Many factors are important to building wealth, but credit is one that people often overlook. And who can blame them? It’s a seemingly boring topic based on metrics most of us don’t know much about.
What isn’t boring, however, is buying your first home. Or driving your dream car off the lot. Or moving to a brand new city and being able to rent an apartment with ease. Whether we like it or not, these exciting life events take good credit. It literally pays to establish good credit.
Healthy credit habits and healthy financial habits go hand in hand. If you’re especially savvy, once you’ve established good credit, you can even use it to help build a fortune. Many wealth-minded folks know how to use credit to their advantage. While most of us see it as a hindrance, they make it work for them, using it to grow their net worth.
Here are a few credit habits of the wealthy, and how you can make those habits work for you.
They Know How The System Works
Donald Trump has famously filed for bankruptcy a handful of times, making many people wonder how he maintains his wealth. Interestingly, Trump has only ever filed for corporate bankruptcy, keeping his personal finances secure.
He learned an important credit lesson when he found himself in deep debt in the 90s, after a failed business venture–the construction of the Taj Mahal casino. Trump had personally invested in the expansion, and when he couldn’t afford to pay the high interest, he nearly went personally bankrupt. After paying off $900 million in personal debt, he learned the important distinction between being personally involved and being involved as a corporation. Sure, he’s had failed ventures even in recent years. But, because he’s only invested as a business, his own net worth is protected.
The point is–wealthy people know how the system works and can navigate it in their favor. On a smaller level, if you want to build your credit, and make it work for you, you should probably know how credit scores work in the first place. Here’s how your credit score is calculated, according to FICO:
Photo source: MyFico.com.
- Payment history: Your credit history makes up about 35 percent of your overall score. You want to make sure you pay credit cards and loan payments on time.
- Amounts owed: Thirty percent of your score is based on something called credit utilization. This is how much money you owe compared with how much credit you have available. The lower your credit utilization, the better. You want to owe as little as possible–ideally, you’d owe nothing. Maxing out credit cards can have a huge, negative impact on this area of your score. Many people beef up their credit utilization by establishing high credit limits on multiple cards, but then they never use those cards. This keeps your credit utilization low and your credit score high.
- Length of credit history: This makes up 15 percent of your score. While that might not seem like much, it’s why many experts advise you keep your oldest credit cards open, even if you’ve paid them in full.
- New credit: Opening too many accounts around the same time can have a negative impact on your score, according to FICO. This factor makes up 10 percent of your score.
- Types of credit used: FICO says they consider the mix of credit you use–private loans, mortgages, credit cards, etc. This also accounts for 10 percent of your score.
They Know Where Their Finances Stand
Wealthy people keep tabs on every aspect of their finances, including their credit. When you know where you stand, you can use your financial strengths to your advantage and improve your financial weaknesses.
It’s easy enough to get a copy of your credit report and find out your score. But surprisingly, only half of consumers know theirs, according to a study from the American Bankers Association. Keeping tabs on your score is important for a handful of reasons:
- You can avoid any errors or mistakes, which can damage your credit
- You know what to expect if you ever need to use your credit
- It can serve as a gauge for your financial habits
Basic Tips for Improving Your Credit
Of course, knowing your score is one thing. Making sure it’s high? Well, that takes a bit more effort. We’ve already mentioned a couple of ways to build credit, but let’s round them up, and add a few more:
- Establish good credit history and make payments on time.
- Keep your credit utilization low.
- Avoid opening multiple lines of credit within the same time period.
- Rather than move debt around, focus on paying it off.
- If you have trouble paying off debt, contact the creditor and see if you can work on a repayment plan.
Where to Get Your Credit Report or Score
Each year, you can get a free copy of your report at annualcreditreport.com. Many bank credit cards–WellsFargo, First National Bank and Discover, for example–also offer free credit information. Some banks will give you a copy of your report. Some will include your score on your monthly statements.
They Leverage Credit to Their Advantage
Wealthy people know how to use their resources to support their bottom line. And good credit can be a particularly useful resource. Many entrepreneurs have leveraged their credit to build a fortune. On a corporate scale, this is known as a leveraged buyout–companies are purchased with large amounts of borrowed money. The private equity firm KKR famously utilized this method when they took over RJR Nabisco in 1989–at a whopping $31 billion.
