Building Financial Success: Why Should You Care about Credit Cards?
Credit cards–who needs them? While various schools of thought offer different approaches to answering this question, we believe that credit cards are virtually undeniable as a resource of modern finance, and represent an excellent tool for building financial wellbeing in general.
In this guide we will explore the reasoning behind this position, and why we think it applies to almost everyone–that is, even if applying for a credit card is not the right decision for you right now, it likely remains a benchmark of financial stability to work towards actively as soon as possible. So if the question is ‘who needs credit cards?’ then the answer is, ‘everyone.’
Of course like any question concerning financial health, in order for information and suggestions to be relevant to you as an individual–whose unique background carries unique demands–we will need to explore all the various realities surrounding credit cards: the different types of cards available, notable risks and benefits to highlight, industry trends and important principles, as well as other important questions to consider.
Credit cards are a fact of American life:
The financial system in America is based on an exchange-economics philosophy–where we provide goods or services in exchange for an agreed upon sum of currency–and this form of economics demands various forms of credit in order to thrive at high levels of efficiency.
And so we believe that in order for individuals to thrive in an exchange based financial system, the individual must, in turn, understand and master the concept of credit as well.
If this seems complicated, don’t worry. We will spend the rest of this resource breaking down the above statements into bite sized sections for easy reading and organized for easy skimming. If you already know your concern or interest, then read ahead to the section labeled accordingly. Otherwise, dive-in to learn all the ins and outs of credit cards, and the secrets of leveraging America’s credit system to achieve lifetime financial success.
When is a good time to get my first credit card?
If you’re asking yourself the question – ‘when should I get my first credit card?’ then there are some fundamental bases to cover in order for you to make the best decision. For those on the fence or those who might be intimidated by the risks involved, there is very little guesswork in determining when the right time is to get a credit card.
So let’s cover 11 of the most crucial basics in deciding when is the best time to get your first credit card, or even your second–and so on. Because while these rules apply most overtly to first time credit card prospectors, they remain true throughout life as well.
- The best time to get a credit card is before you need a credit card.
- Like many aspects of financial planning, one rule remains relevant across various contexts: preparation is key. Even if a financial plan can be put into action quickly, life is usually chaotic and plans go awry, so the best way to account for this is to try and stay one step ahead of your needs.
- If you do not think you need a credit card, it might just be the most beneficial time for you to get one.
- Get a credit card when your credit allows it.
- While there is no time like the present, there are inevitably some roadblocks to landing your ideal credit card. Most notable of these is the barrier of credit score and financial history.
- Not all credit cards are created equal and the best options are locked behind high end credit requirements and strong financial backgrounds. So be sure to pursue the credit card you want when your credit score and history allows you to — see our section on credit scoring if you are unsure of what this means.
- Start early in life.
- If you’re wondering when the absolute best possible time is to get a credit card, then the answer is ‘as early as possible.’ For instance, a teenager can begin building a strong credit history as a teenager if their parents are willing to assist the process of acquiring a credit card for them.
- Another notable opportunity occurs when students enter college or graduate school, as many credit cards are designed specifically for students and offer unique privileges and rewards.
- Get a credit card when you have surplus income.
- A credit card does require a level of financial mobility and security. So you need to be sure that you have the necessary income needed to support regular payments.
- Get a credit card is when you have steady, regular expenses.
- One of the best times to get your first credit card is when you have steady and predictable expenses. For example, let’s say your first credit card only offers a limit of $500.
- A great way to use this card efficiently to build credit is to use it specifically for your predictable monthly expenses, such as utility bills, groceries, or gas. That way you are able to predict exactly how much money will be going out monthly when you pay your credit card bill with less chance of surprises. It will also be a great way to start incorporating your credit card into bill-paying habits.
- Get a credit card when you are able to accept total financial responsibility for yourself.
- While credit cards and the credit system in general is fair on average, it is undeniably unforgiving. A credit card can be a terrible idea if you are still figuring out your personal accountability as an adult. The best time to get a credit card is early only insofar as it allows you to build a positive credit history.
- If you suspect you might make some mistakes as a first-time user, such as missing payments or overcharging, then it is better to wait until you are more confident in your financial management abilities, rather than jumping in prematurely only to damage your credit score.
- Get a credit card when you know what kind of card you want.
- As mentioned before, not all credit cards are created equal. And this reality often presents itself in extremes. Any user of credit cards should be wary of shady credit card dealers known as “debt traps.”
