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Credit Scores Made Simple and What to Know

Credit & Debt

A credit score is like a grade which follows you long after high school and all throughout your adult life. It’s an indicator of your ability to handle money and referred to by creditors and lenders if you ever apply for a loan, credit card or other types of credit.

Unless you have a large inheritance or won the lottery, someday you will need to borrow. It might be a mortgage for a house or condo, or it might be for a car or something else. Unless you have the funds in your account you will probably choose to borrow for a large purchase. 

Credit Score Basics

Your credit score is based on a few factors to know. Being smart about how you manage your finances and use any credit available will help you to manage your score.

  • Payment History (35%) – ability to make payments on time
  • Amounts Owed (30%) – outstanding debt you may have
  • Length of Credit History (15%) – age of accounts on your credit profile
  • Credit Mix (10%) – types of accounts (loans, credit cards, mortgage)
  • New Credit (10%) – related to new accounts and recent inquiries for credit

Paying your bills and debt (loans/credit) on time will help you to keep your payment history having a positive effect. The amount owed is related to your debt to income ratio, or DTI, and often advised to always keep below 30%. Our recommendation is 10%, since this allows room for credit such as a loan when the time comes you need one. The length of credit history is how long you have had an account, so avoid closing when possible. A loan might come to an end, but any credit cards you have are often what makes for aged accounts. Your credit mix is self explanatory and based on different types of credit like loans, credit cards or lines of credit. And your new credit rating is about new inquiries, which you should limit until needed.

Credit Profile

Maintaining your credit profile is more important than it might seem to many young adults, but there can be all sorts of challenges with bad credit that you want to avoid. 

Your credit score is like a reputation, but for your finances. It can take a long time to build, and a few bad decisions can destroy it quickly. Also known as creditworthiness, it’s inevitable for just about everyone that it will play a role in their lives.

RELATED: What is a Good Credit Score 

Protecting Your Credit Score

This is a good time to mention that developing good habits with your finances will benefit you throughout your life. Paying your bills on time and saving money for other goals are a couple examples of good financial habits. Developing your understanding of financial literacy is an ongoing thing that you should always look to improve on. When it comes to finances, no one knows everything and it’s an area we all just keep learning. From kids to young adults, it’s really never too early to learn. But it does help if financial lessons are age appropriate to be effective. 

You also want to get an understanding of budgeting basics which is another topic where it is never too early to learn about. The earlier that you learn finance topics like these, the easier it will be to understand and use them. 

RECOMMENDED: Learn about Saving Money

Credit Tips for Young Adults

Many young adults will get themselves into trouble financially with a credit card in their 20’s by maxing out the amount of credit available. To make matters worse, it’s often the case that they can only afford to make the minimum payments, which will leave you with paying a lot in interest charges and take a long time (often years) to pay off. When it comes to credit cards, it’s best to have a plan with how you use them. Either pay down the balance immediately to avoid interest charges, or have a plan for paying off as soon as possible and pay more than the minimum payments. 

Making any debt payments on time is another important way to protect and build your credit. Since your credit history is a large part of your overall score and is closely related to your ability to make payments on time, it is something you can manage that will benefit you later. 

Once a year you should take a look at your credit report so you can ensure that the information the credit bureaus have is accurate. If you find issues you can dispute them with the credit bureaus. 

One final tip for young adults is to live within your means and not allow your spending to get out of control. Some can get themselves into debt by trying to keep up with other friends that might be able to afford spending more. From dining out all the time or spending too much on entertainment to shopping to buying flashy items to impress your friends can be a problem. It’s easy to fall into this trap where the fear of missing out and trying to keep up with a lifestyle you can’t afford leaves you in the ‘poor house’ with mountains of debt later.

If there is one last thing to mention, that would be to monitor and manage your credit score, so you are in good shape when needed. There will eventually come a time that it matters. When you are looking for a loan your credit score will play a big part in what interest rate you might qualify for or how much you could be eligible to borrow. 

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