Building good credit is crucial as you step into adulthood. It shows lenders, landlords, and even employers that you’re dependable. By borrowing money and consistently paying it back on time, you demonstrate financial responsibility. This can open doors to major opportunities, such as securing a student loan, buying a car, or purchasing your first home.
Starting fresh? It's a great chance to develop strong credit habits. Pay your bills on time, use your credit card wisely, and pay off any debts quickly. Remember, having a strong credit score is more than just borrowing money—it's about proving your financial responsibility.
Understanding Credit Scores
A credit score is a numerical expression derived from an individual's credit history. It represents the creditworthiness of that individual, essentially measuring the likelihood that they will repay their debts. Credit scores are used by lenders, landlords, and sometimes employers to evaluate the risk they undertake when lending money or providing services. These scores are calculated using data from your credit reports and typically range from 300 to 850. High scores are preferable as they indicate lower risk.
Key factors that influence your credit score include your payment history, the amount of debt you owe, the length of your credit history, the mix of credit types you have, and any new credit accounts you've opened. Maintaining good financial habits such as timely bill payments, managing your credit utilization, and regularly checking your credit reports for errors can help improve your credit score over time.
How to Start to Building Credit
Building credit from scratch can feel like a daunting task, especially when lenders and credit card companies prefer clients with a proven track record of credit. However, don't despair, there are several strategies you can adopt to start building your credit.
- Apply for a secured credit card: A secured credit card functions similarly to a regular credit card, but it's backed by a cash deposit you make upfront. This security deposit amount is usually the same as your credit limit. You use this card like any other credit card, and over time, with regular on-time payments, you can build your credit.
- Become an authorized user on a credit card: If a relative or significant other is willing, becoming an authorized user on their credit card is another way to start building credit. When you're added as an authorized user, the account's credit history could be added to your credit report, boosting your credit.
- Get a credit-builder loan: Some banks and credit unions offer credit-builder loans, a type of secured loan designed to help people build credit. The money borrowed is held by the lender in an account and not released to you until the loan is paid off. It's a forced savings program of sorts, and your payments are reported to the major credit bureaus.
- Leverage credit building apps and services: Some financial services companies offer subscription products that report regular bill payments for utilities, rent, or even streaming services to the credit bureaus. This can be a relatively easy way to build a positive credit history.
Remember, the key to building a solid credit score is making timely payments and keeping your credit utilization low. As you start to build your credit history, be sure to also make good financial habits a part of your routine. Regularly check your credit reports for errors and understand the factors that contribute to your credit score. Building credit takes time and patience, but it's a journey well worth undertaking.
Using Credit Cards Wisely
Responsible use of credit cards will positively influence your credit score. If you don’t know what it means to responsibly use your credit cards, here are a few tips:
- Making small purchases and paying them off immediately is key in building a solid credit history. It shows lenders that you're capable of managing your credit responsibly by borrowing only what you can afford to repay quickly. For instance, consider using your credit card for routine expenses like grocery or gas station purchases. After making these purchases, instead of waiting for the bill, you can pay off the amount straight away. This habit not only helps to build your credit history but also prevents you from accumulating debt.
- Next, maintaining a low credit utilization ratio is another critical factor. Credit utilization refers to the percentage of your total available credit that you're using. For example, if your credit limit is $1,000 and you have a balance of $200, your credit utilization is 20%. It's generally recommended to keep your credit utilization below 30%. This shows lenders that you're not overly reliant on your credit and can manage it effectively.
- Paying off your balance in full each month is arguably the best credit card habit to develop. This is because carrying a balance over to the next month and having to pay interest doesn't contribute to your credit score. It simply costs you more money. By paying your balance in full each month, you avoid interest rate charges, keep your credit utilization ratio low, and demonstrate to potential lenders that you're both capable and responsible when it comes to managing your financial obligations.
Diversifying Your Credit
Diversification of your credit portfolio is a crucial part of building a robust credit history. This means having a mix of different types of credit, such as installment loans and revolving credit. Not only does this show potential lenders that you're capable of managing different types of credit, but it also accounts for 10% of your FICO® score, the most commonly used credit score model.
