Debt often seems like a four-letter word - something everyone should do their best to avoid. To younger generations, the concept of debt hits even closer as they witnessed the struggles their parents faced during the Great Recession of 2008. Following their college careers, student loans overwhelmed many. Then the pandemic hit as they were about to make their entrance into the job market.
It’s been a wild ride for everyone, but younger Millennials and older Gen Z have been hit especially hard. As a result, debt has earned the reputation of being something to avoid at all costs. But it may not be as simple as that.
The Consequences of No Debt
Being debt-free is a goal that tops the list of financial milestones most only dream of achieving. While you don’t want to be strapped down with loans, not having any debt can hurt you.
As you know, our society runs on credit and loans. Everything from renting an apartment to buying a mobile phone can revolve around your credit score. Without credit or loans, you can’t build your credit score, and without a credit score, your chances of one day buying a home or even your first car are limited.
The trick is to find a balance – build your credit score with loans, but don’t let debt take over.
A Simple Strategy to Build Credit
Your credit score is a grade or snapshot of your credit report and overall ability to manage your finances. While most commonly used when applying for loans, your credit score can also impact other areas of your life.
For example, an excellent credit score can result in waiving fees on utility deposits, earning discounts on car insurance, and helping you rent an apartment. Some employers will even check your credit. Building your credit without taking on debt isn’t that difficult. In fact, it can be pretty easy. All you need to start is a credit card.
Use the following strategy to start building your credit history with only a credit card:
- Obtain the lowest rate possible. Rewards cards you see on TV and in ads usually have very high-interest rates. Plus, you typically need to spend a lot to earn rewards. Your goal here is to limit spending, so these perks won’t apply right now. Instead, stick with the lowest rate credit card you can find from an institution you trust.
- Request a lower limit. Credit cards come with a set limit that you can spend. The higher the credit limit, the more temptations to spend - and the more opportunities to get into financial trouble. Since your goal is to build credit and not boost your spending power, request a card with a lower limit, such as $250 or $500, to start.
- Make small purchases. You want to make small purchases throughout the month that you can repay immediately. For example, use the credit card to fill up your gas tank or pay for lunch once a week. Then repay the balance in full before your due date – ideally right away so you don’t forget about it.
- Set up auto payments. Your goal is to pay off your entire credit card balance each month. Carryover balances on credit cards are something you want to avoid. Enrolling in automatic payments will ensure you never miss a due date and that your balance is repaid in full monthly.
How this Strategy Boosts Your Credit Score
Five categories of money management determine your credit score. Using the strategy above, you can see how it’s designed to help you improve each area without accumulating significant debt.
- Payment history: How often you make payments on time.
This strategy calls for you to only make small purchases throughout the month that you can easily repay. Ideally, you’ll want to repay your entire balance immediately, but you can also set up automatic payments to ensure you never miss a payment.
- Types of debt: You want a mix of debt – secured and unsecured. Secured debt is when there is collateral (car or home). Unsecured lacks collateral (personal loans, student loans, credit cards).
While you may not have secured debt yet (your focus right now is on your credit card), you can begin to build this portion of your score by utilizing unsecured debt. Once you prove you can manage a credit card responsibly, lenders are more likely to extend secured debt to you when needed.
- Length of credit history: How long you’ve had your credit accounts.
Open your first credit card early – ideally after you graduate high school or whenever you feel you can responsibly manage the card. The sooner you start building your credit, the quicker you’ll improve this portion of your credit score.
- Amount owed: The amount of debt you currently have outstanding.
By only making small purchases that you can repay in full each month, your amount owed will be $0 or extremely low. Not only will this boost your credit score, but it will improve your Credit Utilization Ratio (a figure used by lenders when approving loans).
- New credit: How often you apply for new credit.
With this strategy, you will not be applying for other types of credit. No new credit means no new hard inquiries on your credit report that would otherwise lower your score. Only apply for credit when necessary.
While you may have witnessed the consequences of having too much debt, not all debt is bad. Using a low-rate, low-limit credit card is a great way to build your credit history. Making small purchases that you can quickly repay will create smart money habits while boosting your credit score.
As you age, you’ll likely need other types of credit and loans. Starting early is a great way to ensure you’ll qualify for and receive lower-rate loans down the road.
We’re Here to Help!
An excellent credit score will benefit you in many areas of your life. While credit is typically required to build your score, that debt doesn’t have to be excessive. Using a credit card from the credit union is the perfect way to get started.
If you’re interested in obtaining your first credit card or want information on rebuilding your credit, we’re here to help. Email us or call 202-479-2270 to get started today.