Building credit is an important financial activity that can help people achieve their goals, from getting loans for expensive items to getting approved for lower interest rates on mortgages and credit cards. Recent studies show that having high credit can save you a lot of money over time. For instance, a person with good credit may be able to save tens of thousands of dollars compared to someone with bad credit on a 30-year mortgage.
But navigating the credit world may be dangerous, and there may be traps that could have serious long-term repercussions. A major credit agency found that 15% of Americans have credit scores that are below 600, which is regarded as poor. Due to significant credit access restrictions and higher loan interest rates, it may be more challenging for them to reach important financial milestones.
In this article, we will delve into ten crucial traps that individuals should avoid while building credit. By understanding and steering clear of these common pitfalls, individuals can ensure a smooth journey toward establishing a robust credit history and ultimately enjoy a healthy financial future.
Read more: 8 reasons why your credit score is important
Why is Building Credit So Important?
Building credit is of paramount importance as it directly impacts an individual's financial well-being and opens doors to various opportunities. Strong credit history is a crucial factor in securing loans for significant investments such as homes or businesses, with lenders assessing creditworthiness to determine loan eligibility and interest rates.
A high credit score can lead to more favorable terms, saving borrowers thousands of dollars over time. Moreover, good credit is essential for obtaining credit cards with lower interest rates and higher credit limits, providing financial flexibility and rewards.
Beyond borrowing, credit influences insurance premiums, rental applications, and even employment opportunities, as some employers consider credit history during the hiring process. Additionally, building credit responsibly can lead to improved financial habits and a better understanding of managing debt.
Overall, a positive credit profile is a powerful tool that empowers individuals to pursue their dreams and secure a stable and prosperous financial future.[1]
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What Credit Score is Considered Good?
A good credit score is typically considered to be in the range of 670 to 850, according to the FICO credit scoring model, which is one of the most widely used credit scoring systems. The FICO score, developed by the Fair Isaac Corporation, is a three-digit number that summarizes an individual's credit risk based on their credit history and various financial factors.
A score of 670 and above is generally considered good and indicates a higher likelihood of being approved for credit and obtaining more favorable interest rates on loans and credit cards. Lenders view individuals with good credit scores as reliable borrowers who are more likely to make timely payments and manage debt responsibly.
It's essential to note that different lenders and credit bureaus may have slightly different credit score ranges and criteria for evaluating creditworthiness. However, in most cases, a credit score of 670 or higher is considered good and represents a significant milestone in building a strong credit history.[2]
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Which 10 Traps to Avoid While Building Credit?
Now we understand the importance of building credit and what constitutes a good credit score. Let's explore ten traps that you should avoid while on your journey to build credit responsibly:
1. Overspending and Accumulating Debt
One of the most common traps individuals fall into is overspending beyond their means. Impulse buying and relying excessively on credit cards can lead to a significant accumulation of debt. High credit utilization can negatively impact credit scores and make it challenging to repay debts.
According to a survey conducted by the National Foundation for Credit Counseling, 42% of Americans admitted to making impulse purchases of $300 or more within the last year.
Solution: To avoid this trap, create a realistic budget, and stick to it. Limit credit card usage to essential expenses and pay off balances in full each month to prevent interest charges from mounting.
2. Missing Payments and Late Payments
Timely payment history is a crucial factor in building good credit. Approximately 35% of a FICO credit score is based on payment history, making it a critical factor in creditworthiness. Missing payments or making late payments can significantly damage your credit score.
Solution: Establishing reminders or setting up automatic payments can help ensure you never miss a due date. If a late payment does occur, contact your creditor immediately to discuss the situation and request a goodwill adjustment.
3. Not Having an Emergency Fund
Not having an emergency fund can lead to relying on credit cards when unexpected expenses arise. Relying on credit to handle emergencies can disrupt your credit-building progress and lead to debt accumulation. According to a survey by Bankrate, only 43% of Americans have enough savings to cover a $1,000 emergency expense.
Solution: Create a dedicated emergency fund with at least three to six months' worth of living expenses to help you navigate financial challenges without damaging your credit.
4. Maxing Out Credit Limits
Maxing out credit cards or utilizing a significant portion of your credit limits can harm your credit score. The credit utilization ratio accounts for 30% of your FICO credit score. High credit utilization indicates a higher risk to lenders, signaling potential financial struggles.
Solution: Aim to keep your credit utilization ratio below 30% by paying down balances regularly. A lower credit utilization ratio reflects responsible credit management and positively affects credit scores.
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5. Co-signing for Others
Co-signing for someone else's credit obligations might seem like an act of goodwill, but it can be hazardous to your credit. By co-signing, you become equally responsible for the debt, and any negative actions by the borrower can directly affect your credit score. A survey found that 38% of co-signers had to pay some or all of the debt they co-signed for.
Solution: Before co-signing, carefully assess the person's financial responsibility and ability to repay the debt. Additionally, consider alternative options to support them without putting your credit at risk.