- For this reason, you should get a credit card only when you have done your homework and you know what you want and what you don’t want.
- Get a credit card when you are interested in earning benefits from spending habits.
- Credit cards, particularly the better ones, offer a host of reward programs. A great time to get a credit card is when you can target one of these reward-outcomes specifically.
- A good example of this is if you travel cross-country a lot, you can pick up an airlines rewards focused credit card. Then you can build your credit while also reaping the rewards of free flights or other perks–a win-win as they say.
- Get a credit card when you want to correct a bad credit history.
- This last point is important because it is so counterintuitive at face value. So let’s clarify upfront. Do not pursue a credit card if the habits or situations that caused your bad credit history are still present in your life.
- You should, however, totally pursue a credit card as a means of correcting a bad credit history if you are confident in your present level of financial responsibility. A credit card is really one of the best ways to build up credit efficiently, and there are not many alternatives.
- Get another credit card if your first one is going really well.
- Like many of the pointers made on this list, it is a pointer offered in the context of supposing a certain level of personal accountability. If you are not sure how to evaluate your financial health and responsibility, then definitely do not make assumptions about it and consult a financial planner.
- If however, you have accurately determined that your first credit card is going extremely well and you can afford another one–it can be one of the best ways to reap rewards, and build credit quickly.
- Do not get a credit card if it causes difficulties in life.
- Most of these pointers can be offered in both positive and negative form. Such as ‘a good time to get a credit card is when you can afford it’ can be translated into ‘don’t get one if you cannot afford it.’
- Tip #10 however, makes most sense when conveyed in the negative. While there are countless benefits to using a credit card correctly, these benefits may not be worth it if you are one individual who gets extremely anxious when managing multiple forms of currency or financial strategies. In other words, do not get a credit card if the benefits do not outweigh its accompanying stressors to you.
Know yourself: Good and bad reasons for getting a credit card
This guide can give you all the theory and knowledge needed to excel in America’s credit system, however if you do not have knowledge of yourself, then you will not be able to achieve the success you could otherwise. For instance, if you know you are the type of person who cannot resist spending money when you have it, then you need to recognize the risk associated with having a high credit card spending limit.
A spending limit is just that–a limit and should be avoided in all cases, except emergencies. The credit system in America is designed in such a way that driving your balance up towards your credit limit is viewed as a major red flag by lenders, which can hurt your chances of getting better credit cards in the future, and even hurt your chances of being approved for a mortgage.
Put simply, you should not pursue a credit card if you are not ready for it–and unfortunately this is probably only something you can know for sure, unless your financial history speaks negatively for itself in which case you likely need to make some changes in order to take charge of your financial life.
While the above listing of the top 11 rules for getting a credit card, this section will outline some of the best reasons and the worst reasons for getting a credit card. These can apply to specific life events or benchmarks in financial achievement. But the fundamental rule here is to know yourself.
The Good Reasons
- You turn 18
- You begin an education program at a university
- Your parents are willing to authorize use as a user on their card
- You have a great credit history, or you are confident you can rebuild a bad one.
- You have concurrent and steady bills and a steady income
- You want to finance a large purchase
- You want to finance a debt repayment
- You want to finance a vacation (done right this might cover the flight through rewards)
- You have demonstrated success with your first credit card
The Bad Reasons – or Red Flags
- Your job or salary is unsteady or unpredictable
- You want a credit card to balance overspending
- You plan on a large purchase in the near future (home, car, etc.)
- You recently applied for credit products
- You have bad credit and are unsure why
- You are not sure what credit card suits you best
Tips for landing your first credit card
- The best cards are not for beginners: When getting your first credit card, be sure to manage your expectations of what is achievable. Many of the best cards with the best rewards will require extensive credit history and a demonstrably robust financial history, which simply isn’t feasible for most first time applicants.
- Cards you prequalify for are excellent options for beginners: In choosing your first credit card, one of the safest routes is to choose a credit card that you prequalify for given certain circumstances such as being a student. Some banks also offer prequalification credit cards, which can help ensure you won’t get shot down and can start building credit immediately.
- Get a secured credit card if you have no credit or poor credit: Secured credit cards are much like pre-loaded debit cards, however they are designed to help individuals with little credit, or even poor credit build a positive history. They function like a security deposit on a credit card, where an individual loads a balance to a credit card and spends from it accordingly with the addition of set monthly payments on the balance.
