(If you’re in a rush, scroll to the bullets at the bottom of the page for the main takeaways of this article.)
(If you’re already excited and ready to apply for a credit card, click here for our article on travel hacking and making thousands of dollars with credit card sign-up bonuses and rewards.)
Though it may sound strange, being a frugal, responsible consumer who only spends money you actually have may actually harm you in the future. Shunning the use of credit cards and using cash/debit cards exclusively might feel like a wise decision, but it can set you back in the long run.
Applying for and using a credit card at a young age allows you to begin building your credit score well before most of your peers and creates the foundation for you to borrow more money at lower rates later in life, qualify for cards with lucrative benefits, and achieve an impressive credit report for future employers who run credit checks.
Credit Cards: An Overview
Credit cards bring instant, short-term loans that you accept each time you swipe. When you buy a $100 pair of shoes with a credit card, the card company actually pays for the shoes for you. Then, at the end of the month, they send you a bill for the amount that you ‘spent’ with your credit card. You’ll then have about a month to pay back the card company before they start to charge you interest. Make sense?
What may already be obvious is that making your purchases with a credit card is virtually no different than doing so with a debit card as long as you don’t spend beyond your means. If you only spend as much as you know you could afford to spend with cash or a debit card and you pay off your credit card in full each month, you won’t be taking on excessive risk or paying any interest.
In fact, by using a credit card, you are reducing your short-term risk in a major way: if someone steals your card and spends $1,000 on it, you will not have lost any money. It’s the lender’s money that has been spent, not yours. It’s usually the card company’s burden to find the burglar or else bear the financial cost of the theft. Credit cards are well known for their solid fraud protection and automatic travel insurance.
Other than that…
Why do I need to start thinking about credit right now?
Credit cards matter to you right now because they are the best way to start building your credit score. What’s my credit score, why should I care about it? Slow down, for Pete’s sake, and stop asking so many questions (don’t tell Pete). We’ll explain that quickly and fully in about 7 seconds.
As you grow older, your financial burden gets heavier. Mom and Dad stop paying the phone bill, insurance, rent, car, everything. So, when you want to make grown-up decisions that involve money (and most of them do), you’ll be at the mercy of insurance companies, banks, phone service providers, etc. They get to set prices and rates based on how much they feel can trust you. To determine your trustworthiness and what you will pay, they run a credit check. They look at your credit report and decide whether you are a trustworthy consumer who deserves a low price or rate.
Let’s say you approach a landlord to rent an apartment. That landlord will take your social security number and pull your credit report. If he finds that you only have a one-year history of responsibly paying bills, he won’t trust you as much as he would someone with a ten-year credit history. Alternatively, if you have a long credit history but a record of missing payment deadlies, you will appear untrustworthy.
If you approach an insurance company hoping for a policy, they have the power to determine what you’ll pay based on aspects of your credit history. If you want a loan from a bank for a house, apartment, car, etc., they will look at your credit score to determine the interest rate they charge you. Even potential employers will run credit checks on job applicants. Despite the fact that credit history does not have a proven correlation to job performance, 47 percent of employers use credit reports when making a hiring decision, according to a 2012 survey by the Society for Human Resource Management.
Credit card providers even run a credit check on you when you apply for a credit card! There are entry level cards for people with no score, and those will be the ones for which you’ll be initially eligible.
As you can see very clearly, building a strong history of paying bills on time, not abusing your lines of credit, etc. is extremely important. Earning a high credit score, and therefore proving your trustworthiness as a consumer, brings wide-reaching benefits that affect both your financial well-being and your ability to freely make decisions concerning your lifestyle.
As you develop a strong credit score over a couple of years and for the rest of your life, you will become eligible for credit cards that offer huge monetary benefits for signing up. You will be offered lower rates by banks who loan you money. You will potentially be offered a job you wouldn’t have gotten if it weren’t for your impressive credit history.
And what exactly are credit scores?
There are three major credit bureaus in the U.S: Equifax, TransUnion, and Experian. You have the right to view your credit report from each of these companies once each year for free. This website will allow you to do so. That’s your official report. Other sites will show you your score for free more frequently, but those educational scores (which are derived from your report) are typically just close, reasonable guesses.
