Needless to say, learning to save and manage your money effectively is a vital skill to have in your toolbox for future endeavors (previously covered in Part 1 of this article [Click here to read.]). Equally important is building and managing credit -- the third step in drastically improving your financial literacy.
Step 3: Managing & Building Credit
Credit, in simple terms, is a way for banks to measure your ability to pay back debts and is measured by your credit score. Think of your credit score as your Credit GPA. The higher your credit score, the more likely a bank will be willing to loan you money. Your credit score can also be helpful when applying for jobs.
The most significant components of your credit score include your payment history, amounts owed, and credit history. Your payment history tracks how you have paid your accounts in the past. Your amount owed is the amount of money you have left to pay back. Your credit history is a culmination of your payment history, account balance, any credit accounts, and total debt.
Some tips for improving your credit score include punctual bill payments and payments over the minimum requirement. Paying more than the minimum and paying in a timely manner demonstrates responsibility and financial stability, which improves your credit score. You can also save money by paying more than just the minimum requirement. For instance, if you buy a computer for $3,000, and you are charged 13% interest to pay it off, the benefits of paying more than the minimum requirement are demonstrated in the table below:
Net Cost of a $3,000 Computer with 13% Interest
Monthly Payment | Net Interest | Net Cost |
$65 | $3,000 | $6,000 |
$200 | $317 | $3,317 |
*the minimum monthly due if $65
Another vital tip when improving your credit score is to never, EVER use all of your credit. It is best to only use about 30% of your credit at a time. For example, if you have a credit limit of $1,000, you should not use more than $300 to demonstrate your budgeting skills you learned from Part 1.
While you must be 18 years old to open a credit account, you can still build credit as a teenager to help you when applying for credit cards. But how?
One way to pre-establish credit is to have your parents add you to their credit account (if they have a good credit score) as an authorized user. Even if you do not use their card, their score will still be assigned to you.
Opening a checking account is also very useful. Bankers will be able to track your account history to verify that you are capable of managing money. (Don’t let your balance dip below $0!) Experience with having a bank account and the bank in general is also crucial when applying for your first credit card.
Now, we have covered just about every way you can improve your chances of qualifying for a credit card when you turn 18, but how should you apply for one? It is best to start at the bank where you opened your checking account since you have a history with them. It is also wise to open just one credit card and wait at least two years before opening a second; you will be a more experienced credit-manager. An additional tip is never open store credit cards due to their generally high interest rates. Finally, be wary of the thousands of credit card ads you will receive when you are off at college. Do not feel overwhelmed. Properly research which bank you would like to open a credit account that best suits your needs.
More information regarding credit can be found at Bank of America’s BetterMoneyHabits.