6. Applying for Unnecessary Credit
Every credit application results in a hard inquiry on your credit report, which can temporarily lower your credit score. Applying for unnecessary credit, such as store credit cards or and multiple loans, without a genuine need, can lead to a series of hard inquiries, impacting your credit score.
Solution: Only apply for credit when you genuinely need it and can manage the additional responsibility. Prioritize your needs and consider alternatives before pursuing new credit.
7. Opening Too Many Credit Accounts
While having a diverse credit mix can be beneficial, opening too many credit accounts within a short period can raise red flags for lenders. Each credit inquiry can temporarily lower your credit score, and having numerous open accounts may tempt you to overspend and increase the risk of accumulating debt.
Solution: Be selective about the credit accounts you open and only apply for new credit when necessary. This approach ensures a healthy credit profile. Avoid unnecessary applications to safeguard your creditworthiness.
8. Closing Old Credit Accounts
Closing old credit accounts can inadvertently harm your credit score. The length of your credit history is an essential component of credit scores. Closing old accounts shortens your credit history, which can negatively impact your creditworthiness. The average age of credit accounts for 15% of your FICO credit score.
Solution: Instead of closing old accounts, keep them open and occasionally use them for small purchases to maintain an active credit history. A study by Experian revealed that consumers with longer credit histories tend to have higher credit scores.
Read more: Closing a Credit Card? When Should You Do?
9. Ignoring Credit Reports
Regularly monitoring your credit reports is essential for identifying errors, fraudulent activities, or suspicious discrepancies. Ignoring your credit reports might allow inaccurate information to persist, negatively impacting your creditworthiness.
Solution: Obtain your free annual credit reports from Equifax, Experian, and TransUnion and review them carefully for discrepancies. The Fair Credit Reporting Act (FCRA) allows you to dispute inaccurate information with credit bureaus.
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10. Falling for Credit Repair Scams
In the pursuit of improving credit, individuals might be tempted by promises of quick fixes and easy credit repair solutions. Beware of credit repair scams that claim to remove negative information from your credit report illegally.
Solution: Legitimate credit repair involves diligent efforts to dispute inaccuracies and resolve legitimate disputes through proper channels. Remember, there are no shortcuts to building credit; it takes time, responsible financial habits, and patience.[3][4][5]
The Bottom Line
Building credit is a critical journey that should not be underestimated. A solid credit history is not just a numerical score but a powerful tool that unlocks numerous financial opportunities. By maintaining good credit, you can access favorable interest rates on loans, secure better insurance premiums, and increase your chances of being hired for certain jobs.
On the other hand, falling into common credit traps can lead to negative consequences, such as higher interest rates, limited access to credit, and potential financial hardships. To ensure a smooth credit-building process, you must prioritize making timely payments, managing credit card balances responsibly, and being cautious about co-signing or settling debts.
Regularly monitoring credit reports for errors and avoiding credit repair scams are also essential habits to adopt. By steering clear of these traps and adhering to responsible credit-building practices, you can pave the way for a strong credit history and a prosperous financial future.
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References:
- https://www.cnbc.com/select/why-building-credit-is-so-important/#:~:text=Therefore%2C%20it's%20important%20to%20build,money%20and%20achieve%20your%20goals.
- https://www.cnbc.com/select/what-is-considered-an-excellent-credit-score/
- https://www.holisticinvestment.in/beware-of-7-traps-and-optimize-your-credit-card-usage/
- https://www.cnbc.com/select/common-credit-card-mistakes/
- https://www.dbs.com.sg/personal/articles/nav/budget-spend/credit-trap
FAQs
Q. How long does it take to build good credit?
Building good credit takes time and responsible credit management. Generally, it can take several months to a few years to establish a strong credit history. Factors such as payment history, credit utilization, and the length of credit history play significant roles in determining your creditworthiness.
Q. Can I build credit without a credit card?
Yes, it is possible to build credit without a credit card. Alternative credit-building methods include getting a secured credit card, becoming an authorized user on someone else's credit card, or applying for a credit-builder loan. Additionally, certain utility and rent payments can be reported to credit bureaus to help establish a credit history.
Q. How can I improve my credit score quickly?
Improving your credit score quickly is challenging, as it involves building a positive credit history over time. However, you can take immediate steps to boost your score, such as paying bills on time, reducing credit card balances, disputing errors on your credit report, and avoiding new credit applications.
Q. Will checking my credit score hurt my credit?
No, checking your credit score through a soft inquiry, such as when you access your credit report or use a credit monitoring service, does not harm your credit score. However, hard inquiries, which occur when you apply for new credit, can have a temporary impact on your credit score.
Q. How often should I check my credit score?
It is recommended to check your credit score at least once a year from each of the three major credit bureaus (Equifax, Experian, and TransUnion). Regularly monitoring your credit report helps detect errors and potential fraud and allows you to track your credit-building progress.
