Key takeaways
- Having good credit helps you get better rates on mortgages, car loans and other debt products, and may affect your ability to rent an apartment or sign up for utilities and other services.
- To build good credit, you need to use your credit — but you don’t want to go into debt along the way.
- Fortunately it is possible to increase your credit score without incurring unnecessary debt and to learn how to build credit without paying interest.
Your credit score is one of the most important numbers in your financial life. It’s a key factor in whether you’re approved for loans and lines of credit, along with the interest rates you’ll be charged. This has become even more important the past couple of years as the Federal Reserve has raised interest rates to fight inflation and lenders have tightened their underwriting standards in response to rising delinquencies.
Unfortunately, 49 million U.S. adults (roughly one out of every five) can’t be scored by the most common credit scoring algorithms, according to Experian. That’s because they don’t have enough credit information on file.
How credit scores are calculated
There are a few different details that go into calculating your overall credit score — the number lenders use to determine your creditworthiness.
FICO (the Fair Isaac Company) created the most widely used credit scoring formula. The most important factor in your FICO score is payment history, which makes up 35 percent of your score. It’s followed by how much you owe (30 percent), the length of your credit history (15 percent), your credit mix (10 percent) and how much credit you’ve applied for recently (10 percent).
In general, it’s best to pay your bills on time, keep your debts low and show that you can successfully manage various types of credit over the long haul (without applying for too much credit in quick succession). These are the habits that can help you build and maintain a great score.
Credit scores are widely used by lenders and are generally viewed as a reliable predictor of whether a prospective borrower will repay their financial obligations in a timely manner. Your credit score is similar to a student’s standardized test score, like an SAT score on a college application. But just as some people feel standardized testing is not an accurate barometer of academic prowess, credit scores have their detractors, too.
Why some people cry foul about credit scores
One of the most prominent naysayers of credit scores is Dave Ramsey, the bestselling author and anti-debt crusader.
As his organization’s website puts it, “Remember, when it all comes down to it, a credit score is really just an ‘I love debt’ score. That’s right, a ‘good score’ simply shows how well you’ve played the debt game. It doesn’t reflect your actual net worth or the amount of money you have in the bank. In other words, it’s really nothing to be proud of. The only way to keep your stellar credit score is to live in debt and stay there — no, thanks!”
While there is some truth in some of those statements, there are also a few questionable assertions that deserve a deeper examination. Building your credit score without taking on debt is entirely possible. One way to do this is by responsibly using a credit card, paying your balances in full each billing cycle to avoid interest. Starter credit cards, like student, secured, or retail credit cards, are good entry points into the credit card market. Another option is to become an authorized user on someone else’s credit card account to jumpstart your credit score.
Alternative credit monitoring programs, credit-builder loans, and platforms like Kikoff can also help you build credit without accumulating debt. These methods focus on incorporating existing payments that are not traditionally included in credit reports, saving money over time, or creating a “loan” without a credit check. By using these strategies, you can improve your credit score without taking on any debt.
Maximizing Your Credit Score
One key factor in improving your credit score is having available credit and using only a small portion of it. This practice looks favorable to credit scoring algorithms and can help boost your score.
Why Your Credit Score Matters
Whether you’re seeking a loan, credit card, or even an apartment rental, your credit score plays a crucial role. Lenders, landlords, and even employers may check your credit report to assess your creditworthiness. A strong credit score can open doors to better opportunities, while a low score can lead to rejections.
Regularly monitoring your credit and following strategies to improve your score can make a significant difference. By being proactive and making smart financial decisions, you can enhance your creditworthiness without spending a fortune.
Do you have questions about credit cards? Feel free to reach out to me at ted.rossman@bankrate.com for assistance.
*Please note that the information regarding the Tomo Credit Card has been independently collected by Bankrate and has not been reviewed or endorsed by the issuer.