO score calculating algorithm comes from your credit diversity. Student loans are a type of installment debt, while credit cards are revolving debt, so the two mix well. Other types of installment loans exist, but most are short duration or they come after your credit is great.
Learn How Credit Scores Get Calculated
You cannot just keep “doing the right things” without knowing why you are seeing good results. It is important to understand the cause and effect of your credit actions. This helps you know how to best plan your finances, while trying to better your credit score.
Below is the standard FICO algorithm.
- Payment history (35%)
- Amounts owed (30%)
- Length of credit history (15%)
- New credit accounts (10%)
- Types of credit used (10%)
If you do not have a FICO score, or you are a new borrower, lenders will use the VantageScore 3.0 rating or a “FAKO” score.
The VantageScore 3.0 algorithm uses the following metrics:
- Payment history (32%)
- Utilization (23%)
- Balances (15%)
- Depth of credit (13%)
- Recent credit (10%)
- Available credit (7%)
FAKO scores are just any scores that are not FICO scores. These get used by credit monitoring companies, as the FICO score is not easy to access. The problem with FAKO scores is that the algorithm is different a lot of the time.
There are endless FAKO scores that exist, but lenders do not spend much time using them. Yet, you just need to check your FICO score once or twice a year. You are able to get a good enough idea on your score fluctuations by tracking the movement of one of your FAKO scores.
Do Not Fall off Track – Always Pay!
You want to improve your credit, which takes a lot of due diligence. Lenders want to see that you can continue to pay your debts for long periods of time. If you ever want to buy a house, the lender will have strict criteria for you to meet. To keep your credit perfect, you do not want to accumulate any major blemishes along the way. Yet, you need to remain active with your credit accounts to get optimal results.
To keep on track with credit card payments, you need to know what to pay. You cannot get ahead by making the minimum payment every month, especially if you use the card a lot. A few months of off budgeting could send you over your limit, causing your credit report to suffer. In return, your credit rating will drop because of your inability to make good on your debts.
If you do not trust yourself, a credit monitoring service is worth it’s weight in gold. You can keep track of every little detail of your finances, so missing a payment will never be an option. As a student, there are many things you need to keep track of in your head. Unless you are going to school for accounting, this type of service will prove to be a true lifesaver.
- What’s your utilization ratio?
You might be looking with confused eyes, “what’s my utilization ratio?”
This is a number you need to know. In fact, it is a number you must set before you ever use a single credit card. So, figure out a percent of your total available credit that you want to set as your maximum. Do not ever exceed this amount, under any circumstances.
20% is a nice number. It shows that you use your credit cards, but you have the choice to stick with cash. To achieve a 20% utilization rate, you must make sure the credit card company reports this rate. You can do so by figuring out when your company reports, but most do it right after the statement closing date and that’s easy to find.
- Why does credit utilization matter?
If someone went to jail for 10 years after opening their first credit card, would you think that person deserves a high credit score? His utilization rate stayed at 0% all this time, and that the bureaus would register as a bad thing.
If someone is always near the maximum of their available credit, that’s also a negative. A lender does not want to think you are just one financial crisis away from going bankrupt. If you cannot keep your utilization rate low, how can you afford to take on new credit in the soon future?
The goal is to make lenders believe you are able to handle more credit. It is a game between the borrower and lender, as both are searching for common ground. By sticking to around 20% credit utilization, you are proving to be a trusted borrower. You can let it reach 30% or even 35% some months, but 20% should be your target.
As said, you need to figure out when your credit card company will report your balance. This factors into the actual use rate that goes into your FICO score calculation. If you are unlucky, the balance gets pulled every few months and your FICO score could get crushed by that fact. If you are lucky, you will always make payments in time to keep your use rate low for when the card company reports to the bureaus.
That said, it might be good to avoid making any large transactions on your credit card. Unless you plan to upload the funds right away, it is not worth the risk of getting stuck with a high use rate. You might buy something for 95% of your available credit, with full intention of paying it all off. Yet, with the wrong timing, your score could still get calculated with the 95% use rate.
- Do not underestimate credit utilization!
You can see a big change in your FICO score in either direction, depending on how much of your available credit you use. We will use an example below to illustrate just how powerful your use rate is on your credit rating.
If you are a typical borrower, using 100% of your $10,000 in available credit, you can expect around a 670 FICO score. If you just use 20% of your available credit, you can expect around a 810 FICO score.
Holding such a strong FICO score would mean you are subject to 3.589% APR, while someone on the opposite end would face a 4.202% APR. This means having a 20% utilization rate, instead of a 100% rate, would generate major savings for you. In fact, on a 30-year fixed loan, you would save you $12,638 in interest for every $100,000 borrowed.
