We asked our Facebook fans and Twitter followers to share their most pressing personal finance questions. Now, John Ulzheimer, credit expert for Credit Sesame, weighs-in.
Q: I’ve never had a credit card before. How should I get started and what should I know to achieve and maintain a perfect credit score? –David
David gets an A+ for thinking ahead. Unfortunately, they don’t teach “Credit” in school at any level, which means we have learn as we earn. And, while getting a question wrong on a high school test may not mean much in the long run, getting it wrong in the world of credit can have a major effect on your life—for years. Making poor credit decisions now can mean 7 to 10 years of negative reporting and hundreds of wasted dollars thanks to higher rates and fees on your credit and loans. So, good for David for taking the initiative to figure this stuff out before he takes the plunge. Now, let’s help him out.
Earning a perfect score is practically impossible and completely unnecessary. A perfect score means 850 on the FICO scale, and that takes, among other things, a well-aged credit report, which you won’t have starting out. In fact, 15 percent of the points in your FICO score come from age related credit report measurements.
If you focus on achieving 750+ (what’s considered an excellent score), you’ll be fine. You’re not likely to get a better deal from a lender for having 750 instead of 850. Plus, 750+ is a realistic target for someone who is new to credit.
First things first: Building credit means having credit. Choose a credit card for which you’d like to apply. If you plan on revolving a balance (you can read more about that here), which I hope you won’t do, I’d suggest applying with a credit union. Their rates are likely going to be lower than those offered by the mega-banks.
If you’re not going to carry a balance, the interest rate is immaterial and a rewards card would be a good choice. There are many options when it comes to rewards cards, and it can get complicated. My advice? Choose a cash back card. Cash has no blackout dates, so you can use it when you need it.
Big banks are more likely to give you large credit limits than credit unions. This is helpful when you’re trying to maintain good credit scores at the same time you’re using the card. One of the most valuable measurements in credit scoring models is the balance-to-credit limit ratio. A high credit limit allows you to use your card without worrying that the ratio is too high.
You want to keep that ratio at 10 percent or below. For example, if you have a credit card with a $20,000 credit limit, you can use up to $2,000 of that limit in any given month without going over 10 percent usage. However, a $2,000 balance on a card with a $5,000 credit limit equals 40 percent usage, which can reflect poorly on your credit.
I’ve said it before, but—to reiterate—missing payments on a credit card can damage your credit scores. So can carrying a high balance. You’ve got a little buffer when it comes to late payments (not that you should take advantage of it). A provision in the CARD Act paired with credit industry policy means that payments must be at least 51 days past the date that the statement was generated in order to show up on your credit reports.
Why 51 days? This can get a little convoluted—even for those of us who aren’t new to the credit world. The CARD Act (or the Credit Card Accountability Responsibility and Disclosure Act of 2009), mandates a 21-day grace period of non-business credit cards. This period begins when the credit card issuer mails or emails the consumer their statement.
On top of that, credit reporting industry guidelines say that the lender can’t report a late payment until it is a full 30 days past the due date. If you’re one or two days late, you may be issued a late fee or some interest, but it won’t show up on your credit report.
Best of luck, David. Credit cards are not evil, as many would have you believe. Using credit cards wisely provides an efficient, safe and practically free means of transacting in commerce. Thanks to the Fair Credit Billing Act, there are excellent fraud protections. Plus, right now, credit card issuers are fighting for good consumers. It’s a good time to be on the “buyers” side of that equation.
John Ulzheimer is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO and Equifax, John is the only recognized credit expert who actually comes from the credit industry. He is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and a Contributor for the National Foundation for Credit Counseling. Follow him on Twitter »