- You can check a credit card’s rates and associated fees before applying: Your first credit card can be an excellent tool of financial mobility, or it can turn into a crippling shackle of debt. This largely depends on the specific interest rates and fees on contract with the specific credit card. Good credit card companies offer varies rates and fees for all levels of credit card users, first-timer and veteran alike.
- Credit card fees can be avoided altogether: While credit card interest rates are built into the monthly payments you can expect to pay on your credit card, many of the fees can be circumvented by savvy use of the credit card. Foreign spending fees are irrelevant if you don’t use your card abroad. Overspending fees are likewise avoided by spending within your limit and so on.
- Even credit card interest rates can be avoided: While certainly more difficult to pull off, you can even manage to avoid credit card interest rates all together if you pay off your credit card balance in full every month before accruing APR during that billing cycle. This is a great strategy for circumnavigating the higher rates of many beginner cards.
- Pay more than your minimum payment: Minimum payments should be viewed as just that–the absolute minimum that you pay–and as such you should in most cases pay more than that. There are several reasons for this, but most impactful of them is that getting too close to your card’s limit can tank your credit score.
How do I identify the right credit card for me?
In many cases, choosing the right card makes all the difference. In a saturated industry like that of the credit card industry however, it can be difficult to separate the genuine article from the pretenders, or worse the deceivers. And make no mistake, there are certainly predatory credit card companies who will take advantage of unsuspecting customers. This makes learning how to evaluate credit cards all the more important.
Let’s review some of the most important terms you’ll come across
- APR: Unlike annual fees, Annual Percentage Rates (APR) represent interest rates you’ll pay based on the balances you carry from billing cycle to billing cycle on your credit card. This is the meat and potatoes as far evaluating the right credit card for you. Important notes are that APRs often vary in types of transactions–such as purchases, cash withdrawals, or bank transfers. Some credit card companies will also enforce penalty APRs which will entail interest rate increases when a payment is late or in the case of overspending beyond the allotted card limit.
- Annual Fee: As the name applies the annual fee is what the credit card company will charge cardholders on an annual basis. This fee is often low, but can be higher in order to balance other lower fees or charges.
- Foreign Transaction Fees: The extent and specification of what constitutes a foreign transaction will vary slightly in most companies, but by and large this is a fee reserved for transactions that occur outside of the United States, or with foreign companies.
- Late Fees: Late fees are the penalties you will face if you fail to meet the deadline for paying the monthly portion of your APR. The real risk is when an individual accrues penalty fees, which in turn have deadlines and thus likewise have late fees associated. Many credit card companies are lenient at lower levels of late fees and brutal after recurrent late payments–not to mention late payments of 30 days or more on credit cards will damage your credit score.
- Overage Penalties: While called by different names, this type of penalty occurs when an individual spends more money than the amount allotted as their card’s limit. These are entirely avoidable and as such are often met with the most unforgiving reprisals and steep penalties.
Evaluating and Applying for the Best Starter Cards
Student credit cards and secured credit cards represent some of the best options for first time credit card users, or for those with damaged credit. These cards are very similar to standard credit cards and can certainly build a positive credit history and good credit score, however they do come with some drawbacks. So let’s explore how to evaluate these options.
6 tips for evaluating student credit cards
- The first tip is to compare your bank’s student credit card with other options. Sometimes the most convenient way to start using a credit card is to add it to an existing account. This ensures easy incorporation into current habits and banking responsibilities.
- Student credit cards operate in all the same ways as a standard credit card. Student credit card contracts will entail all the usuals that we went over above–an APR, late fees, and annual fees, as well as all the industry-typical penalties.
- Where they diverge from other credit cards is that student credit cards come with lower limits and higher interest rates in order to balance the higher risk associated with first-time or low-credit users.
- Because of the higher APR of student credit cards, many of them will not carry annual fees, and if they do they will be much lower than industry averages. So just remember when evaluating a student credit card that if there is a lack of annual fees, it is balanced by fees elsewhere in the contract.
- One of the great selling points of student credit cards is that they offer rewards packages, and so the right card for you will be the one that offers rewards that you can make the most of–such as cashback on Amazon purchases, travel, or groceries, whichever you prioritize most as a student.
- The next great selling point of student credit cards is that they can be upgraded after a successful use history. This means that they represent excellent entry points into credit card usage because students can use them to build solid credit scores and then leverage that score to seamlessly transition their existing card into an upgraded card with better APR and a higher limit.
