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Coming out of college, I was determined – pay off my student loans and do not take on any more debt. Well, I did just that … I paid off all of my student loans in under a year (a discussion for another post), and there was not a thought in my mind to apply for a credit card. So I was living debt free, enjoying life and only spending what I had in my bank account.
I wanted to invest my money into something now that I didn’t have the student loans, and I was thinking about purchasing an apartment or a townhome. What did I do next? Well, I decided to get a pre-qualification loan to see how much money the bank would lend me for a mortgage.
I had an awesome loan officer who analyzed my payment history, the amounts owed, length of credit history, and all the other factors that play into your credit score. Although I had a great credit score, it wasn’t “perfect” which is preferred if you want to get good mortgage financing rates.
I felt a bit discouraged because I thought I was doing everything right to have that perfect credit score – I was out of school, working full time and had $0 debt – what else could the bank want?
What Makes Up Your Credit Score?
What I did not realize that about 35% of your credit score is composed of payment history – and it’s been about 6 months since I stopped making my final payments on my school loans. Because I did not have any loans and was not making payment, this part of my score was slowly declining.
Approximately 15% of your credit score is the length of your credit history. Well, I took 5 years to rack up the school loans and 1 year to pay them off. End of story. I stopped contributing to this aspect of my credit history as well.
About 10% of your credit score indicates the types of credit you are able to handle (revolving payments, such as car payments, credit cards, etc.). The more diversity you have in your credit history, the less risk you pose to lenders. Whoops.
Ok, what about the rest of 45%? Well, about 30% is your debt capacity (check!), 10% credit inquiries in the last 12 months (none, check!).
I’m glad this all came to me relatively quickly and I was able to better understand how to build up my credit strategically. In this article, I will share with you some insights about why it doesn’t make sense to be completely debt free and how you could build up your credit strategically.
One caveat that I want to bring up before I continue: credit history takes some time to build, but if you do things right – it will pay off! Believe me, I was able to improve my credit history and buy my first home by 24. Hope you find this helpful!
Tips On How to Build Up Your Credit
1. Get a Credit Card
It took me a while to find the right credit card with a good APR % and conditions. So shop around and see what’s available before you jump onto the first offer!
I’ll admit, my husband and I have a few credit cards, but we do not use all of them every month! I’ll explain. We periodically buy Apple products for ourselves or family members, and on our of these shopping trips, an associate introduced to us their financing plan. The value prop goes as follows: you buy any product and finance the tech at 0% for a specified period of time.
Apple is not the only one that does this. Best Buy has a financing plan that we periodically use as well, which allows you to purchase items on a payment plan. You keep the item, use it and build up your credit at literally no cost to you.
One caveat to this: you must pay off the amount that you financed “by the end of the promotional period”, otherwise the interest that you did not pay during this time will come to bite you in the butt (seriously). What actually happens is that the interest does accumulate on the monthly amount, but it is waved by the bank. If the amount is not paid, the accumulated interest is added to the remaining amount.
Pay Attention to the Terms
Pay attention to the terms! The promotional financing terms are awesome for a specific time period, after which an unbelievably high APR % kicks in (27%+). Banks do this in an attempt to recoup their money for letting you “borrow” the funds.
Only use this if you can repay the amount in full by the end of the promotional period!
2. Spend only what you can pay back in a month (+ earn cash)
In addition to the cards that we use to finance higher priced iced (in item 1 above), we have 1 credit card that we use for most of our other expenses. Quite literally – almost everything.
We created a budget to see how much we’re spending on electricity, phone bills, pet insurance, and [almost] everything else. Plus, we knew approximately how much we’d be spending each month, so whether the money was coming out of our bank directly or whether it was paid by a credit card and repaid immediately – didn’t really matter. Yes, it requires an extra step in the process, but we’re willing to go through the trouble!
Why the headache? The credit card that we use has an awesome CASH BACK program. You can % cash back on different categories of products. For example, we get 3% cash back on gas purchases and 2% cash back on travel.
Think about it. You’d be spending the same money with your bank card, now you’re shifting your payments to your credit card but repaying it back immediately. And you’re not earning interest … and you’re getting cash back!
Just last year, we earned almost $1,000 just with this one credit card.
3. If you’re planning a big project – negotiate for 0% financing!
After about a year after we settled into our new home, we decided to replace all of our windows as they were original and were letting air through – causing our electric bills to skyrocket. We invited a company to price out the replacements over the weekend. The representative mentioned that they have a financing plan but wasn’t sure what the APR % was.
He called me back on Monday with the “great news” which I should been super excited to hear, at least that was the sentiment. The offer: 6% APR for 5 years.
I thought ok, how do I turn this situation around so that I can finance the windows and not pay interest – that would be the ideal scenario, right?
What did I do? I went in. The worst that could have happened is for us to go back and forth, and at least negotiate the APR % down. But if I wanted 0% interest, I had to start my negotiation there. I asked whether the bank would be willing to lend us the money under 0% interest. As expected, there was silence on the other line – probably in disbelief of what was happening.
He asked me to wait while he checks with the bank. An hour later – guess what? The bank agreed to the terms in the balance was repaid within 12 months.
Seriously, do not settle on whatever the contractors offer you and do not accept those terms as a matter of fact. Negotiate! Last year, my brother had the siding of his house replaced, and I gave him this same advice. Result: 0% financing for 18 months! He’s an even better negotiator than myself!
Caveat: do not agree to these terms if you do not think you’d be able to repay the full amount in the specified period. The default APR rates are very high. Again, this is how banks recoup money for “waving” the interest for that time.
A few years ago, I was sitting in a Finance class as part of my MBA program when a light bulb went off. The professor explained the term “time value of money” that resonated with me so well! Basically, the concept means that money today has a higher earning potential than it does in the future. In other words, you want to hold on as tightly as you can to the money you have and not hand it out freely.
Think about it – it makes total sense. If you pay large sums as a single payment, you have less money sitting in your bank earning interest! So why would you want to part ways with them if you potentially have the opportunity to finance something at a 0%? Sometimes it may even make sense to finance something at some percentage, as long as you are earning higher interest in your savings account.
Ok, before your head explodes from all of this information, I hope that you reconsider being completely debt free. There are ways to finance at 0%, improve your credit score and even earn money doing it!
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