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It's ironic how often we get ourselves into trouble by failing to exercise common sense, despite the fact that from the time we are children through our advancing stages of life, there is always someone offering us common-sense advice in the form of a maxim or parable. Who hasn't been counseled "Don't count your chickens before their hatched," "It's better to be safe than sorry" or "Don't bite the hand that feeds you?" When it comes to finances, there is no shortage of common sense advice on prudent savings and investing, from "A penny saved is a penny earned" to "Don't keep all your eggs in one basket."
No doubt, each of us has been given advice on just about any conceivable situation or scenario we are likely to face in life, except when it comes to one of modern life's mysteries - credit. Most people haven't a clue about how credit works, yet credit - and more particularly our credit history and credit reports - impacts our everyday lives, from the way we live to the decisions we make. While most people understand it is advantageous to have good credit, going about achieving and maintaining good credit is one of the rare instances where there isn't an abundance of good advice available. Ironically, the key to doing so comes down to simply exercising good, old-fashioned common sense.
Key 1: Pay you bills on time
While it might seem a rather rudimentary piece of advice, this is by far the most important key to maintaining good credit. Failing to pay on time and as promised, according to Evelyn Chase, a Denver-based CPA and personal finance consultant, is the number one "negative factor" reported on individual credit reports. "While non-payment of obligations is more of a negative factor and will result in worse damage to one's report, paying debt obligations late is still a close second in terms of how it adversely affects individuals' credit reports," she says.
Chase suggests that you take advantage of automatic payments and other online bill payment strategies offered by lenders and credit card issuers in order to ensure timely payments. If you do forget to make a payment, she suggests you promptly notify the creditor and quickly act to rectify the situation. Whatever the situation, she warns that you don't ignore creditor notices regarding late- or non-payments.
Key 2: Build a strong payment history
Late and non-payments are two of the most common items that are reported to the credit agencies, yet they are the two factors you have the most control over. You can avoid these adverse conditions by making on-time payments. Another key to building a strong credit history includes establishing a pattern of paying off large credit card balances "in full" each month, which conveys a sense of responsibility for your debt obligations. A good way to implement such a strategy is to begin charging everyday living expenses on your credit card, while at the same time deducting the charged amount from your checking account and then paying off the monthly credit card charge in full each month.
Key 3: Limit the number of cards you carry
As a general rule of thumb, you should limit yourself to 3 - 4 cards maximum. This number allows some flexibility in your spending (use of specific cards for specific spending) while allowing you to maximize perks or benefits (points, cash back, rewards, etc.) associated with many credit cards nowadays. On the flip side, maintaining a large collection of cards is likely to hurt your credit rating.
Key 4: Limit the amount of overall credit you use
A key consideration for creditors is an individual's debt-to-income ratio, which measures one's ability to meet their debt obligations. As such, excessive loan balances skew the ratio, in turn negatively impacting your credit rating and scaring off creditors. To avoid this, pay down existing loan balances as quickly as possible and make it a habit to limit the number of credit card and loan accounts you take out.
Key 5: Avoid maxing out available credit limits
Another key consideration for creditors is the percentage of credit available that you are using. Maxing out available credit limits signals perspective creditors you are not using your available credit wisely and/or are likely to be overextended with regard to your debt load. In either case, your credit score will be adversely impacted and potential creditors will be less likely to offer credit with good terms. A good rule is to keep balances at less than 30 percent of the available credit line. Even if that is not possible at any given time, you certainly don't want to exceed 60 percent on the high end, as doing so will drive down your score and send up red flags to potential lenders.
Key 6: Limit inquiries on your credit report
There are numerous situations where a company will request a copy of your credit report from one of the national reporting agencies. According to Chase, these can include companies with whom you're requesting credit, insurance companies, contractual service companies, utilities companies, potential employers, etc. When such a request is made, a credit inquiry will generally be recorded on your credit report by the agency who received the request. She cautions that too many such inquiries within a short period of time will drive down your credit score. "It's sort of a catch-22 with inquiries. You want to shop around to ensure you get the best available deal, but doing so sends a message to potential lenders that you are looking for credit," Chase notes. Her advice - only seek credit when you need it and don't get caught up accepting credit offers just because they're available.
Key 7: Review your credit report annually
Errors within credit reports have always been a problem, despite the best efforts of the major reporting agencies. Estimates range as high as eight in 10 reports containing errors of some sort. Ultimately, it is up to the individual to monitor their reports to ensure the information contained is accurate. Inaccurate or missing information can cost an individual in the form of denied credit or credit offered at higher rates than the individual might actually merit.
Chase actually suggests more frequent monitoring to guard against identity theft. "Unlike a lost or stolen credit card, where you know there might be a problem, identity theft can go on undetected for months or longer," she cautions. "Unfortunately, the longer the identity theft continues undetected, the worse damage is inflicted upon the victim's credit, which can sometimes take years to clear up."