How to get a student credit card
While you will have a much higher chance of being approved for a student credit card, as compared to a standard credit card, there are still certain requirements to meet. But even if it is your first credit card, or if you have been denied on a previous card application, or you have a low or no FICO score, you still have good odds for approval if you meet the following requirements:
- You are a US citizen (or resident) with a social security number.
- You are a student over the age of 18 years old.
- You have some form of income: a work-study position, or part-time job will work.
- You do not already have a bad credit history.
Most students will not see a problem in these requirements and will likely have no trouble earning approval on their student credit card application. If you think you may have some trouble meeting any of these requirements, have no fear. Because there is still one more card type that offers even better odds of being approved.
6 tips for evaluating secured credit cards
- When evaluating what secured credit card offers the best value to you, it is important to note that secured credit cards have some of the most consumer friendly fees and approval ratings available.
- Banks are able to offset the risk of a first-time credit card user, or the risk associated with a bad credit score, by using the customer’s own assets as collateral to insure the secured credit card account.
- So when choosing your secured credit card, the available spending limit will likely be equal to the amount you deposit as collateral. It is very rare for secured credit card lenders to allow limits above the requisite collateral.
- With these points in mind, do not worry about trying to compare and contrast rewards for secured credit cards. Industry standards suggest that the ‘reward’ of using a secured credit card is building credit with little risk.
- So what will determine a good secured credit card is down to a small margin of convenience. For instance, it will likely be most efficient to pursue a secured credit card with the bank where you already have current accounts.
- Another determining factor of what constitutes the best secured credit card for you will be the amount allowed as collateral insurance. If you wish for your secured credit card to be your primary method of spending, you will want to find a lender who allows for higher secured credit limits/spending.
How to get a secured credit card
Secured credit cards are intentionally designed to provide alternative routes to building credit for both first-time users and those who do not meet the requirements for other cards. For this reason, there are very few barriers to earning approval for a secured credit card. Still there are some procedures to setting yours up:
- Determine the appropriate amount to deposit as the collateral account (the amount deposited will in turn act as your spending limit).
- Contact your bank to determine if they will approve this amount (you might have to lower the spending limit accordingly).
- Review the terms offered by your banking institution, but as mentioned above the fees and interests should be notably low.
- Bring your state identification and social security number to your banking professional to have them setup the account, and you will be on your way to building a positive credit history.
Is a low-interest credit card right for you?
If you are confident in your credit history and wish to skip the more beginner-friendly cards, then a low-interest credit card might be an excellent option for you. Low-interest credit cards offer a limited time offer of little or no APR–yes, that’s right up to 0% interest rates. But like all credit cards these strengths are balanced by some notable cons, so let’s review both sides of the equation.
Pros of a low APR credit card
- Depending on your contract, you will have around 6 to 18 months where you will pay 0% interest on purchases during this time.
- Some of the most appealing low APR credit card contracts even offer 0% interest on balance transfers–meaning you can transfer a high interest credit card balance to a low APR card in order to avoid the high interest rates on that balance.
- If approved, a low APR card will be an excellent starter card because it allows the user to begin incorporating the card into financial habits without the risk of being overcome by interest rates.
- A low APR card is an excellent option for individuals looking to space out the payments on a large purchase such as a television or vacation. This can allow you to space payments on such a purchase over 6 to 18 months without building interest rates.
Cons of a low APR credit card
- Some rates still apply. Not all low interest cards allow for 0% interest on balance transfers, and even if they do, there are often other flat fees incorporated into the contract. This means that these contracts often require a keen eye for evaluating fine print.
- Because offering lower interest rates means that lenders are taking on more risk, the penalties for breaking contract are extremely severe. If you fail to pay one of the contracted fees or penalties, the lender has the right to drop the low interest period, or even introduce penalty interest rates which can be extraordinarily punishing.
- Whether the low interest period ends naturally, or if you break the terms of contract and end the low interest period prematurely, the fact remains–a low APR credit card is a temporary benefit.
- What’s more is the resulting APR after the low-interest period is up may not be low at all, and might even be high enough to make you reconsider the benefits of 18 months with zero interest.
Is a cash rewards credit card right for you?
