Establish good credit now for future success.
Credit is a vital component of any good financial plan. While it may seem intimidating, a healthy credit history will ensure your ability to graduate with a credit score and background that make it possible to start post-Princeton life on a good foot. A great credit score, for example, will enable you to rent an apartment and finance a car with favorable terms. A basic understanding of how credit works and a solid management plan are all you need.
Credit Report vs. Credit Score
You may have already heard these terms related to credit and financing and, while related, they are two different concepts. A credit report is a detailed report of your credit history. It contains your personal information, employment information, and the status of all open (current) and closed (past) credit accounts. This report can be used by potential lenders, landlords, and employers as a test of creditworthiness. The information within your credit report is tracked by three major credit bureaus: Equifax, Experian, and Transunion. While your report from each of these bureaus is likely to be similar, there may be differences, so it is a good idea to review your report from each bureau. You may obtain a free copy of your credit report three times a year, once from each bureau, by visiting www.annualcreditreport.com.
A credit score is a numerical value assigned to you primarily based on your credit report; it provides a snapshot view of your credit at one point in time and can go up and down. The most common scoring model is the FICO score, which ranges from 300 to 850. A higher score reflects better creditworthiness and lower risk of defaulting on a loan. With a higher score, you may be able to negotiate lower interest and other favorable terms when borrowing in return for the lower risk you present to lenders. This is useful when thinking about graduate school, auto loans, insurance, and mortgages.
How Can You Build Credit?
The simplest way to begin building your credit history is to apply for a credit card. The bank or credit union where you manage your checking and savings accounts may have credit card options geared toward students. Making modest purchases and paying off the balance in full and on time each month will build your credit history while avoiding interest. In contrast with a debit or check card, when you use a credit card, money is not immediately taken out of your account, so you must be able to keep track of your spending to successfully use a credit card. Before applying for a credit card, create a budget that you would be comfortable working with each month.
What Affects Your Credit Score?
To calculate your credit score, bureaus utilize a mix of factors to measure your risk.
- 35% Payment History—This is the most heavily weighed component of your score and essentially measures if you make your payments on time. Late payments, no payments, and other negative factors will decrease your score. The easiest way to increase your credit score is to make consistent and on-time payments.
- 30% Debt Burden—How much debt do you have? This measures the number of accounts with balances, the amount you owe across accounts, how much you have paid down on loans, and your debt-to-credit ratio. Your debt-to-credit (or debt-to-limit or credit utilization) ratio measures how much of your available credit you are using (amount owed ÷ total credit limit). If you regularly max out your credit card, for example, you will have a high credit utilization ratio. This can make you appear too dependent on credit and lower your score. Some guides recommend a utilization ratio of below 30%.
- 15% Length of Credit History—This is simply a measure of how long you have had a record with the bureaus; it measures the average age of your open accounts and the age of the oldest account. Lenders like to see borrowers have had long relationships with other lenders; this is why it can be a good idea to get started now.
- 10% Type of Credit—Your credit mix measures the different types of credit accounts you have open. Revolving credit, such as a credit card, is an account on which you have a pre-approved limit from which you can withdraw, repay, and withdraw again any number of times. Installment credit, on the other hand, has a fixed number of payments until the loan is paid off; an auto loan is an example of installment credit. Having a good credit mix demonstrates the ability to manage different types of credit.
- 10% Credit Inquiries—Any time you apply for a new credit card or loan, a "hard inquiry" is performed, and your score can drop several points. If done repeatedly, this can have a drastic effect on your credit score. There is some relief though; if you are shopping for a car, for example, and want to search for the best rates, multiple inquiries within a short period of time will count as just one hard inquiry. Note that pulling your own credit report is a "soft inquiry" and will not decrease your score, so feel free to continue to monitor your credit.