How to Build Credit
By Dawn Papandrea
If you're just starting out in life and have big goals and aspirations, like owning a new car, renting a nice place or owning a cozy home, one thing is certain: you'll need to build credit.
Building up your credit file takes time and diligence, but it's one of the best things you can do to set yourself up for financial success. If you're someone who lacks credit history, here are the basic steps to consider:
Step 1: Open Up a Credit Card
If you're under 21 and don't have a full-time job yet, you may not be able to get approved for a standard credit card. However, there are a few other options to help you start building up credit:
Student credit card. Many card issuers have special student credit cards that are geared toward younger customers. They usually offer low APR, credit management tools, error forgiveness, and even some rewards. And best of all, they often require only a part-time job during college for you to be approved.
Secured credit card. With a secured credit card, you’ll put down a deposit, which serves as your credit line. The deposit is held by the issuer in a separate account to guarantee payment for your charges. Because of that guarantee, the approval rate for these cards is high. When choosing a card, your top criteria should be that the card you choose reports to each of the three major credit bureaus: Experian, Equifax and TransUnion. After all, that’s the whole point — to make your good credit behavior count.
Becoming an authorized user. Piggybacking onto a parent's credit card account will allow you to use a card and begin building credit in your name. However, the main account holder is 100 percent on the hook if you don't pay the bill. In other words, be sure to use the card responsibly, or you can mess up your own credit as well as mom's or dad's.
Before signing up for a credit card, it's a good idea to carefully assess your financial situation to make sure you're ready for a credit card in the first place, and to have a plan in place to make sure you can make those monthly payments on time. It's smart to shop around and understand all of the fees and conditions involved before getting a new credit card. Consider cards with low or no annual fees, and low annual percentage rates (that's the interest you pay), and be cautious of cards that have attractive low introductory rates that will increase after a certain period of time. If it's your first time as a credit card user, it's wise to start with a low credit limit, so you can confidently make payments within your means. And, it goes without saying that if you merely make the minimum payment every month, you'll be paying more in interest, which can really add up. Paying the balance every month will help you keep more of your hard-earned money.
Step 2: Pay Your Bills on Time
Once you get approved for a credit card, you have to use it regularly and responsibly. After six months, you'll receive a credit score, which is a number used by lenders to assess your creditworthiness, or how likely you are to pay your debts in a timely, responsible manner. Your payment history comprises 35 percent of your FICO score (the most widely used credit scoring model, created by the Fair Isaac Corporation) making it the biggest factor, so it’s especially important to pay your bill each month on time. Setting up payment notifications that text or email you when a bill due date is approaching can help ensure you stay on track. Another option is to actually set up an automated minimum payment. It's a great backup plan if you tend to be forgetful, and if your balance is higher than the minimum, you can log on at any time to make an additional payment for the difference.
Step 3: Manage Your Credit Wisely
In other words, try not to carry big balances. You might think that as long as you pay on time, you’re in the clear, but the credit scoring powers-that-be also care about the amount of debt you are carrying. The fancy term for it is credit utilization, and it accounts for about 30 percent of your FICO score. So for example, if you have a $500 limit on a card, and you owe $400, you are utilizing 80 percent of your credit. Ideally, you want to keep your utilization under 30 percent, and as close to zero as possible while continuing to use your card.
Step 4: Handle Your Other Debts Responsibly
Beyond your credit card accounts, your credit score also involves installment accounts like your student loans. Making those payments each month will reflect positively on your score, whereas missing a payment or two will hurt you. Likewise, although other bills like rent, utilities, and cell phones are not reported to the credit bureaus, not paying those bills might result in your account being sent to collections, which can become a negative mark on your credit report.
By opening up a credit card, paying it on time every month (along with your other bills), and keeping your balance to a minimum, you're well on your way toward building a strong financial foundation. As you prove yourself over time, lenders and creditors will offer you increased credit limits and products with better terms, lower interest, and other perks. And when that happens, you'll see just how much good credit can pay off.
The information in this article is for informational purposes only. It should not be considered legal or financial advice. You should consult with an attorney or other professional to determine what may be best for your individual needs.