Unlike travel rewards credit cards, a cash rewards credit card offers easy to understand rewards programs. For this reason they are excellent options for a first timer’s reward-centered credit card–if you have a strong enough financial history, and are responsible enough to manage the rewards programs without accruing debt.
But as is becoming a recurrent theme in this guide, the notable benefits are balanced by drawbacks that may or may not make a cash reward credit card desirable to you. So let’s explore both perspectives.
Pros of a cash rewards credit card
- Cash rewards are the name of the game. Some cash rewards offer per-dollar-spent rewards programs in the form of flat rates, such as 1% cashback on all purchases, or in the form of benchmark style rewards where you earn certain benefits at certain spending levels.
- Many cash rewards credit cards offer sign up bonuses, which can be significant. These bonuses might even include a 0% APR period.
- Because the focus of cash rewards credit cards is the return on investment in the card, many of these contracts involve no annual fee, or lower fees if they are present.
- Beyond the flagship rewards program, many of these cash rewards credit cards offer shopping perks such as price matching, guarantee on returns, or extended warranties.
Cons of a cash rewards credit card
- Many cash rewards credit cards offer time-limited rewards, such as 0% APR or signup perks. In some cases these time-limited programs conceal much more predatory terms after the allotted time period is up. This means cash rewards are more risky in general and require astute judgment and evaluation in choosing the right contract.
- Cash rewards credit cards are by definition a rewards program based on spending. Many individuals need no incentive to spend their money, and indeed would likely overspend if given cash reward incentives. Thus these cards will not be good options for those likely to overspend and accrue large credit card balances.
- Cash reward credit cards often balance their rewards programs with higher than average interest rates. For this reason, some homework must be done to determine if the rewards packages outweigh the higher APR.
- Further limiting the scope of rewards, these credit cards often entail earning caps. In other words, depending on the specific card there will be different strategies to ensure you do not earn unlimited rewards–even if they describe their program as offering “unlimited rewards.” What they should say is that you can earn an unlimited amount of limited rewards.
Applying for a credit card: How banks evaluate your income
Now that we have covered some of the best credit card options for beginners, let’s look more closely at the application process itself. One of the primary components of landing a credit card approval is your income. For instance, if a customer’s monthly income sits around $3,000 then it would not make sense for the lender to approve a monthly limit of $2,500. Doing so would assume the customer would spend most of their income every month, making it highly unlikely the customer could pay off the balance as well as associated fees and interests.
With a monthly salary of $3,000, a limit of $1,500 is much more reasonable, because the customer could max out their card and still be able to pay off the balance monthly. The exact ratio of allotted credit card limit to yearly income will vary from lender to lender, while being heavily weighted by credit score as well. So let’s look more closely at the matter.
Tips for evaluating income in credit card applications
- Do not lie about your income, or report inaccurate figures on your credit card application. Credit card rates and spending limits are government-regulated calculations designed to make sure that you can effectively afford the card you are applying for.
- Dishonesty on your credit card application, or even an honest mistake, could contribute to ‘credit card fraud,’ a serious crime. So it is always better to be safe than sorry when filling out your application. One man received $50,000 in fines and another was imprisoned for falsely inflating income on a credit card application.
- It is only risky with no benefit to you to be approved for a credit card that you cannot afford. “This is a crucial issue,” says Eric Tyson, author of “Personal Finance for Dummies.” “You might not intend to carry a balance. But before you agree to accept a card, understand all the terms and conditions because your situation might change … Stay away from ones with exorbitant fees and high late fees, even if the other features seem relatively attractive.”
- With this being said, if your lender wants to assess your current income it can lead to a credit increase, which is a good thing–particularly if you don’t increase your spending after, because then you utilizing less of your total credit, which boosts your credit score.
- If your financials are not looking great however, a credit card company may consider lowering your credit, or closing your account entirely–and it does not need to request your income before doing so.
- Steadiness is key. Make sure that you feel comfortable with your career and your income before applying for a upper-end credit card spending limit.
What types of income count to credit card companies?
As long as you are 21 or older, you can record pretty much any form of income so long as you are able to access these funds. For instance, a trust which you are denied access to until certain events occur will likely not count to many lenders. With that said, any of the following forms of income are generally viewed positively by credit card companies.
