Did your parents have two “little talks” with you? If so, the first undoubtedly had to do with, well, we don’t have to tell you what it was about. But if you were lucky there was a second “little talk” about personal finance. Your parents might have warned you about not creating debt, about saving and investing and maybe even about the importance of budgeting. But even that talk about personal finance probably did not include some very important lessons about credit. Or maybe they did talk to you about credit but you just sort of tuned them out because it was boring or you didn’t feel it was really something you needed to know. In either event, here are six credit lessons that your parents probably forgot to teach you that you really should know.
Just a half-a-percentage interest rate reduction does matter
Your parents might not have told you this but when it comes opening a line of credit it’s possible to negotiate a better interest rate. You might not get exactly what you ask for but you and your lender could end up with an interest rate lower than what you were originally offered. This is a case where just a .5% interest rate reduction can actually make a difference. As an example of this, if you applied for a $1000 loan at 17% but then negotiated this down to 16.5%, you would save five dollars a month. That’s a beer, a latte or in 12 months, a pair of shoes.
Paying interest can be really, really painful
It’s just not fun having to make monthly credit card payments. But it becomes much more painful when you add interest to your balance. Most credit cards today have an interest rate above 12%. If you make just the minimum payment or, worse yet, carry balances forward from month-to-month it can get really painful. As an example of this if you owed $5000 on a credit card at 15% and paid just the minimum each month it will take you 56 months to pay off that $5000 and will cost $1974 in interest.
Using a credit card can protect you from fraud
If you are asked to name the safest way to make a purchase and your choices were credit, cash or debit what would be your answer? The odds are that you would say a debit card. But you’d be wrong. The best way to protect yourself from fraud is by using a credit card to make your purchases. The reason for this is if you became the victim of identity theft most credit card issuers will remove those fraudulent purchases as soon as you alert them to suspicious activities. Plus, they generally limit your liability to $50. If you use a debit card then filing a claim could be much more complicated and it might be two weeks or more before you’re reimbursed for those fraudulent purchases.
The harsh truth is that good credit doesn’t build itself. You need to be proactive. Getting and keeping a good credit score can save you a lot of money over the long run. If you have a good credit score you can lock down lower interest rates and make larger purchases such as taking out a mortgage. If your goal is to build good credit, you should start soon and start small. Make a few small purchases with your credit card and then immediately pay for them. When you make small purchases and pay them off immediately this will help you build good credit habits early on as well as a good credit score.
An even better idea is to start with a secured card. If you’re not familiar with this type of card it’s where you deposit money with a bank – usually $300 or $500 – and then use the card to make purchases until your balance reaches zero or near zero. At that point if you want to keep using the card you will need to deposit more money. There are two good things about a secured card. First, it prevents you from creating debt. Second, how you use the card will be reported to the three credit reporting bureaus and, assuming you use it sensibly this will help you build a good credit score.
Your credit limits aren’t just suggestions
When you got that first credit card and saw it had a limit of $2500 that was pretty exciting. Just imagine! You instantly had $2500 at your disposal, right? Well, yes and no. Just because you have a credit limit of $2500 doesn’t mean you should use it. Most financial experts say that you should keep your credit utilization or how much of your limit you’ve used below 30%. This means is that you should use only 30% of that $2500 or $1500 total. The reason for this is because your credit utilization counts for approximately 30% of your credit score. If your credit utilization were 40% or even 50%, this would definitely ding your credit score. Do the math. If you find that your credit utilization is above that magic 30% you need to either get to work paying down your balance or open another credit card so that your credit limit would go up accordingly.
Your credit score will ultimately depend on your financial philosophy
Whether you have a good or bad credit score will ultimately depend on your financial philosophy or whether you’re an ant or a grasshopper. If your approach to finances is that of an ant where you’re saving money, paying off your balances on time every month and have an emergency fund, you’ll ultimately have a very good credit score. It may take a while but it will happen. On the other hand, if you’re more of a grasshopper – if you spend money as fast as it comes in or if your approach to debt is that of Scarlett O’Hara and “I’ll worry about that tomorrow” – it’s absolutely certain that you will end up with a poor or bad credit score. And a bad credit score will cost you money in the form of higher interest rates, higher insurance premiums and might even prevent you from renting an apartment or house.