- Installment loans are a type of credit that involves borrowing a specific amount of money and repaying it with interest in a series of fixed payments, or installments, over a set period. Examples of installment loans include auto loans, student loans, or mortgages. These types of loans are often larger and longer-term, and making regular, on-time payments can demonstrate your reliability to potential lenders.
- Revolving credit, on the other hand, is a type of credit that does not have a fixed number of payments. The most common form is a credit card. With revolving credit, you have a credit limit, and you can use as much or as little of that limit as you like. You make payments based on the amount of credit you've used, plus interest.
Having a mix of both types in your credit portfolio can benefit your credit score. For example, you might have a mortgage (an installment loan) and a couple of credit cards (revolving credit). This shows lenders that you can handle different types of credit and payment structures, which can positively influence your credit score.
Ultimately, diversification of your credit portfolio should be done responsibly. Taking on debt simply for the sake of diversifying your credit can lead to financial stress and potential damage to your credit score if you can't manage the repayments. Always consider your financial situation and capabilities before taking on any new credit.
Maintaining Good Credit Habits
Maintaining good credit habits is essential for preserving and improving your credit score, which in turn can influence your ability to secure loans, credit cards, and other financial products and do so with the best possible interest rates. Here are several tips to help you maintain good credit:
- Always Pay Bills on Time: Your history of on time payments is a significant factor in your credit score. By consistently paying your bills on time, you demonstrate to lenders that you're reliable and responsible with your financial obligations.
- Keep Old Credit Accounts Open: Age of credit is another factor that affects your credit score. It might be tempting to close an old credit card that you no longer use but keeping it open—provided it's not costing you unnecessary fees—can actually benefit your credit score by lengthening your credit history.
- Regularly Check Your Credit Report: Regularly review your credit report for any errors or discrepancies. If you find any mistakes, report them to the credit bureau immediately to have them corrected. This is important because credit reporting errors can negatively impact your credit score.
- Limit Applications for New Credit: Each time you apply for new credit, a hard inquiry is placed on your credit report, which can temporarily lower your credit score. Try to limit applications for new credit to when it's necessary.
- Maintain a Low Credit Utilization Ratio: As mentioned earlier, aim to keep your credit utilization—how much of your available credit you're using—below 30%. This shows lenders that you're not overly reliant on credit.
- Diversify Your Credit Mix: A diverse mix of credit types—credit cards, auto loans, mortgage—can positively impact your credit score. It shows lenders that you can responsibly manage different types of credit.
Maintaining good credit habits is a marathon, not a sprint. It requires consistency and discipline, but over time, these habits can significantly improve your credit score.
What to Avoid as You Build Your Credit
While building credit is essential, it's equally important to understand the common pitfalls that can harm your credit. Here are few things you should avoid during your credit-building journey:
- Missing Payments: Your payment history accounts for a significant portion of your credit score. Skipping or regularly missing payments can have a severely detrimental impact on your credit score. Always endeavor to pay at least the minimum amount due on time.
- Maxing Out Credit Cards: This refers having most or all of your available credit card balances near their credit limits. High credit utilization can be a red flag to lenders, indicating that you may be overly reliant on credit. Ideally, you should aim to keep your credit utilization below 30% of your limit.
- Applying for Too Much New Credit at Once: Each time you apply for credit, a hard inquiry is placed on your credit report. Too many hard inquiries in a short period can lower your credit score, as it may signal to lenders that you're a high-risk borrower. Space out your applications for new credit, and only apply when necessary.
- Ignoring Your Credit Report: It's crucial to regularly review your credit report. If left unchecked, errors or fraudulent activity on your report could negatively affect your credit score. If you notice any discrepancies, report them to the credit bureau immediately for correction.
- Closing Old Credit Accounts: The length of your credit history is a factor in your credit score. Closing old accounts, particularly those with positive payment history, can shorten your credit history and may negatively impact your score. Keep old accounts open unless there's a compelling reason, like high fees, to close them.
- Relying on Only One Type of Credit: Having a diverse credit mix—revolving credit like credit cards and installment loans like a mortgage or auto loans—shows that you can manage different types of credit responsibly. Only using one type of credit could limit your score's potential.
By avoiding these common mistakes, you can strive to build a strong, healthy credit history that will serve you well when you need access to loans or other forms of credit.
