If you want to increase your access to capital as an entrepreneur or side gigger, the first think you will need to focus on is financial literacy. If you are just getting started with building your credit or improving your score, it is much like building muscles. It takes time, effort and consistency to increase it. The term credit is simply your reputation as a borrower. You always want your reputation to proceed you- even financially. Being a borrower is not a bad thing, it is used by high level entrepreneurs and everyday individuals. The difference is in how it is used. Entrepreneurs use credit to invest, while most people consume the money on everyday needs or wants. Your ability make good on your word and repay is what will build up your reputation over time. Many people are scared to get a credit card due to the stories that other people have had. However, in many cases it is the inability to truly understand how credit works that harms people. Let’s see how credit works.
What is Credit?
People take out loans on a daily basis. They take them out to purchase education, cars and homes. Lower income people even end up borrowing to purchase groceries for their families. Credit is your history as a borrower. It measures your ability to stay on top of loans and credit cards. Before a lender will open new lines of credit with you they want to know your history of repaying borrowed money. 
They will typically use what is known as a credit report. From this they can determine whether or not to approve you for the loan and how much to charge you for the loan. Usually the lower your credit score, the higher your interest rate. This means you pay back more than what is necessary. I’ve never been a fan of this method, because it is setting people up for failure by charging more to people who may not be able to truly afford it. Then they end up in that perpetual cycle of “robbing Peter to pay Paul” A phrase, that means you end up going from one person borrowing from them and taking that money to pay someone else to whom you owe money. The thing is you still owe the first person from whom you borrowed money. You will either need to increase your income to pay that person or go borrow…..again.
What makes up the Credit Report?
Understanding credit reports is a vital aspect of your financial literacy .Credit Report is comprised of your lending history. It breaks down the lender, duration, the amount borrowed, and remaining balance. It even gets as detailed as listing the months that you made a payment, missed a payment or even made a partial payment. These typically stay on the report for 7 years. You can look up your credit report at www.annualcreditreport.com so you can see your borrowing history and dispute any transactions that might have been made by you.
What is a Credit Score?
A credit score on the other hand averages your history of repaying lenders over your history of borrowing. The elements that make up this score are derived from the credit report. Credit score is like a college degree. At university, some people graduate Cum Laude, Maga Cum Laude, and the rest…just graduate. Similarly credit scores range form 300-850. For simplicity they are usually divided into Very Poor, Poor, Good, Fair and Excellent. Lenders do not have time to look through pages and pages of a credit report to create their analysis and make a decision to lend to you–especially when they have other borrowers knocking at their doors too! They rely heavily on the credit score. Credit Scores are created by Credit Bureaus. The three U.S. bureaus are Transunion, Equifax and Experian which each create algorithims that analyze your credit report and formulate a score which is used by lenders.
Anatomy of a Credit Score
- 10% Type of credit. There is huge difference between credit card debt and school loans. It is preferable to have education or mortgage, than other debt (credit cards) or personal loan. However a fine balance of them all is favorable.
- 10% is New Credit-Every time you seek new loans your report the credit bureaus are alerted and it gets added to your report. This is what they call a hard inquiry. If you are going from place to play seeking credit, you are seen as a risk and this action can negatively affect your score.
- 15% Length of Credit-This is determined by your oldest account, average age of your accounts and the newest account. It is good to have a long standing account with a good payment history and a low balance.
- 35% Payment History – As I mentioned earlier, the report breaks down your payment history on a monthly basis; however, these delete off every 7 years.
- 30% credit utilization. As a good rule of thumb you should only spend 10% of your available credit to have maximum results on you credit score. 30% utilization is pushing the limit and will have negative affects on your score. So, make sure that if you have a $1,000 limit that you us at least $100 and at max $300. If you go over that amount be able to pay off any overages before the next statement.
Why is this Credit Stuff important?
It is super important because it will help you secure loans to reach your goals. Some of these goals include: buying a home, purchasing a car, or even investing in real estate or business opportunities. Most people are not rich, and need this assistance to pay off such huge loans. Even if you are affluent, it is still important to maintain credit to keep your score on the higher side. Credit is not a bad thing. It is our irresponsible use of credit that has detrimental effects on our ability accomplish goals.
What Should I do next?
- You can get a copy of your credit score at Annual Credit report.com. This is free of charge and comes from each of the credit bureaus so you can compare. You can only request one per credit bureau a year. It usually comes as a .pdf document.
- Credits scores are not located on the credit report, so you will need to find a reputable company that will connect you to your score. Learn how you can access your personal score here– especially if you plan on borrowing money to start a business someday.
- Start crafting a plan to pay off the oldest outstanding balance. Next focus on the loans and credit cards with the highest interest rates as they will be harder to pay off.
- Never take out loans for everyday purchases, if you cannot pay them back in one month. If you pay them back the original amount in a month you will have to repay with little to no interest.
- Make an effort to pay your bills on time.
- Pay over the minimum amount due. This will help you pay down the loan quicker. Anything over the minimum is allocated towards the principle.
- Develop great spending habits. Make solid decisions based on your realistic ability to repay the loan. Think about how much your interest will be and how much you will be required to payback. Don’t get all happy about a $1,000 loan when you have to pay back $1,750. If your minimum payment is $250 for 7 months, just think, you could you have delayed gratification just saved up $250 for 4 months. Think strategically.
