Photo (cc) by jessiejacobson
So you’ve just graduated from college – congratulations and welcome to the real world. If you’re like the majority of recent grads, your status just changed from “student” to “unemployed.”
A Wall Street Journal article last week cited an unreleased academic report that claims just 49 percent of students who graduated between 2009 and 2011 “had found a full-time job within a year of finishing school.”
The article also mentions the growing student debt burden and (because of the recession) lower salaries for entry-level work than in previous generations. All of this bad news makes good credit even more important for college grads – because credit matters when you apply for a job, a lease, insurance, and obviously any kind of loan.
In the video below, Money Talks News founder Stacy Johnson offers some tips for grads on establishing solid credit. Check it out, and then read on for more advice…
You thought you were done with classes, but there’s one more worth taking: Credit 101. But don’t worry. We only have five lessons, and there’s no final exam…
1. Think before you borrow
When you were living on campus, you were always poor, hungry, and looking for free food. (Or was that just me?) So once you land a job, there’s a big temptation to indulge yourself. After all, you’re a grown-up now, right? So you want grown-up toys.
Better idea: Maintain the thrifty habits you learned in college. One of the weird secrets to good credit is to have a lot available but use little. (More on how that works in a minute.) But the main lesson here is that every dollar of interest you pay is one less dollar you have. Keep and invest those dollars, and you’ll earn interest – maybe not at the crazy rates credit card companies charge, but as we’ve written before, save just $5 a day, invest it at 10 percent for 30 years, and you’ll end up with $340,000.
There are a lot of misconceptions about how credit scores work. Here are the components of your credit score:
- 35 percent: record of on-time payments
- 30 percent: amount owed
- 15 percent: length of credit history
- 10 percent: new credit
- 10 percent: type of credit used
Young college grads are handicapped on the first component because they don’t have a lot of accounts that have been paid responsibly, and the third component because they don’t have a long credit history. But those will take care of themselves over time when everything else is done right. So let’s focus on “everything else.”
“Amount owed” sounds obvious, but it’s important, so we’ll cover it separately in Tip 3 below.
“New credit” refers to applications for credit – regularly applying for new credit makes lenders think you might be desperate or bad at managing money. It’s best to make multiple credit inquiries within a small window, and keep applications to a minimum.
“Type of credit” means lenders want to see you’re well-rounded and can manage different kinds of credit. The two types are open-end or revolving lines of credit (like credit cards, which you pay back at your own rate and can borrow from again) and closed-end or installment loans (such as auto loans and mortgages – loans with fixed payments and a fixed pay-off date).
Ideally, you want to have both types, but you don’t have to buy a car or house to get the latter kind. If you have student loans, you already have closed-end credit. If not, try a signature loan. We explain them in 8 Tips to Get Credit When You Don’t Have Any.
3. Don’t overdo it
Let’s get back to “amount owed.” Part of this component is a “utilization ratio” of how much you owe relative to how much you’re approved to borrow. The sweet spot is at about 30 percent, so if you have a credit card with a $1,000 limit, try to keep your balance below $300.
For more on credit scores, check out Credit Scores: 9 Things That Don’t Matter, 5 That Do.
4. Start small
As the credit score breakdown shows, young adults are at a disadvantage because they’re basically missing both a long credit history, and lots of credit accounts that have been paid on time and in full – that’s half their score. This leads to a catch-22: How can you build credit when you can’t get credit?
Fortunately, there are options. One is to join a credit union, which is like a bank but can be more flexible about lending. Another route is a secured credit card – easy to get because you deposit money in an account to guarantee the credit line.
One potential problem with secured cards: many don’t report your timely payments to credit bureaus, so are ineffective at helping build a credit history. Check to make sure before you sign up, and also be on the lookout for high fees and lousy terms.
One more idea: Get someone to co-sign a loan, meaning payments (made or missed!) will be reported in both names. Essentially, you’re getting a lift from someone’s more established credit. Great idea for you, not so great for them – hopefully they didn’t catch our story 3 Reasons You Shouldn’t Co-Sign That Loan.
5. Be punctual
Showing up late to class might impact your grade, but that grade only mattered until you graduated. Your credit score’s going to be around for much longer, and a bad mark is like a broken mirror – seven years of bad luck.
The best way to make sure your payments are always on time is to schedule or automate them. Then budget well, and start building an emergency fund of three to six months’ living expenses. You can’t avoid unexpected expenses, but you can prepare for them.