Mint offers updated Equifax scores quarterly, and Capital One and Credit Karma offer you updated scores each week. Don’t get bogged down in which score you’re looking at: there are hundreds of scoring models, and each lender works in its own way.
Credit scores measure*, among other things…
- Have you paid your bills on time? You can count on payment history to be a significant factor. If your credit report indicates that you have paid bills late, had an account referred to collections, or declared bankruptcy, it is likely to affect your score negatively.
- Are you maxed out? Many scoring systems evaluate the amount of debt you have compared to your credit limits. If the amount you owe is close to your credit limit, it’s likely to have a negative effect on your score. Try to keep your credit utiliztion ratio below 10%.
- How long have you had credit? Generally, scoring systems consider your credit track record. A young credit history may affect your score negatively, but factors like timely payments and low balances can offset that.
- Have you applied for new credit lately? Many scoring systems consider whether you have applied for credit recently by looking at ‘inquiries’ on your credit report. If you have applied for too many new accounts recently, it could have a negative effect on your score. Every inquiry isn’t counted: for example, inquiries by creditors who are monitoring your account or looking at credit reports to make ‘prescreened’ credit offers are not considered liabilities.
- How many credit accounts do you have and what kinds of accounts are they? Many scoring systems consider the type of credit accounts you have. It’s generally recommended to have a diverse collection of accounts- credit cards, auto loans, etc. But, in our opinion, most debt is bad debt, so if you can avoid it, do. Especially credit card debt.
It is difficult to build a solid credit score quickly because of the overarching element of time, which is the reason to start building credit as early as possible.
Are credit cards the only way to build my credit score?
It’s virtually free– in terms of both money and effort– to start building your credit score with CCs. If you’re older than 18, then you should go ahead and apply for one. If you aren’t approved or denied immediately online, you’ll usually hear back in about a week via old-fashioned mail. Because you have either no credit score or an underdeveloped one, you’ll need to apply for entry-level credit cards.
- Beginner cards include the BankAmericard Better Balance Rewards Credit Card. We recommend this card with extreme optimism because it issues you up to $120 per year as a statement credit for just using the card once a month. (You have to pay off more than the minimum amount required each month, too).
You could subscribe to Netflix, which will automatically bill you each month on your BankAmericard, and the card will pay for your subscription. If you’re reading this article, chances are you aren’t spending enough on a card (roughly 12,000/year or more) to beat these benefits with a more elite credit card (which would also carry an annual fee, unlike this one).
2. If you aren’t ready to apply for your own credit card or are younger than 18, then another great way to build credit is to become an authorized cardholder on a parent’s account. You’ll be issued your own plastic rectangle with your name on it. As you spend on the card and your parent pays off the card each month, your credit score will be improved. Remember, though, that if your parent misses a payment, this will negatively impact your credit score as well as theirs.
3. Finally, pay all of your other bills on time. These could be traffic tickets, rent, internet bills, etc. Anytime someone has your name and/or social security number and you owe them money, pay them on time. Having a credit history isn’t the only goal: it needs to be a good history. Remember, your credit score is what proves that you can be trusted.
You know yourself better than anyone. Never apply for a credit card if you do not feel confident that you can refrain from spending beyond your means. Many credit cards will be issued with automatic credit lines of $10,000, even for young people with limited credit history! If you suspect, even a little bit deep down, that you may overspend when provided with such financial power, don’t apply for a credit card.
Being financially secure can be a powerful stress-reliever, but being in debt, or being financially extended outside of your comfort zone, can bring ten times the stress that money could ever relieve. Sorry to get serious, but these are powerful financial strategies. When they are misused, the lessons learned are just as powerful, but not in a pleasant way.
- Developing a credit score at a young age is most easily done by using a credit card.
- Doing this will provide you with the power later in life to pay cheaper rates, access more lucrative credit cards and cheaper loans, and negotiate payment structures that can save you tens of thousands of dollars.
- Potential employers often review your credit report (though not your credit score) when considering you as an employee, despite the fact that it is a groundless and harmful practice.
- There are also ways to make thousands of dollars per year by earning points and sign-up bonuses with elite credit cards, of which we’ve written an overview here.
What do you think? Let us know in the comments!
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