Find Another “Rainy Day Fund”
Now that you are taking your credit serious, it’s important to transition away from the idea of using it as a “rainy day fund” of any kind. Relying on your credit in emergency situations will just lead you to bigger problems down the road. In fact, it is often the ‘nail in the coffin’ that crushes the credit score of an on-the-fence borrower.
If you “must” then it’s acceptable to use credit to help you out in an emergency. But, you should always try to save money on the side for this reason. If you are paying back a big amount of debt, but your payments are large, maybe you can save a little on the side. The lesser effect on your debt repayment is negligible.
Plus, you do not want to later try and finance a home with the idea of using your credit for the down-payment. Then, it just takes one serious repair to put you in real financial trouble. Just find a way to save money on the side, even if you do not have an immediate purpose. To keep your credit safe, it is well worth the effort.
You could even make a “rainy day credit card” later. For example, you could do this by taking a $1,500 card out of $15,000 total and only using it for emergencies. When doing this, you should still apply the utilization ratio rules here. Say you did not want to use over 20% of $15,000, then you cannot use more than $3,000 of it. But, if you go into your rainy day fund, $4,500 would just tap 33.33% of your total credit. This still keeps you in a safe range. So, it’s a good and effective savings strategy to use as protection against any financial emergency.
Plus, you should aware yourself on the effects of tapping your credit. As illustrated, your credit score will see a big change from the difference in use rates. Your lowered credit score will make it harder to get approved anywhere else. If you need to dig another hole before getting out from below, you will just end up paying even more. Then, you will find yourself consolidating your debts at a “competitive” rate.
Take an “Eye in the Sky” Approach
You do not need to control all, but you need to know everything. This is why many borrowers turn to credit monitoring services, as it is often too difficult to keep track of all the little details.
As a college student, your biggest financial risk is not following a budget. School is full of unexpected expenses, especially for those that like to socialize. You need to know you can afford what you plan to spend each month, or else you are setting yourself up for disaster.
Soon enough, you will tap your credit until there is nothing left. Then, your problems will snowball by the time you start a job. Next you know it, wages and taxes are getting garnished to start paying off what you owe, and all your hard work seems likes it was for nothing.
Your credit cards are not there to help you, yet. With high interest premiums, you cannot expect to rely on these funds for everyday expenses. Your FICO score will drop in a heartbeat if you believe this is possible. Instead, you must use cash for most of your expenses, and just find ways to use your card to build its activity up.
Worst case, get yourself a budgeting app or software to help keep track of your expenses. You might even be able to pair your online banking with a credit monitoring service, which serves as the best of both worlds. You will have your credit use, your credit report and score, and all your expenses factored in a single place. This makes it easy to get a full picture on your credit, as there are no uncertainties that can interfere with your expectations.
Do Not Fear New Credit
You should not deter yourself from accepting a new credit offer just because you think it’s bad to take on new credit. If your current credit card provider offers you a limit increase, there is no reason to say no. As long as you trust yourself, that limit increase will cause an automatic increase to your FICO score. Your credit availability will go up, and your credit in use will go down.
Of course, not all credit offers are good. You should not add a fourth or fifth credit card to your arsenal, just because you got the offer. You need to get an impressive credit limit, a low interest rate, or something else to make it worthwhile. If you get a strong FICO score, your goal is to find a much more attractive credit card. At this point, you will likely find yourself applying for one that has specific interest to you.
As a college student, you should jump from your first credit card or two, to also having a cashback rewards card. That one can become the card you use the most, and the others can remain more dormant. Getting You can also transfer funds between credit cards, if the terms are right, which might help you balance your debt.
IMPORTANT: Credit Building is Not a Static Process!
You need to erase the idea of “doing (A) causes (B) to happen” because your credit report is not a static piece of paper. There are no simple numbers used to measure the cause and effect of your actions.
The worst of it is when there is an unknown domino effect playing out. This is a chain reaction scenario that is hard to prevent. You need to be aware of all the effects your actions can have on your credit rating.
As an example…
You must despise the idea of carrying a large student loan debt well into your thirties. Yet, it might be smarter to do this, instead of paying it all off right away. Yet, many make the mistake and
You take on a student loan debt, which you later pay off with a 0% credit card offer. This seems like a good move, because you save thousands on student loan interest payments. Yet, your credit score does not follow suit. The repayment of an installment debt, ending it’s term, means less credit diversity. FICO puts emphasis on the balance of your outstanding revolving debts (such as credit cards) not the fixed ones. So, you also drop your credit availability, while shooting up your utilization rate at the same time.
In that scenario, it becomes clear that repaying the debt totals is not the only focus. To build great credit, you must look at what the credit reporting bureaus view as good. There are many misconceptions here, and this scenario exemplifies a few.
Read about some common credit score myths to save yourself from unexpected failure!