- Part-time or full-time income
- K12 income, or investment income
- Alimony or child-support
- Gifts, winnings, or inheritance
- Trust Fund payouts (given reasonable access)
- Pensions and retirement funds
- Social security
- You can count your partner or spouse’s income towards household income
Not all forms of income are created equal however, and many banks and lenders will evaluate sources of income differently. This is a fairly rational system. For instance, lenders will weight a yearly salary of $60,000 much higher than a one-time lottery winning of the same amount. The basic line of reasoning behind this evaluation is risk assessment.
Banks and lenders are trying to evaluate the risk in assuming you will have continued access to the reported income and how you will spend it. $60,000 lasts much longer for some than others. So during the process of evaluation banks and lenders will be asking themselves the following questions:
Is this reported income subject to change in the future?
- Earnings from gifts, winnings, or irregular sources of income will be weighted lesser than regular income.
Will the customer have trouble accessing these funds?
- Trust funds, or even stable income can be gated behind existing debts or bad spending habits.
Does the customer’s spending habits alter the assessment-value of their income?
- If a customer’s spending habits confer financial risk to the lender then they will be afforded a much lower credit limit than typically allotted to their income bracket.
How to calculate your income
When reporting your income on your credit card application, there are some important terms and calculations you should be familiar with. These are industry standards to evaluating and understanding your income, and will help you build a strong understanding of the relationship between income and credit cards.
Important terms for consideration
Weekly income – Weekly income is often considered by lenders when they are trying to decipher how often you will be using your credit card. For instance, individuals on a monthly compensation schedule will be more likely to spend more actively at the beginning of the month when they gain access to surplus funds, rather than at the end of the month. Bi-weekly and weekly earners on the other hand will spend much more regularly.
Monthly income – Monthly income is your gross income divided by 12, and is often considered by lenders when they are try to evaluate spending habits throughout the year. For instance, if monthly income is low and is weighted by a high annual income (through capital gains, investment returns, etc.) then assessors can better predict spending habits based on these schedules.
Annual income – Annual income is your monthly income multiplied by 12, and will be the primary method for evaluating your credit limit.
Gross income – Gross income is defined as your total income before anything is taken out of it, such as bills, expenses, and taxes.
Net income – Your net income is ‘your take home income’ and is your yearly salary minus taxes and similar expenses such as those conferred to a 401(k) account. If your income is set and consistent year over year, it can be helpful to check the previous year’s tax return for your net income.
DTI: Debt-to-income ratio
While banks and lenders will use a variety of methods to assess your income, there is a go-to calculation that will give you a good snapshot of what they will see–known as the DTI. This calculation reveals a simple percentage that conveys the relationship between your income and your expenses and debts, and whether the relationship is healthy or unhealthy.
You calculate your DTI by dividing the sum of your monthly debts by your monthly salary.
- You have a yearly salary of $48,000 communicated through monthly payments of $4,000.
- You have the following monthly debts: a car payment of $400, student loan payment of $150, and rent at $1,200.
- Your debts equate to $1,750 per month.
- This DTI is calculated as follows: 1,750 divided by 4,000
- This DTI would equal out to 43.75%
Credit card companies will tolerate different DTIs according to their specific policies, however a DTI below 43% is typically viewed as strong, because anything above this typically results in a failed mortgage application. Many credit card companies will tolerate much higher DTIs, but this is just one measure to help you get a grip on how your financial health will be evaluated by banks and credit card companies.
Because it is often not worth the time it takes for credit card companies to validate income information for the smaller lines of credit allotted to first time credit card users, many times they will simply refer to an individual’s credit score when evaluating a first-time applicant.
What is a ‘Credit Score’ & How do you check it?
If an individual’s DTI confers the individual’s overall financial strength commuted by their income and expenses, the credit score conveys an individual’s financial trustworthiness and the risk associated with lending them money. If you think about it, the risk of lending someone money really doesn’t have as much to do with their income as it does with whether or not they will pay you back at all–or at least that is the position of most banks and credit card companies.
As discussed throughout this guide, the best way to take advantage of the credit card industry and all it has to offer is to demonstrate a positive history using it. Your credit score is the industry’s standardized method for evaluating your credit-use history and the financial decision making therein.
Why is your credit score important?
- A good credit score will allow many beneficial maneuvers in financial such as earning approval on upper-tier credit cards, mortgages, and other financing options.
- A good credit card will further improve all the terms of these contracts – lower mortgage rates, lower APR on credit cards, and higher credit card spending limits.
- For this reason, a good credit score will save you tremendous amounts of money in the long term if managed well.
