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Establishing and building good credit is often essential to achieving financial success in life, but a solid credit rating can be difficult to attain. With credit, there are a lot of potential pitfalls, especially for those new to the concept. It is important to understand what credit is, how it works and how to use it wisely.
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Credit is the ability to take on debt. Some common examples of credit include student loans, car loans, credit cards and home mortgages.
Credit allows you to borrow money from a lender to access goods or services now, with the understanding that you’ll pay for those items later. However, in addition to paying back the amount you borrowed, you’ll also pay interest charges and perhaps additional service fees, which can make managing credit more complicated.
Also, lenders will only let you borrow money if they believe you have the ability to repay your debt. The process of building up that trust is called establishing credit. Every time you borrow money and pay it back, you increase your creditworthiness and improve your ability to borrow again.
Lenders such as banks, credit unions, and credit card issuers report your borrowing and repayment history to the three independent credit bureaus—Experian, TransUnion and Equifax—which compile your credit history into a credit report.
A credit report is essentially a summary of your credit history and includes information about the number of credit accounts you have, your borrowing limits and outstanding balances. It will also include a record of any late or missed payments.
The credit bureaus calculate a credit score for you that distills all of the relevant information about your credit history and current credit accounts into a three-digit number. Credit scores generally range from about 350 to 800, with a low score indicating a person with poor credit, and a high score indicating a person with good credit. Having a high credit score offers many advantages, such as better interest rates on mortgages and other types of loans, and higher credit limits on credit cards. Your credit score is often the first thing a creditor looks at when determining whether or not to extend you credit.
It’s a good idea to check your credit report every year for inaccuracies. Everyone is entitled to receive one free credit report every year. You can get a free copy of your credit report from www.annualcreditreport.com or through one of the major credit bureaus.
Building credit doesn’t happen overnight—it takes time and diligence, which is why it is important to develop good spending habits and begin building credit early.
If you have a history of making payments on time and managing credit effectively, you’ll be more likely to receive a credit card or loan with favorable rates and terms. Conversely, if you’ve never used credit or have a history of missed payments, it will be more difficult to get approved for a loan or credit card, and if you do, you may get less favorable rates.
Credit cards are one of the most common and effective ways for young people to build credit. When used responsibly, credit cards can help teach young people how to use credit wisely. However, irresponsible credit card use is also one of the fastest ways to wind up in debt and damage your credit.
Credit cards aren’t the only option for building credit. Other ways you can build credit include diligently making payments on student loans or a car loan, or getting someone with established credit to open a joint credit card account, add you as an authorized user to an existing credit card account, or co-sign a loan. You can even ask your landlord and utility companies to report your history of making on-time payments to the credit bureaus to build a credit history.
Credit scores are typically used by banks and other businesses to determine if you’re someone who’s responsible with money or if you are a high credit risk. Good credit is essential if you want to borrow money to fund a major purchase such as a car or a home, and can help you qualify for credit cards that can let you buy things that are only possible with credit and pay for unexpected emergencies.
Credit reports and credit scores are used by more than just credit card companies and banks. Many employers will check your credit report before they decide to hire you. Landlords may also use credit as a factor when deciding whether to rent you an apartment or when determining the size of your security deposit.
Halsey Schreier is a senior wealth strategist for CIBC Private Wealth Management. In this role, he works closely with high net worth clients in New York, the Mid-Atlantic and the Southeast to provide integrated wealth management services, including comprehensive estate and financial planning solutions, multi-generational legacy planning and fiduciary administration for trusts and probate estates.
CIBC Private Wealth’s Wealth Your Way podcast series is an educational offering for clients and their children, and demonstrates our commitment to developing the rising generation.
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