Bank Accounts

An account at a bank or credit union is a good first step to establishing credit, if you handle the account responsibly. Overdrafts and bounced checks not only cost you money, they can cost you the ability to apply for credit down the line. However, a checking account in good standing can save you hundreds of dollars when compared to the fees charged by most check-cashing businesses.

When shopping for a bank or credit union, try to choose one that has few or no maintenance fees, and make sure that you will have an ATM available to check your balance or make withdrawals for free, as high ATM fees can wreak havoc on your budget. Take advantage of online bill-pay if your bank offers it for free – it’s a quick and low-hassle solution for keeping track of your expenses from month-to-month that will help you stay on top of your credit scores.

Secured Credit Cards

If you don’t qualify for an unsecured card with reasonable rates, a secured credit card is a great way to start out. Some banks or credit unions will place your deposit in a money market account or another interest-bearing account, which means that if you only charge what you can pay off each month, you can actually make money by using this method.

You want to avoid any card that charges high annual fees, or that has any other hidden costs. Additionally, you need to make purchases that you can pay off in full at the end of the month, without using more than 30% of the credit card’s available balance. Make sure you have the discipline to stick within your spending limits before you get the card – how you manage your bank account is a good indicator. If you can stay within the available funds in your bank account without going over, and actually have money left at the end of each month, you can probably handle your credit card with equal responsibility.

Shift a regular purchase such as gas, groceries, or a specific utility to the credit card, and use your budgeted funds to pay it off. This will prevent you from misusing the card by buying things you don’t need in the name of building your credit.

Student Loans

While taking out unnecessary student loans is ill-advised, a necessary student loan can be a real boost to your credit score. Generally seen as a type of ‘good’ debt, most banks and lenders look favorably upon student loan debt as long as you make payments on time, or have a qualified deferment or forbearance in place. Another benefit: the interest you pay on your loan is tax deductible – so you can claim it at the end of the year on your taxes.

Because there are so many payment options available for student loans, chances are good that you can find one that will fit your budget. If you start paying before you graduate, you have the added bonus of building up a solid repayment history that can assist you in obtaining additional credit after your graduation.

While no one action can guarantee good credit in the future, by making sure you establish your credit in a responsible and diverse way from the start, you can avoid the temptation to overspend on credit cards and instead focus on building a responsible financial plan that will both improve your credit scores and your financial outlook going forward.

Effective July 1, 2009, the government is instituting a new repayment plan called Income Based Repayment, or IBR.  This new payment plan adjusts your payments to reflect your income as well as your dependents. After 25 years, if you still have a balance on the loans, that balance is forgiven. For individuals who have low income or several dependants, this provides a viable way to keep your credit rating clear, while still maintaining affordable payments throughout your loan term.

Student loan debt is often a factor when determining whether or not you qualify for credit. Unless you are currently in deferment or forbearance, the total amount of your student loan debt is part of your debt-to-income ratio. However, most lenders view student loan debt as “good” debt, and are less likely to penalize you in that regard. Showing a consistent payment history out of forbearance and/or deferment can help to build credit as well – if your monthly payments are lower under IBR, this can also be a factor when creditors are deciding whether or not you have the ability to repay.

Regardless of whether or not you have your student loan payments adjusted under IBR or some other program, it’s important not to let payments on student loans lapse. While having student loan debt may not prevent you from qualifying for the credit that you deserve, missed payments on student loans certainly can. And because student loans fall under a special category of debt, in most cases you cannot have student loans discharged with bankruptcy, or any other means. If student loans are a potential tipping point for you with regards to your ability to repay financial obligations, IBR’s lower payments may be useful to you as well.

For individuals who have a higher income level, or who expect to have a higher income level in the future, IBR may not be the best option. Because the repayment plan is so lengthy, it is best suited for individuals with lower income jobs over the long term. If you have a temporary financial setback, forbearance and deferment are still your best options. Whichever repayment or deferment option you choose, you should check your credit report to ensure that it accurately reflects your current payment status. Often, missed payments can be removed from the credit report if you have your deferment or forbearance take effect retroactively – this will give you a clean slate to start with when you begin your repayment again, and will give your credit scores a natural boost as well.

Good Debt

The term ‘good’ debt applies to almost any type of credit or loan that helps you to make tangible progress in some way. They may be secured loans, such as for a mortgage or a car loan, or they may be unsecured, as in the case of student loans. In all cases, however, this type of debt demonstrates a commitment, or responsibility that is directly correlated to responsible lending habits. By having a mortgage, you demonstrate stability. Student loans are generally seen as a good thing, as higher education often yields a better job, and thus, an individual who is better capable of paying off his or her debts.

However, you should be careful with this kind of debt, just as you would any other. Falling behind on a mortgage in today’s financial climate can lead to foreclosure and a black mark on your credit report. Student loans that are unpaid will go into default, leaving you unable to further finance your education, along with other detrimental effects, not the least of which being the damage to your credit score.

