A dear friend, who resists using credit cards, barked, “What difference does it make if my credit scores are in the mid-600s or the high 700s? I rarely need credit.”
Sometime in the future my friend is going to need to buy a car, get a loan or apply for some form of credit, in addition to his two current credit cards. When he does, he will end up paying a much higher interest rate since lenders will look at his lower credit scores and view him as a higher risk customer. The chart below demonstrates why excellent credit matters:
|Advantage of Good Credit
Financing an auto with a loan of $30,000 for 5 years*
|Excellent Credit (720-740 and up)||2%||$525.83||$31,550|
|Slightly Flawed (620-680)||15%||$713.70||$42,822|
|Damaged (below 620)||20%||$794.82||$47,689|
*Credit score ranges vary by lender. These FICO scores represent general guidelines.
If you are just starting to build your credit for the first time or you’re reestablishing it, there is a helpful tactic you can use: You can become an authorized user on an established account that has a high credit limit, perfect payment history, and extremely low balance. How? If you have a relative or friend with excellent credit and they will agree to add you to one or two accounts, their excellent payment history will raise your credit scores dramatically.
While it’s absolutely legal to become an authorized user, this option may not be available much longer because creditors don’t think this tactic is fair. After all, you get the credit scoring benefits of someone else’s excellent credit history without any legal responsibility for the account.
This year Fair Isaac, the company that develops the credit analysis software used by the credit bureaus to compute your FICO scores, is scheduled to release a new product that will eliminate all authorized users from credit reports.
A long litany of unfair credit practices has placed the credit industry under legislative and legal scrutiny during the past year. This examination of the industry may cause the Fair Isaac FICO 2008 product to be delayed since it will produce negative consequences for many caught in the aftermath of the credit crunch, including reducing credit scores for couples who are authorized users on each others’ accounts.
If you are financially responsible and you simply need a leg up to get your credit humming, ask a friend or relative if they will add you to an account or two. It will be particularly helpful if the accounts are at least two years old with credit limits of $5,000, or more. It’s even better if they are used regularly to charge small amounts that are paid off immediately. Tell your potential benefactor that you do not want a credit card. You have no desire to charge on their account. It will simply help your credit rating to be added as an authorized user.
In a previous column, You Can Build Excellent Credit, we focused on what drives positive credit: four ongoing, active accounts; paying all bills on time; and — to rapidly increase credit scores — keeping balances under 10 percent of the credit limit on any revolving/credit card account. Your four accounts can include any loans for school, cars, or other items that lenders report to the three major credit reporting agencies (Equifax, Experian, and TransUnion) . Unfortunately, personal loans from relatives or friends are not reported to the three major credit bureaus so they will not affect your credit ratings.
It’s also important to remember that each time your credit is checked by a potential lender, points are deducted from your credit scores. Take another look at my column How to Raise Your Credit Scores Immediately.
Building excellent credit takes time and dedication. A jump start can provide a helpful boost to your bottom-line rewards.