- A little-known fact is that employers often consult an applicant’s credit score to get a snapshot of their financial responsibility and judgement making ability.
What determines your credit score?
- Depending on the credit agency scores typically range from 300 to 850 points.
- Overall credit history: how long you have made use of a line of credit, and how well you used it
- Your payment history on any current credit cards (late payments will drop your score, even if they are very low)
- Different accounts accrue credit or penalize credit differently–such as utilities, retail accounts, or credit card accounts
- The total amount of debt you owe (student loans, house payments, etc.)
- Number of credit card accounts and/or applications (if you are constantly applying for new cards, or racking up new sources of debt, your score will drop)
- Any issues with the IRS may also negatively impact your score (unpaid taxes, fees, or penalties)
- The three digit score predicts how likely you are to pay back a loan 24 months after scoring (this is why credit scores are slow moving, because they are risk-assessments of the future.)
What credit limit will my credit score qualify?
(Sourced from Experian and CNN Money)
|781 – 850
|661 – 780
|601 – 660
|500 – 600
|300 – 499
Top 3 credit scoring bureaus
Despite appearing to be a universal number, the credit score is approached differently by different credit bureaus of which there are three. Credit bureaus, which are tasked with assigning a credit score to individuals, should not be mistaken for crediting agencies, which are tasked with assigning credit scores to businesses or debt-based organizations.
The three credit bureaus in the United States are Equifax, Experian, and TransUnion. These three companies are private, but are heavily regulated by the Fair Credit Reporting Act (FCRA). So why are there three credit bureaus and how do they affect the consumer? What are the differences between them? Let’s take a look at these questions, so that you make the best decisions when evaluating your credit score.
Equifax, Experian, and TransUnion
As a first-time applicant of credit cards, what you need to know is that you will rely on one of these three bureaus for your credit report. For all intents and purposes these companies are the same in their approach, but different in their methodology. You might get a slightly different score with one or another, and for this reason you should absolutely pursue a credit report with all three agencies.
While each companies uses the same information to make their calculations, these companies are full of people who make mistakes. It is common for these mistakes to impact your credit score either positively or negatively, which makes it all the more important to verify your score across the three agencies.
One other point of note is that these companies function by a kind of regional superiority. Equifax, for instance, is based in Atlanta, Georgia is the primary bureau in the Southeast and east coast United States. Experian is based in Costa Mesa, California and dominates the western states. TransUnion is based in Chicago and typically manages midwestern regions.
This regional influence is only important to you insofar as you might want to work primarily with the bureau in your area, since they will be more experienced dealing with your local banks, employers, and other financial institutions. Otherwise, you should work with the bureau that provides you with the strongest credit score.
But don’t worry–this won’t cost you any money, at least for the first time. Just hop over to AnnualCreditReport.com and get your first yearly credit report done for free once each year. This process is guaranteed by Federal Law, so be sure to take advantage of it every year in order to stay on top of your credit.
FAQ & Final Considerations
If you have made it this far, then you should be a veritable master of all things credit related. But it is a tremendously deep subject, which is why people can spend their entire lives mastering the credit system in America and still regularly learn new things. So let’s review some final questions and considerations before transitioning to some interesting facts about credit cards and their unique history.
What if my first credit card application got rejected?
- The first major point here is to remain calm; this happens to millions of Americans, and there are some clear and simple steps you can take.
- First, do not apply again and halt the process if you have any other pending credit applications–doing so can further harm you credit score.
- If you have not already, be sure to file for a credit report and do not apply for a credit card again until you have this report.
- Consult the lender on why you were rejected, and see if there is a clear problem. Do not worry if they cannot disclose the reason–a credit report will reveal the issue.
- Takeaway: Chances are there was some small red flag that was missed in your preparations, but is easy to correct. If the problem was a poor credit score or the lack of a score at all, you can take steps to start building your credit immediately. Whether your first credit card application was denied, or if you just want to increase your odds of being approved in the future, you can open a secured credit card–which has a minimal risk of being denied–and start correcting your score immediately.
- Also be sure to change institutions before applying again. Many lenders have underwriters that will view a previously failed application as a red flag. So to increase your odds of being approved next time, change the institution you are applying to, and take your time with the process.
Are there any other ways of building credit when mine is bad?
- Thankfully there are a couple things you can do.
- Become an authorized user – If your parents, spouse, or partner has good credit and a good credit card, you can sign up as an authorized user on their account. This will build a source of ‘trickle-down credit’ from their spending.
