College is usually the time when people start dabbling in the world of credit. Most of us have credit through student loans, but it can be confusing to see how repaying those loans affects your future. Enter the credit score: the three-digit number a lender will see when deciding whether you deserve their money.
Your credit score will follow you into major purchases in college and beyond. Good credit takes time to build, and bad credit can be detrimental to your financial future.
What is credit?
Credit can mean two things: an agreement where a person borrows money from a lender with the intention of paying it back over time, and their history of paying back borrowed money. Good credit means that you are responsible with and consistently pay back borrowed money. Bad credit is the opposite — paying late, using a high amount of credit compared to your income or skipping payments altogether.
A line of credit lets you choose how much to borrow at any time up to a certain limit. Usually, you will have to pay back some of the borrowed money monthly. You are given a minimum dollar amount to pay to be considered “on time.” You will accrue interest, a set percentage of extra money added to whatever you owe, on whatever you do not pay back at the end of your payment period.
What is a credit score?
Credit scores are a numeric prediction of a consumer’s credit behavior. Whether you are getting a car or home loan, applying for a credit card or renting an apartment, lenders may look at your credit score to estimate how likely you are to pay back your loans on time. Basically, a credit score shows lenders whether it is safe for them to share their money with you.
One of the most commonly used credit scoring systems is the FICO score, named after the Fair Isaac Corporation that created the calculation. While the exact calculations remain secret, a FICO score is made up of five components.
- Payment history (35%). Your payment history score is based on whether you pay back your credit on time and if you have ever had any collections or missed payments. To get this score higher, you must regularly pay at least your minimum payment on time.
- Amount owed (30%). This component takes a ratio of your credit spending compared to your credit limit. The lower your credit usage, the better your score. For example, if you have a credit limit of $5,000, you will be seen as less risky if you have spent $100 than $4,950. Lenders like to see credit usage at 30% or less.
- Length of credit history (15%). Becoming trustworthy in the eyes of lenders takes time. That’s why it’s important to start building credit early. The longer you have open credit lines, the safer you are to lenders.
- New credit (10%). Constantly shopping for new lines of credit can make you look like you need more money than you have. Each time you apply for a line of credit, it lowers your score. If you infrequently open new credit, make payments on time and keep your usage low, the slight ding will be made up for.
- Credit mix (10%). You will be more attractive to lenders if you can prove you can be responsible for multiple credit types. Credit can either be revolving (such as retail or gas cards) or installment (such as mortgages and car loans). Student loans are installment credit, where a Target RedCard is revolving.
Your credit score and other credit information (such as account status and inquiries) are consolidated into a credit report by one of the three major credit bureaus: Experian, Equifax and TransUnion. Experian and Equifax offer free credit reports. Experian will show you your FICO score for free and all three services have subscription services for more credit information.
Why does my credit score matter?
Having a good credit score can help you get higher credit limits and lower interest rates in the future. Building good credit also helps you with the big purchases in life, like a new car or a home. Lenders will be more likely to give you a loan when your credit score shows you are responsible.
How can I build credit?
Paying installments like your student loans after graduation or paying on a car loan can also build credit, although these debts are heftier. Loans require you to pay a principal amount and interest. The principal is the money you borrowed, and the interest is the money you give the bank for letting you borrow.
Usually, you pay the interest on a loan before the principal, and you accrue interest while you are making payments. If you can pay more than required, you will pay down the loan faster by shrinking the time you are accruing interest on it.
Credit cards are one of the easiest and safest ways for college students to build credit. There are many options for college credit cards, which usually have lower interest rates and lower or no annual fees.
You typically apply for these cards through the bank’s website. They will decide whether you qualify and how much credit to give you based on your existing credit history. Being in college doesn’t guarantee access to a college card.
Secured cards or credit builder cards offer first-time credit users the opportunity to build credit without a credit check. These cards, like the Chime Credit-Builder card, allow you to set your own credit limit. You transfer money from your checking account to the card, spend money from the card and the bank reports positive payment history to help build your credit.
The bank you have a checking account with may have options for college cards or other lines of credit, too. If you have good banking history, you could get a higher credit limit through a card from your bank.
Using a credit card has security benefits, especially for online purchases. If your credit card gets stolen, your money is generally better protected. You may be liable for fraudulent purchases on a debit card because the money was spent from your checking account, whereas stolen credited money never left your pockets.
Credit cards often come with rewards. Retail cards can give you discounts or cash back on in-store purchases, or you can earn points or miles toward events, travel and other rewards through your bank.
For the best luck with credit cards, keep a close eye on your budget. Treat your credit purchases like spent money and pay off the full balance on your card at the end of the month to avoid paying interest.
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