First of all, what’s the whole point to having a good credit score? To borrow money of course. It may also help with setting up other accounts such as for TV or utilities, but they will just require a deposit if you don’t have good credit. The only real reason is to get good rates on loans, but if you have too many loans that’s not good either. It’s really and balancing act, and despite popular belief it really is optional. If you’re good enough with your money to never need a loan, then there’s really no need for credit or a good credit score.
For those of you who insist on having good credit, here’s a good six account formula that I’ve come up with from reading about credit and from personal experience that I believe will help anyone maintain an excellent credit score while still allowing you to achieve financial peace and freedom. Please keep in mind that I’m not a financial expert or financial counselor, and I really do believe that the ultimate goal should NOT be to get perfect credit, but rather to achieve financial peace and ultimately financial freedom and independence.
First of all, the basics: Don’t make late payments, avoid bankruptcy and judgments at all cost, have 2 major credit accounts, don’t even come close to maxing anything out, make regular monthly mortgage or rental payments, and check your credit reports at least once a year to make sure they are accurate. If you don’t plan to use your credit history any time soon, you should contact the credit reporting agencies and have them put a freeze on your credit report so that you (or anyone else) cannot use it on a whim. Every time you allow a potential lender to look up your credit, it shows up on your credit history, and too many of these will hurt your score. Freezing you credit history can also prevent a lot of those annoying letters for pre-approved credit cards, as well as help to prevent identity theft and fraud.
If you don’t have all of these accounts right now, don’t feel rushed to go out and get them right away. If you are just starting out, be patient, as building really good credit takes a long time and very careful planning. If you have too many open accounts start closing them, but one at a time until you get a good feel for what you truly need. You don’t want to close the one’s you’ve had the longest either (unless you have a poor history with them), as a long stable relationship with your creditors will actually help your credit score.
Remember, you really only need a good credit score if you plan to finance something, so if you’re going to an all cash basis, as Dave Ramsey suggests, you really only need the first two or three accounts. With that in mind, here’s the 5 to 6 accounts I recommend (in order of importance):
1 – Savings.
We all need to save money, and this account will help you get started with that. This will give you a safety net for when emergencies come up. It should not be used for anything else. It doesn’t need to be huge either, in fact once you’ve saved the enough to cover a year’s worth of basic necessities, you probably have way more than enough, and should be already be investing into higher yield investments such as mutual funds (Investment funds are not included here because they don’t affect your credit score, though they can help when taking out large loans such as a mortgage).
Just about any lender will lend you as much money as you have saved regardless of your credit, because they at least have some collateral that can be used to pay back the loan. Of course I wouldn’t recommend buying anything on credit in the manner as you’ll probably end up with a very high interest rate for something you could have just as easily pay cash for.
2 – Checking.
If you have a long standing checking account in good standing this will help your credit. You’ll want to keep a minimum balance in it (some banks require this to avoid maintenance fees), and you’ll want to manage it well so that you never bounce checks or incur overdraft fees. The more money you keep in this account as a minimum balance, the better it looks, but don’t keep so much that you’re losing out what could be well invested money (not to mention safety issues). I’d suggest between $1,000 to $10,000 for a minimum balance, depending on your situation, plus however much you need to cover what you’re paying for with it.
3 – Mortgage or Rent (or any long term high dollar loan).
Certainly an affordable mortgage is going to help your credit, if you make your payments on time religiously every month. On the other hand if you are upside down on your house, paying more for it then anywhere close to what you can really afford, or not making payments on time, this will very likely destroy your credit. Be wise when buying a house, save up a good down payment, and buy something that’s much less (not more) then what you can afford.
What if you are a Renter? Many rental facilities will report your payment history to the credit reporting agencies, but even if they don’t they should at least be willing to give you good reference letters stating that you’ve made your payments on-time every month; as well as how much you were paying. Make sure you understand the landlords policies on this matter before renting from them. Any good lending institution with a good underwriter should be able to use these letter effectively, especially when you are applying for a mortgage.
4 – Line of Credit.
To truly have good credit you need at least one revolving credit line, such as a major credit card; though many credit consolers will recommend two major credit cards to obtain perfect credit, but I think having financial peace and decent credit, is far better than being constantly tempted by your credit cards in an effort to obtain perfect credit (Personally, I’ve never had perfect credit, but I’ve also never had trouble getting excellent loan rates). This account is not needed to show that you can make payments, but rather that you are responsible with credit, and aren’t the kind of person who pushes their available credit to its limits. I would suggest a small line of credit of no more than $1000.
This line of credit should be tied to a debit card threw your checking account as an overdraft protection. The Debit card should also be tied to a major credit card company so it can be used as a credit card with all the protections that come with it. The thing you want to watch out for is that you never actually use the line of credit, but if you end up doing so only do it because it’s an emergency and with the determination to immediately pay it off using your emergency funds in your savings account.
If you bank doesn’t provide this type of product or protect, find a good Credit Union that does. My Credit Union actually lets me setup it up so that it pulls from my savings first before hitting the Line of Credit.
5 – The payment history loan.
This loan can be almost anything. It is where you get your secondary payment history from (after rent and mortgage payments, but if you still live at home or in a collage dorm, this may be your primary payment history). It could be a student loan, a car loan, a credit card or credit at your favorite store.
Be sure to use this account very responsibly. The key to having this load without destroying financial peace is to be conservative. If it’s a line of credit, religiously pay it of every month, and do some research to find a good credit card that you feel comfortable sticking with for the long term. If it’s a structured loan, don’t borrow anywhere near to more than you can afford, or even more then you can pay off quickly and easily should the need arise. Also, be sure to find the best interest rate you can, as this could save you thousands over the life of the loan.
You actually only need to have this loan open for a minimum of six months (the longer the better), and you only need one of these loans every few years for it to show up on your credit report and improve your score. Make sure you close these accounts when you are done with them, as having a too many open accounts will hurt your credit score, even if you never use them.
6 – The Optional accounts
Having as many savings, checking and/or investment accounts as you want is probably ok so long as you can actively manage all of them responsibly, so they really don’t apply here. However, some of you may want an additional credit card or store card, and you’ll probably find that responsibly using one or two of these additional credit accounts will further improve your credit score. My suggestion to you is to use them wisely, and don’t have more than one or two of them open at a time. Pay them off every month, and make sure you get good rates (less than 10% interest) on any balances.
Some credit councilors actually recommend carrying a balance of about 10-25% of your after tax income on credit accounts, but that sounds like slavery to me. Remember every bit of money you pay to interest charges, is that much less money you have to purchase with or save. On the other hand, ever bit of interest you make on your savings and investments brings you that much closer to true wealth. If you truly want to build wealth you’ll need to stop borrowing, and start making your money work for you as hard as it can; instead of going towards making someone else rich.
P.S. Yes, co-signing also counts toward these accounts. I would suggest that the only reason to co-sign is so that you and your spouse are both on the loan so there’s no confusion as to who the assets go to in the event of a tragedy. On the other hand, if you want to keep your finances separate, and still want everyone to have good credit, then you and your spouse should each have these five to six accounts. In such cases one of you can replace #3 with an additional #6 type account, but #3 is likely to be the one you’ll both want to be on. Likewise, you can share some of them, and have others be separate, so long as each person only has their name on 5 or 6 accounts.
-Posted By S.J. Hollist