Credit

Avoid debt. Consumer debt, acquired through credit cards and auto loans, is especially bad. It usually has a high interest rate and was used to purchase depreciating assets. That's a financial loss.

There are a few “good” forms of debt, though. Student loans toward a degree that leads to a lucrative job, for example, are usually worthwhile. A home mortgage is also often good debt, though there are exceptions.

For these rare occasions when taking on debt is worthwhile, you should seek to minimize the loan's interest rate. Your interest rate, especially for mortgages—and whether you can get a loan at all, in fact—often depends on your credit history.

Your credit history is stored by credit bureaus (technically consumer reporting agencies, or CRAs), which are independent businesses with no government affiliation. There are four significant ones—Experian, Equifax, TransUnion, and Innovis. They're under-regulated scoundrels with a history of terrible security practices, but you'll have to deal with them from time to time.

Monitoring Your Credit

So, how can you check your credit history? It's obnoxious, but necessary.

By law, each bureau must allow you to see their record of your credit history once per year for free. The easiest way is to request this is through annualcreditreport.com.

You'll want to take advantage of this. It's easy to forget, so I have an annual recurring alert set on my calendar to remind me.

If you're monitoring your credit especially carefully (perhaps you think someone is trying to take out a loan in your name, or you're considering a mortgage in the near future), you might consider staggering your reports. You can do this by rotating through the three major bureaus (TransUnion, Experian, and Equifax) and requesting your credit history from one of them every four months. This ensures that you're still only requesting one report from each of them each year, but the same item often appears on several reports, so this can give you slightly more information.

A lot of people use a free third-party service, like Credit Karma or Credit Sesame, to monitor their credit for them. These services perform regular “soft pulls” on your credit records (which means that the checks don't appear in your history), and provide week-to-week estimates of your credit score. Their business models involve affiliate marketing for mediocre credit cards. I wouldn't suggest using these sites as a substitute for getting your annual credit report, but they seem to be a convenient and relatively harmless supplement.

Your Credit Score

Since it's awkward to deal with a credit history in toto, it's often reduced to a numeric credit score. Scores range from an abysmal 300 to a stellar 850.

Each of the credit bureaus uses their own proprietary, secret algorithm to calculate your credit score, and bureaus may have different information, so you may find that your score varies slightly between agencies.

The FICO model is widely used for calculating scores, and the algorithms that bureaus use seem to be variants on it. The factors that FICO considers, from most to least important, include:

  • Your payment history—have all of your payments been on time?
  • The fraction of available credit you're currently using—less is better. If you have a $500 balance on a card with a $5,000 limit, for example, you're utilizing 10% of that account's limit.
  • Average age of your accounts—a longer credit history is better.
  • Variety of accounts (credit cards, auto loans, student loans, mortgages)—a wider variety raises your score.
  • How often you seek credit—applying for credit temporarily lowers your score a bit.

Building Your Credit

You'll probably need to take on some debt in the future, so it's worthwhile to ensure that your credit score is high enough.

What's “high enough” mean? To get the best rate on a mortgage, a score of 750 is usually sufficient. There's certainly no harm in raising your credit score past that point, but it's not really necessary.

For the purposes of building up your credit score, I'd suggest that you get a credit card if you don't already have one. Use it sparingly and pay it off every month.

For more information, the r/personalfinance subreddit has a terrific guide to building your credit.

Most companies have an “autopay” feature, which can be used to automatically pay off the whole balance on time every month by deducting it from your checking account. Set that up. It'll make it impossible to forget a payment.

Additionally, my bank (Ally) allows me to set up an automated overdraft protection system. If a charge overdrafts my checking account, the bank will automatically (and without a fee) pull money from my savings account to cover that charge. I keep a fairly close eye on my finances, so I haven't had to rely on this yet, but it gives me a little peace of mind to know that it's there.

If you find that having a card is causing you to spend more, stop using it! Put it in a drawer, or cut it up and throw it away, if you have to. Keep the line open, though, since the number and average age of accounts contributes to your score.

How Much Does Credit Matter?

Your credit score almost never matters—it's only really important when you want to secure a loan, which should occur rarely.

This point is important, so I want to re-emphasize it: your credit score only matters when you need to get a significant loan (notably, a mortgage). It's otherwise almost useless as a measure of your financial health. Don't obsess over it.

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