Clearly, you’re reading this because you have a goal in mind: establishing or building credit.
Luckily, you’ve come to the right place!
Credit doesn’t have to be something scary or unknown or “dangerous.” Before we get into this simple way of building your credit, you first have to understand what credit is, and what it means for your financial future.
Credit, put simply, is just a measurement at how good you are at paying back money. When you use a credit card, you are using the bank’s money to buy something. All they care about is that you 1) don’t use too much of their money at once, and 2) pay it back. Let’s dive deeper into these two concepts.
1) Don’t use too much of their money at once. This isn’t literally a rule, because you technically can spend money right up to the limit of your credit card. However, that doesn’t mean you should. Ideally, you want to spend less than 1/3 of your credit card limit. Using only 10% of the amount is even better. This will boost your credit score and show that you’re responsible with your money.
2) Pay it back. The bank will lend you their money and allow for you to pay it back over time in payments smaller than the initial amount you charged to your card. The caveat here is that interest accumulates on your balance. The amount of money that is added on from interest depends on the interest rate on your card. (The interest rate is a percentage of the amount you owe that is added on, increasing the amount you owe. The interest does not go towards your outstanding balance, otherwise known as the principal. The interest you pay is money you’re giving to the bank since they let you borrow theirs.) Interest may seem scary, but there is a way to avoid it! Since interest is added on in cycles (usually monthly), if you pay the amount you owe before the cycle is complete you don’t owe the bank any extra.
For example, if your statement balance is $100.00 and it is due on the 30th of the month, but you pay the $100.00 before the 30th (let’s say you pay it on the 25th of the month), then you only pay the $100.00 that you charged to the card, and you don’t owe the bank money that you didn’t spend.
So, now that we know the very basics of how a credit card works, and we know it is in our best financial interest to pay off the card before it’s due to be paid, what is the best way to start building credit?
My answer (as well as many other financial gurus) is to open a secured credit card. This card works a little bit differently from an unsecured credit card.
An unsecured credit card is basically a card that has the bank’s money on it and none of yours- so you are borrowing from the bank, then paying them back. If you don’t pay off the card within a certain time frame (like missing multiple payments), your credit can plummet and you have to figure out a way to get their money back to them.
A secured credit card works differently, because your credit limit depends on how much of your own money you let the bank hold on to. You will give the bank some of your money, kind of as an insurance for them. In case you don’t pay them back, they’ll pay themselves with the money you gave them when you opened your card. You don’t want to ever have this happen, but the absolute worst case scenario doesn’t leave you on the verge of financial havoc. Assuming everything goes smoothly as you have the card, whenever you’re ready to close the account for the secured card you get the money back. It serves as insurance for the bank, and they don’t need it anymore if you’re not using their credit card.
This card is good for a couple of reasons:
- Your limit depends on how much money you already have. This is good because you can’t spend you don’t have with a secure card. If you give them $500.00, then your limit is $500.00. You won’t have that $500.00 in your pocket for as long as you have the card open, so you’ll still make monthly payments. But as you learned earlier, you will get that money back when you close that account.
- Because you have to give the bank your money upfront, you have a much higher chance of being approved for a secure card. With unsecured cards, the bank really has to trust you- and if you don’t have the credit score or history to gain that trust, you application for a card can be denied. With a secure card, since you’re giving them your money up front to be able to open the account, the bank is going to be much more trusting of you (and even if they don’t trust you, they have your money incase you don’t pay them back theirs). This gives you good chances of being approved, meaning you’ll be able to start on your credit building journey!
While you still treat a secure card as an unsecured card, it is a helpful tool to use as a stepping stone into building credit.
Now, what are you waiting for? Get started on building your credit today now that you’re well equipped with the tools for success!
An Olive Writes 