Unless you plan to pay cash for every major purchase, building and maintaining good credit is a must. Even if have enough cash on hand to avoid taking out a car loan or a mortgage, though, having bad credit could still impact you, since more and more employers are running credit checks on potential employees.
The nationwide consumer credit bureaus – Experian, Equifax and TransUnion – create a credit report based on your credit history, payment habits and amount of times companies inquire about you. This information is then crunched into a three-digit credit score.
You're entitled to a free credit report each year from each of the nationwide consumer credit bureaus thanks to the Fair Credit Reporting Act. Access the reports via the three agencies' jointly run website, AnnualCreditReport.com. You can also get a free credit report and score at our sister company, Bankrate.
"It is important to remember that consumers have more than one credit report. Since there are three different credit reporting agencies, the information on each of their credit files may differ," says Clifton M. O'Neal, former vice president of corporate communications for TransUnion.
Requesting a free credit report "can help consumers keep tabs on all of their financial activities," says O’Neal. He also advises checking each report for fraudulent activity and correcting any errors that appear. Each credit bureau's website has information on how to fix errors.
See related: 5 key federal laws that help credit card holders
Having a low credit score will raise a red flag for lenders and could lead to having a loan application rejected. Or even if the application is accepted, your interest rate could be much higher. In other words, if you want to buy a house or a car, improving your credit score is an essential first step.
"If you are going to be applying for credit at any point in the future – whether a new credit card, a mortgage, a home equity line of credit or a small business loan – your credit score will largely determine how little or much you are going to have to pay for that credit ... if you get it at all," says Russell Wild, NAPFA registered financial adviser and co-author of "One Year to An Organized Financial Life."
Each credit bureau has its own criteria for calculating credit scores, which often results in different credit scores depending on where you look. But the best way to improve all of your credit scores is to show responsible financial behavior for an extended period of time.
Start by paying bills on time, keeping your debt below 30 percent of your available credit – although the lower your credit utilization, the better – paying down debt and disputing errors on your credit report. Since many lenders and landlords don’t regularly report on-time bill payments (just late and delinquent ones), these efforts can take some time to impact your score.
Platforms like Experian Boost can help you take more control of your credit score by allowing you to self-report good behavior. But it’s still too soon to tell how much of an impact this will have on your overall score.
See related: FICO’s 5 factors: The components off a credit score
No one wants to read the fine print, but it contains all the important information about payment terms, interest rates, annual fees and penalties. Your credit card contract – also called a card agreement or "terms and conditions" – lays it out, though it often takes strong eyes and college-level reading comprehension.
"Most people don't bother reading the terms and conditions, and that's a mistake," says David Jones, president of Association of Independent Consumer Credit Counseling Agencies. "You shouldn't be surprised when your interest rate goes up because you missed a payment. It's all there in black and white."
See related: Credit card agreement: Find yours online
According to Jones, credit card statements are easier to understand than ever. The Credit CARD Act of 2009, whose major provisions took effect in February 2010, required new design and disclosure requirements to make statements more reader-friendly.
Among the requirements, the fees for making late payments and how much is being paid in fees and interest on different types of accounts must be shown. Additionally, per the CARD Act, card statements must show how long it will take to pay off a balance if you pay only the minimum.
If there's something that doesn't make sense, call your credit card company or a credit counseling agency accredited by the AICCCA or the National Foundation for Credit Counseling to ask questions.
See related: Making sense of confusing credit card statements
"As soon as the January bills come in and cardholders realize how long it's going to take them to pay off their holiday spending, paying down credit card bills becomes a priority," Jones says.
When it comes to paying off credit card balances, avoid making new charges, focus on paying off the card with the highest interest rates first and always pay more than the minimum payment.
Choosing the right card at checkout can save you a bundle, according to Wild.
Consider the payment terms, he says, "most notably the interest rate you'll pay if you don't pay off your debt at the end of the month."
If you don't pay off your balances at the end of the month get a card that has a lower interest rate, rather than one with good rewards.
Annual fees can also add up. For instance, if you're paying $50 per year on several airline rewards cards, but have never cashed in a single air mile, those accounts might not be the best fit for your spending habits.
See related: Comparing the various types of credit cards
Your credit score is determined, in part, by the variety of accounts you have, and whether you have eaten up a lot of your available credit by carrying balances. In other words, outstanding balances on multiple cards will affect your credit score. Wisely manage those balances and don't be in a hurry to close out accounts.
"Any major changes in your credit habits, including canceling cards, will throw up a red flag and impact your credit score," says Jones. "If you want to reduce the number of cards you carry, cancel one card and a few months later cancel another instead of canceling them all at once."
Having multiple lines of credit and low balances gives you a low credit utilization ratio, which is good for your credit score. Be sure to keep your balances low – overall, and on each credit card you have. And use each card every so often so the credit card company doesn't cancel the account.
See related: How to cancel a credit cards – wisely
If you're struggling with debt and having too much available credit may lead to the temptation to spend, you might be better off canceling those credit cards. It's better to let your credit score take a hit for closing accounts than to face the consequences of charging too much debt and not being able to pay it off.