Bad Debt

So-called ‘bad’ debt isn’t necessarily bad, but like all forms of credit, it should be used in strict moderation. Bad credit encompasses things like credit cards, store credit, and revolving accounts that can be used for purchases of less than essential items. While credit cards are not bad in and of themselves, carrying too many credit cards or too much of a balance on your credit cards can cause your credit score to dip dramatically.

The best advice when it comes to credit cards and store credit is to only use what you need and to keep your balances as low as possible. In this way, you demonstrate responsible credit consumption, and your credit score won’t take a hit from having too much debt on unsecured credit cards.

The Balance

Ideally, you should have a good mix of secured and unsecured credit, which demonstrates both stability and responsible credit consumption habits. As much as 10% of your credit score can be determined by the type of credit you have, so be careful not to open a lot of credit card accounts, especially if you don’t have a mortgage or car loan to offset the difference. You should also avoid going the other route – avoiding credit cards entirely and paying only with cash or debit. If you don’t have any payment history with unsecured loans, some lenders may be reluctant to extend credit on favorable terms.

In general, when considering new credit, ask yourself if you really need it, or if it’s just going to be one more credit card to add to the pile. Taking advantage of a low interest rate to pay down a few balances is more than acceptable, but opening an account just for an introductory discount on purchases might not be – especially if you don’t really need the items you would purchase. Keep your financial goals in sight, and you can take full advantage of both types of credit, while still improving your credit score.

Scenario 1: Refinancing High-Interest Credit Card Debt Using Home Equity

This scenario has been commonly used by many companies claiming that they can lower your credit card debt. By taking out a second mortgage using home equity, a person can pay off high interest credit card debt with the funds received. There are several problems with this scenario:

You must have equity in your home to qualify. This means that for new homeowners, this type of financing option is unavailable. However, in the current market, this is actually a good thing and here’s why:

Financing credit card debt through a mortgage trades an unsecured debt for a secured debt. This means that when you use the mortgage money to pay off credit cards, you’ve essentially tied your home ownership into your ability to pay off the debt. If for some reason you default on the second mortgage, you can lose your house. While credit card debt and late payments may be damaging to your credit, they are unsecured. The credit card company can’t take away your purchases made with the card, but the bank can and will take away your home if you default on a mortgage.

The last problem with this type of scenario is that it is not foolproof – if you decide to use your credit cards again for purchases, then your debt problem doubles. Many times, people who try to eliminate credit card debt end up with more credit worries as they have to make payments on two mortgages and the new credit card charges.

Scenario 2: Consolidating Student Loans

If you are making payments on multiple student loans, consolidating those loans can seem like a smart idea. In some cases it is, however, if you are still in school there are better options available.

• Forbearance – if you are unable to make payments, you may qualify for forbearance. There are several types of forbearance, including one that applies if you are not making enough money to meet all of your financial obligations.
• Deferment – this is usually the best option if you are still in school. Even if you are only taking classes half time, you can get a deferment on student loan payments. Just be sure to have your school verify that you are attending, and continue to take enough courses to qualify for in-school deferment.

Once you consolidate your current student loans, you cannot re-consolidate at a later time. Therefore, if there is a chance you will be taking out further student loans, your best bet is to use forbearance or deferment options, and only pay the interest on the loans until you are able to meet the financial obligation.

• Avoid multiple credit card accounts – students who rely heavily on credit cards may find themselves in over their head with debt well before graduation. Instead of credit cards, consider using debit cards with a Visa or MasterCard logo, or prepaid cash cards. These provide the freedom necessary to purchase supplies without having a negative impact on credit. Exception: if your college student has job, you may wish to allow one credit card with a low credit limit that can be repaid steadily. This will allow your student to build a solid history of payment without the risk of racking up too much debt.
• Don’t take on excessive student loans – student loans can quickly add up over the course of a four-year degree. While they can be necessary to cover such things as books, food, clothing, and school supplies, student loans should not be used to finance excessive or frivolous spending. Some students have a problem with understanding that student loans will have to be repaid; you can help your student to understand the impact of future interest rates and the cost that they will pay if you clearly outline exactly how much interest will be paid back with each loan compared with the amount of money they are receiving now.
• Encourage budgeting – help your college student create a budget and stick to it. By providing clearly defined guidelines and goals, you can help your college student avoid the path of problem credit. Unless it’s an emergency, don’t bale your student out if he or she goes over budget. By having to confront the negative consequences of financial irresponsibility, your student will learn the importance of keeping within proper financial guidelines.

But what to do if credit is already a problem for your college student? Credit repair services may be able to help your student if the debt is severe. However, you should not let these problems linger as having problem credit early on can make employment opportunities more difficult to come by. Problem credit can also have an adverse effect on some insurance rates, so be certain to handle the problem as soon as you are made aware of it. The earlier these types of problems are taking care of, the better your student’s chances of having an excellent credit rating when the time comes to make a major purchase such as a car or home. It’s never too soon to learn the value of good credit and financial responsibility. If you help your student learn the proper role of credit and how to manage spending wisely, you are setting him down the path to financial success and stability.