Most millennials do not shy away from buying. They earn, they spend, and they borrow. There is also the You Only Live Once or the YOLO phenomenon, which contributes to the overall tendency to borrow, spend, and then borrow again. In addition, the fact that credit is easier to get today only complicates the problem. Instant gratification often leads to major stress later in forms of debt traps etc. So how do you stay out of a financial mess?
Since every financial aspect of your life is shaped by the credit you take, it is important to practice financial discipline.
Here are 5 easy yet important credit rules that should set you on the path to building a good credit history.
Paying Dues on Time
Paying loan EMIs and credit card dues on time is the key to achieving a good credit score. The credit score is an important factor that is considered by a financial institution while giving a loan. It indicates the loan applicant’s creditworthiness and the likelihood that he or she will pay-off the debt.
Let us keep in mind that financial institutions generally prefer to extend loans to people with a credit score of 780 & above. Therefore, it is always a good habit to stick to due dates and pay the due amount in full.
Never Fully Utilize your Credit Limit
Keeping the credit utilization ratio of your credit card at 70-75% can boost your overall credit score.
After the payment history, the amount owed contributes 30% to the overall calculation of the credit score and credit utilization is one contributing factor.
Bumping against your credit limit always indicates your over-dependence on credit, which may hurt your repayment capability in the future, and thus negatively affects the credit score.
This factor plays an important role in shaping-up your credit profile and, therefore, it is always recommended to maintain a lower credit utilization ratio to boost your overall credit score.
Balance your Credit with Income
After credit score, financial institutions look for your debt-to-income ratio to process your loan application.
The debt-to-income ratio indicates your ability to service the loan compared to your gross income. A lower debt-to-income ratio improves your chances of getting a loan from the financial institution.
It is advisable to keep the debt-to-income ratio at less than 36% of your gross monthly income and never cross the 50% mark. Anything above 50% raises a red flag since it indicates that your chances of falling into a debt trap are high.
While a credit score is a backwards-looking approach, which shows your credit history, the debt-to-income ratio is the forward-looking approach.
A financial institution can reject your loan or credit card application based on debt-to-income ratio, even though you might have a high credit score.
Reviewing your Credit Score
Reviewing your credit score at regular intervals will help you gain important insight into your credit behavior and factors which are moving the credit score.
A general thumb rule is to review your credit score once a year or before applying for a new loan. If the score is low, then you can incorporate changes into your spending habits and work towards building a good credit profile. This will ensure that you are aware of your creditworthiness.
Going through Terms & Conditions of Loans
The terms and conditions of the loans vary for each financial institution and it is important to go through them carefully before signing.
Make sure you check the interest rate, fees and processing charges, penalties, and repayment tenure offered for the loan. Careful consideration of the overall impact on your credit score and debt-to-income ratio is also recommended. Going through the fine print of the loan documents will help you to counter any issues and challenges in the future.
Conclusion
Even though millennials have a better economic sense than their predecessors, they tend to lack financial discipline and understanding. The emergence of the Do-it-Yourself (DIY) approach in financial literacy and higher discretionary spending among millennials are making them prone to risks of falling into the debt trap. Hence, practicing financial discipline and following credit rules is the key to financial freedom and success in the long term.
If you would like to know about improving your credit score read All You Need To Know About Credit Scores.