Agree with this practice or not, many people use this same concept on a microcosmic level.
When it comes to buying a home, some buyers opt to put down less than the traditional 20 percent, even when they can afford it. The reasoning is that, with good credit, they’re approved for low mortgage interest rates. In fact, the rates are so low, borrowers would rather invest their money and earn a return, instead of putting it toward the purchase. They’d rather borrow money, paying little in interest, and invest the money they have, earning even more money.
Similarly, some savvy car buyers prefer to take out a loan, even when they can afford to pay for the vehicle in full. Again, they’d rather invest the money they would have paid for the car, and get a return on it. In the end, they actually earn money from borrowing.
Obviously, this type of leverage comes with risk, and it isn’t for everyone. But the point is: with good credit, you have these options. You can consider how you can make your credit work to your wealth-building advantage.
Even if you choose not to go this route, you can still save money with good credit by qualifying for lower loan interest rates. When your credit history shows you’re a responsible borrower, lenders are more likely to give you a low rate and work with you on closing costs and fees.
Your credit history might seem meaningless. It might even seem designed to work against you. But when your credit is healthy, it can play a part in helping to build your wealth.
Another way to use good credit to your advantage is with credit card rewards. When you’ve got an attractive score, you’re eligible for cards that come with some pretty sweet perks.
Using Credit Card Rewards Responsibly
If you have good credit, you can use credit card rewards to earn hundreds of dollars of cash back throughout the year. Or, use them to pay for lavish vacations. Some people simply opt for gift cards. Whatever the reward, the idea is the same: you get freebies just for spending money. What’s more, you build credit by using that card.
Of course, this can be a dangerous game. It can lead to overspending. It can lead to debt. But wealth-minded people play it responsibly and reap the rewards without any repercussions. Here’s how.
- Never pay interest: Pay your cards in full, preferably well before the due date. Set up automatic payments, and make sure you always have enough in your checking account to pay off your card.
- Draft a budget: Budgeting is key to making sure you don’t overspend on your card. Only spend according to your budget. In fact, if you’re prone to overspending, you might want to get that in check before you play the credit card rewards game.
- Don’t open too many cards: Again, opening too many cards at once can damage your score. Keep this in mind when mulling over tempting credit card offers. Choose discerningly.
- Beware of fees: Some of these cards have such great programs, they come with annual fees. In some cases, the fee might be worth it. But that’s something you’ll have to calculate and decide on your own. Overall, though, you want to be aware of these fees. Make sure to read the fine print of any credit card offer.
In general, rewards cards can be a great way to earn extra cash and keep your score high. But this is only true when they’re used responsibly.
They Foresee Risks to Their Credit
One difference between the rich and the wealthy? Wealthy people are less likely to lose their money. Part of that is being able to prepare for the future, and learning lessons from your past, like Trump.
Wealthy people develop awesome credit foresight. This means they know what events pose risk to your credit. It also means they’re prepared for financial issues that may arise. You can develop foresight by adapting the following credit habits.
Cosign with caution: Some people will co-sign without giving it much thought, and this can lead to financial issues down the road. When you cosign a loan, understand that you’re responsible for that line of credit. Proceed with caution.
Don’t let past debt come back to haunt you: Rome wasn’t built in a day, and usually, neither is wealth. Some wealthy folks may have ugly credit pasts. But financially savvy people do their research and know how to deal with past debt so that it doesn’t affect their future finances.
Review your finances: Even if you regularly review your monthly budget, it’s important to assess your annual spending. This can help you see how much your expenses add up over the course of a year, and adjust accordingly.
Build an emergency fund: When a financial emergency arises, many people find themselves desperate. They take out payday loans. They borrow from retirement. These decisions can lead to larger financial troubles and keep you caught in a debt trap. An emergency fund can prevent that from happening.
Building wealth is about thinking long-term. It’s about having full control of your finances. Sure, developing good credit habits might not seem like the most exciting jolt to your short-term financial picture. But poor credit gives creditors control over your money. Establishing good credit shifts that control to you and goes hand-in-hand with building wealth.
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