Marc A. Hebert's Money Sense: The baby steps toward establishing good creditBy MARC A. HEBERT
August 11. 2018 11:08PM
You may have heard the phrase "establishing a credit history," but just what does this mean? What is credit? Credit usually refers to the ability of a consumer to obtain goods or services before payment based on the trust that payment will be made in the future.
People seek credit for various reasons. Perhaps you are moving into your first apartment and need furniture. Perhaps you have an unexpected expense, such as your car engine dying (by the way, this is also the reason to have an emergency reserve).
You may need credit because you don't have fast access to cash. Using credit wisely can help you improve the quality of your life, overcome financial difficulties, and deal effectively with emergencies.
Each time you make a purchase on credit, you are being trusted to make final payment at some time in the future. Every time you do pay the lender, the more likely the lender will want to do business with you. After all, you have paid as you agreed to do so.
Some lenders report activity to major credit-reporting agencies. With this information, soon everyone will have access to your habits in the form of a credit report. This is what establishing good credit means. This report will be available for other lenders to review.
If you don't pay as agreed, the lender is less likely to want your business. If this is the case and the lender does decide to offer you credit, you will often have to pay more in terms of a higher interest rate. Continuing to not pay your bills or paying them late every time will eventually mark you as a bad credit risk. Negative activity will be reported to the credit reporting agencies as well. This is not a reputation you will want to have.
So how exactly do you build a good credit reputation? Here are a few hints to get you started:
The first step is to get employment. Lenders like to see some form of continuing and predictable cash flow. Without a cash flow, those regular payments that lenders like may just not be there.
Next, start with borrowing a small amount. If you start small, a lender's exposure to loss is not as great, so they may be more willing to lend to you. Perhaps you might initially ask for $400. Pay this off promptly and then apply for another slightly larger loan. Pay this one off promptly as well. By borrowing and paying off as expected, eventually you will build a trustworthy credit relationship with this lender.
If you are working with a lender that reports to a credit-reporting agency, the positive activity will be reported on your credit report. This will inform other potential lenders that you are a good credit risk.
Another option is to choose a credit card with a low credit limit. Sometimes major credit card companies will offer small lines of credit to groups, such as credit union members. If you belong to the group, consider getting a card, using it, and once again paying the balance off promptly. This activity will show up on your credit report.
Many retail stores issue charge cards. If you are making a purchase anyway, consider signing up for a card. Just be aware that this interest rate can be high and the credit limit low. As with all credit, use it responsibly.
Another suggestion is to make a large down payment. If you are making a large purchase, such as a car, consider saving and making a large down payment. Since the amount you will borrow is less when making a large down payment, the lender may be more inclined to lend you the money.
Marc A. Hebert, M.S., CFP, is a senior member and president of the wealth management and financial planning firm The Harbor Group of Bedford. Email questions to Marc at email@example.com. Your question and his response might appear in a future column.