- Reduce your DTI – A big limiter on your credit score is whether your DTI is too high. Reduce your debts and prioritize lowering the balance on any existing credit card balances.
- Pay your bills in a timely manner – Bills are a fact of life and the sooner you make paying them in a timely manner your second nature, the sooner financial institutions will take that fact into account when constructing your credit score.
Credit building is a marathon, not a sprint
- Throughout this guide we have come back to some universal rules and ideas, and one of those is that there are no shortcuts when when credit is involved.
- Credit cards are a fact of life. Living a financially smart life will necessarily bring you back to them time and time again.
- While your credit score will be incredibly important at some points in your life, and easy to forget in others, it takes lifelong diligence to reap the rewards. Much like a ladder, if you forget to pay attention to it you might fall and injure yourself. And unfortunately, mistakes in your credit history can take years and years to recover from–much like an injury sustained from a fall.
How did credit cards become a fact of life?
Now that we have brought you up to speed on the ins and outs of getting your first credit card and all the minutia involved, you might be asking yourself, “how did credit cards become so important in the first place?” Understanding the history of credit and credit cards can help you understand how they became a cornerstone of modern economics in America today.
The invention of credit cards
- Believe it or not the history of credit cards does not begin with the first credit card, and in fact, traces back to the first notions of credit in ancient Rome.
- But to keep things contemporary, we see the first traces of modern credit around 1792 in Iraq where farmers negotiated payment terms for purchasing their seed, so that they could pay for the seed after the harvest when their harvest revenue picked up speed.
- In the 1930s the first metal card was minted, and represented a way to track certain membership credits or other purchasing options.
- In the 1940s this idea expanded into a travel credit card where certain airline members were afforded certain luxuries or credits depending on the card they purchased.
- The credit card as we know it–though still lacking magnetic strips–wasn’t developed until the 1950s but as soon as they became accepted into the retail industry they took off, becoming a world-spectacle of financial innovation.
- Before long the credit card became a commonplace occupant of every American’s wallet.
Innovation of credit cards and their reception in America
In the 1980s the credit card took its most significant leap in design and became the ultimate tool of convenience with the addition of the magnetic strip. Now Americans could make a purchase with a single swipe, instead of counting bills and fumbling with pocket change.
Credit card technology saw no more real upgrades for the better part of a decade until EMV chips were first prototyped in the 1990s. Despite the technology existing for some time, the EMV chip was only fully implemented in America gradually over recent years.
Further innovation is moving away from the card itself, and attempts to assign the capabilities of the credit card to things like your iphone or iphone account in technology such as the ‘mobile wallet’. It is safe to assume that we will see further iterations and innovations in the near future.
What was the original purpose of credit cards?
The original iterations of credit cards had less to do with the concept of ‘credit’ as we understand it today, and had more to do with basic convenience. As mentioned before, it was simply inefficient for Americans to carry around cash for large purchases, and the checkbook had its own limitations and challenges.
As the uses for the credit card multiplied, so too did our understanding of the immense potential for ‘credit’ in our transaction-based economy.
The purpose of credit cards today
What if Americans with a strong financial history could spread out the expense of a purchase over time, allowing them to pay as much or as little as they wanted, balanced by a system of interest payments and enforced through a system of strict but fair fines?
This question led to the development of credit cards as we know them today, and the larger credit scoring industry as well. ‘Credit’ in America today functions essentially as a financial health and trustworthiness score–where you have greater opportunities available to you the more healthy and trustworthy your financial history becomes.
The credit system in America offers new routes to success
For all intents and purposes, the credit system in America is a system of financial success that runs parallel to the system of finance determined by one’s salary. The credit system allows opportunities where individuals can overcome salary fluctuations, unsteady pay, or other difficulties through savvy management of credit score and credit cards. While a traditional salary certainly determines vertical financial mobility, the credit system in American determines horizontal financial mobility, that is, what can be done with a certain amount of money.
For example, consider two Americans–one with good credit and one with bad credit. Give them the same salaries and the individual with good credit will be able to do a lot more with the same amount of money. This is financial mobility in action, and it serves as the primary reason why credit cards make such excellent tools for financial success–because they increase the options of what you can do with your money. And in this way, the credit system in America is responsible for much of the economic growth that has established America as a dominant world power, which in turn offers such incredible opportunity for those living here.