Steps 1 & 2 Steps 3 & 4 Steps 5 & 6 Steps 7 & 8 Steps 9 & 10 Quiz
Step 7: Establish a Good Credit History

Your credit report and score can affect your life in many ways. Obtaining a mortgage or car loan (especially one with a good interest rate), renting an apartment, finding a job (many employers check credit reports), and obtaining insurance with low rates is usually easier with a good credit history.

Like the name implies, your credit report tracks your credit activity. There are several types of credit, including credit cards, store cards, personal loans, car loans, mortgages, student loans, and lines of credit. Credit-related legal actions, such as judgments, foreclosures, repossessions, liens, bankruptcies, and evictions, also appear on your credit report. Your credit score is a numeric summary of the information in your credit report and is designed to measure the risk you will not repay what you owe.

In order to have a good credit report and score, you need to have credit. However, it can be hard to get approved for credit the first time since you don’t have a credit history. What can you do about this Catch-22?

A good option for many people just starting out (or rebuilding) is a secured credit card. A secured credit card requires you to put down a deposit, which the creditor gets to keep if you do not make payments. While they are typically easier to get than regular credit cards, the credit limit is usually low, and the fees can be high. However, many creditors are willing to convert a secured credit card to a regular credit card after a year or two of on-time payments.

Another option is to ask a friend or family member who has a good credit history to cosign on a loan or credit card for you. Be especially careful with this type of arrangement. Any late payments you make will not only reflect poorly on your credit report but your cosigner’s as well. After six months to a year, you may want to reapply for credit on your own.

Once you have credit, it is very important to use it responsibly. Always make your payments on time, and keep the balances on revolving credit, such as credit cards, low. Missing payments, especially to the point where accounts get sent to a collection agency (which typically happens after 4-6 months of non-payment) and carrying high balances will hurt your credit report and score. Repossessions, foreclosures, judgments, and bankruptcy are also damaging.

Step 8: Delete Your Debt

It is best to never carry a balance on your credit cards. However, you may be in a position where you are already dealing with credit card, personal loan, and/or other type of debt. Having debt can not only absorb a significant portion of your income each month but also cost you thousands of dollars in interest payments. Conversely, paying off your debt can provide a feeling of relief and give you more money for other things, like savings.

Use the Debt Worksheet to list all of your debts.

There are two basic methods of accelerating debt repayment. One is to increase your payments. Minimum payments are often set very low, so it could be years before you are debt free if that is all you pay. If you have multiple accounts, you will save more money by being systematic and focusing your extra payments on one creditor at a time instead of sending a little extra to all of your creditors. (Of course, you should continue to make minimum payments to everyone.) Many people like to start with the debt with the lowest balance because it will be paid off the soonest, providing gratification that makes it easier to keep going. However, you will save the most money by starting with the debt with the highest interest rate. Once the first debt is paid off, put that money toward the debt with next lowest balance or highest interest rate (depending on the option you choose) and so on until all of the debts are paid off.

The other method is to lower your interest rates. There are several ways that you may be able to get lower interest rates, including:

  • Asking the creditors directly to lower the interest rates. Creditors are usually more willing to do this if you have made your payments on time. Of course, they may still say no, but it does not hurt to ask.

  • Transferring your balance to a card with a lower interest rate.

  • Getting a consolidation loan. Whether or not you can get one will depend on your credit score, income, and current level of debt.

  • Paying off existing debt with a home equity line/loan or cash out refinance (where you refinance your mortgage for more than you owe). The interest rate is usually lower than for other debt, and the interest is tax deductible. However, it is important to remember that you are increasing your mortgage payments, and you will lose your home if you cannot make them.

  • Participating in a debt management plan, in which creditors offer lower interest rates in exchange for going through counseling and closing your accounts.

If you are thinking about a balance transfer, consolidation loan, home equity line/loan, or cash out refinance, remember that you are using debt to pay off debt. If you start using and carrying a balance on old cards, you are actually increasing your level of debt, not decreasing it. These options work best if you are committed to not taking on more debt.

These two methods of accelerating debt repayment are not mutually exclusive. In fact, it is a good idea to try to increase your payments and lower your interest rates at the same time.

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