Everything you were taught about credit was probably wrong, but rebuilding credit doesn’t have to be complicated.
That’s a bold statement to start off with but it’s probably true.
Generally speaking, we aren’t taught how to handle money properly.
Not by our parents…
Or our teachers…
We had to learn the hard way.
And if we weren’t taught how to handle our money well, what odds did we have when that charismatic person offered us our first credit card in college and gave us just enough rope to hang ourselves with?
You need to know the rules of the game if you’re ever going to win.
If you want to get a handle on your credit today, you need to understand the rules of rebuilding credit first.
The Nine Rules of Credit
- Rule #1: Always pay your bills on time
- Rule #2: High balances equal lower scores
- Rule #3: You must have established credit
- Rule #4: Some types of credit are better than others
- Rule #5: What you don’t use, you lose
- Rule #6: Be careful with joint credit
- Rule #7: Applying for credit lowers your score
- Rule #8: Closing your credit account lowers your score
- Rule #9: Don’t let someone else wreck your credit
In this post, we are going to talk about the first two rules and how most people ignore them to their detriment.
Rebuilding Credit: High Balances Equal Lower Scores
Most people understand that if they don’t make your payments on time, their credit score will go down. That’s not a great sign of creditworthiness after all.
But the majority of Canadians don’t realize that the balances they’re carrying have as much of an impact, if not more.
If you loaned a friend a $1000 with the expectation that they would pay you back over time and they started missing their payments, do you think you would be eager to loan them more money?
What almost no one realizes is that carrying a balance over 50% of your credit limit is also a negative factor.
That’s right, you could be making regular payments to your credit card, on time every time, and your credit score will still go down every month!
Think of the scenario with your friend again.
Let’s say you know how much your friend earns (just like the credit card company knows how much you earn) and you have an agreement that your friend can borrow up to the $1000 from you and they have to pay it back at regular intervals, but they can always borrow more, up to the $1000 limit.
You’ve determined that the $1000 is the maximum amount you’re comfortable with risk-wise and your friend opts to borrow the full $1k.
A few months go by…
They’ve made the payments each month, but they always end up borrowing the money again and floating around the $1000 mark.
How would you feel about your friend’s ability to pay you back in whole? What are your odds of getting the full thousand back if you needed it today?
This is an example of what your credit score ultimately is. It’s a number that measures how companies offering credit “feel” about you and how risky you are.
Having a balance over 50% of the limit on any of your credit cards is actively making your credit worse.
Read More: Avalanche Method Vs. Snowball Method
Generally, the credit bureaus like Equifax and Transunion don’t care about how much you owe. It could be a $1000 or it could $100 000. They consider the ratio of how much you owe compared to your limit a much better indicator of how risky you are.
So, if you want to start rebuilding credit and see your score start rising each month instead of gradually declining, get your balances to below the 50% mark and keep them there. If you can pay off the balances each month, even better.
We will cover the remaining Rules of Credit in the next few articles. In the meantime, you need to know where you stand. You can access your credit score for free by going to Credit Karma or directly from Equifax and Transunion.