How to Build Your Credit

April 20, 2009

As many of you are aware, I have been harping on how low mortgage rates have been over the past few months and how much of an opportunity we all have to lock in a long-term low interest rate right now. So let us assume you have decided to heed my advice, gotten all of your ducks in a row, and have gone to the bank or mortgage lender to negotiate a refinance. BAM! They offer you a refinance somewhere between 5.5% and 6.5%. But, but, but…. Brian, I thought you said mortgage rates were around 4.5% to 5%?

What has more than likely happened is that potential lender has pulled your credit report. Credit report? Well, Brian, I’m not a bad person. I’ve never stolen anything from anyone. I pay all my bills on time for the most part. Why are you mentioning credit report to me? The reason is because that small little number, aka your FICO credit score, affects every single one of us, good or bad.

Because of this, I feel that it is appropriate (especially since you, my listeners, are the cream of the crop) to share some tips with you to ‘outsmart’ the system. Basically you credit score is a mathematical equation composed of five parts. Those five parts are:

  1. Payment History
  2. Debt Level
  3. Length of Credit History
  4. Type of Credit
  5. Credit Inquiries

As you listen to the show, I will go through each one these as well as explain how much of an impact it has on your credit score. Listen for some of these high points:

Payment history     35%– Obviously lenders (credit card companies, mortgage companies, banks, etc.) are concerned with whether or not you will ever pay them back. There is not a truer indicator of your probability of repayment than how you have paid back debt in the past. For a moment, though, let’s assume you don’t have a blemish free credit history. Then what do you do?

Debt level     30% – The next largest component of your credit score is determined by your debt level. Another term for this is your debt-to-income ratio. Assume for a second that you have two individuals. Individual A has $2,000 in credit card debt and if he gets to $2500, his credit card will be “maxed out”. Let’s also assume Individual B has $2,000 in credit card debt, but his credit card doesn’t max out until it reaches $10,000. Which one of these two people would you feel more comfortable lending to: the one utilizing 80% of his available credit or the one utilizing only 20% of his available credit? Even though they have the same exact amount of debt, you can see how different this looks to the lender. So what should a young individual do? Always try to make sure that the amount of debt you are carrying is less than 50% of the total debt available to you.

Length of Credit History     15% – This may be the most difficult part for young people trying to establish credit. 15% of your overall credit score is comprised of how long you have actually been using debt. The easiest and most affective way to always keep this 15% working on your side is to keep open the first credit card you apply for. Even though it may have been that Macy’s retail card back in college and you don’t even use it anymore, cut it up, throw it away, and forget about it, but DON’T close it. The longer that account stays open (assuming there are no annual fees or inactivity fees) the higher your credit score will be.

Type of Credit     10% – The type of credit you have accounts for 10% of your credit score. This shows lenders that you have the ability to manage different kinds of credit. The two basic forms are open-ended and close-ended. Open ended credit is credit that can fluctuate or “revolve” such as a credit card or a home equity line of credit. Closed end credit is credit such as an auto or home loan and does not vary overtime.

Credit Inquiries     10% – The final piece of the credit score puzzle is credit inquiries. These are basically your applications for credit. Too many can harm your credit score. Having a retail credit card to every store at the local shopping mall isn’t going to look good to lenders. But what about the ‘pre-approved’ credit card offers? Don’t they say that they’ve already looked at my credit account and I’ve been approved? Yes, they do, but these are known as ‘soft’ inquiries and do not count against your credit score.

One other key point to note when considering your credit score is that good information never revolves off of your credit report, but unfortunately, it can take bad information, such as one late payment, up to 7 or 10 years to finally go away. Be sure to keep this in mind when deciding how you are going to utilized debt in your own personalized financial plan

If you do not know what your credit report looks like, you should know that you are entitled by law to one FREE credit report from each of the three credit reporting agencies (Experian, TransUnion, and Equifax) each year. Although there isn’t a catchy jingle or any well-made commercials, the website to access these free reports is actually www.annualcreditreport.com.

FILED UNDER: Featured, Podcasts

Most Recent Episodes

Dave Ramsey vs. The Money Guy: Which Strategy is The Best?

Dave Ramsey has an incredible legacy of helping folks get out of debt and take control of their financial lives. We agree on a lot of things, but there are a few points of contrast. In this episode, we’ll discuss differences between The Money Guy Show and Dave Ramsey...

Top 4 Financial Mistakes We Saw This Year! (2022)

We saw some wild financial mistakes this year during the bear market. From making extreme changes to portfolio allocation, chasing the hot dot, and using too much leverage, we’ll talk about some of the biggest financial mistakes we saw in 2022 in this episode.   In...

How Millionaires Build Wealth! (With Dave Ramsey)

Join us for a very special episode as we welcome personal finance radio host and influencer Dave Ramsey to The Money Guy Show! There’s so much misinformation out there about building wealth. We had the pleasure of having a great conversation about how millionaires...

Do These 4 Things with Your Finances BEFORE 2023!

There are unique financial opportunities available at the end of the year - especially this year with the market down. In this episode, we’ll talk about what you need to do with your money BEFORE 2023! In this episode, you'll learn: What you need to do with your money...

How to Win When the Financial World is Burning!

Lately it’s felt like the financial world is in chaos, with rising interest rates, a falling stock market, and high inflation. Let’s talk about how to focus on what you can control and how to minimize the time spent worrying about what you can’t control. In this...

Financial Advisors React to RIDICULOUS Money Advice on TikTok!

The most powerful time to get serious about building wealth is when you’re young. So, what is the younger generation learning? Financial Advice (good and bad) is being produced in massive rates across online platforms and TikTok is the new frontier. Is there good...

Loss Harvesting: Why Wealthy People Love It (And You Should Too!)

Tax-loss harvesting: what is it and should you be doing it? In this episode, we’ll cover everything you need to know about tax-loss harvesting, including whether it makes sense for you, how much it could save you in taxes, and how to eliminate the downside of loss...

The Market is Crashing! (Where Should You Put Your Money?)

The stock market has not had a great year so far. You might be asking yourself, “Since the market is crashing, where should I put my money now?” In this episode, we’ll discuss how to invest when the market is dropping and how to make the most of your money. In this...

Will Rising Interest Rates Tank the Economy?!

The Federal Reserve is raising interest rates to combat inflation, and many are concerned about how it will affect the economy. In this episode, we’ll discuss what rising interest rates means for your wallet and how to make the best of it. In this episode, you'll...

How to Be Wealthy By Age! (Can You Catch Up?)

How much does it take for you to meet your retirement goals by age, and what are some common traps your peers fall into? Learn more about how to be wealthy, mistakes to avoid, and exactly what a little extra saving can do for your retirement income. In this episode,...