How To Build Good Credit: Credit Building Basics
This post is sponsored by Lexington Law.
Having an excellent credit score is a building block to a strong financial future. You need credit, especially a high credit score, for good interest rates that will save you money, for buying a home or a car, future employment, and even insurance.
If you’re reading this, it’s likely you want to know how to build good credit. And for good reason! Having excellent credit helps us build a financial foundation we can rely on. This in turn, gives us more choices and options to access what we want in life. And that is so powerful.
So where exactly do you start? In this guide we’re going to cover how to build good credit, what options you have, how to use a credit card for credit building, plus do’s and dont’s. Let’s go!
How To Build Good Credit
What is credit?
We can’t start this off without first making sure we’re all on the same page here. Your credit is based off of a numerical score ranging from 300 to 850 that illustrates your credit worthiness to lenders. This number is known as your credit score. It’s essential your financial reputation. The most commonly used score calculation is the FICO score.
Your FICO score is made up of the following key factors:
- Payment history — 35%
- Utilization ratio — 30%
- Length of credit history — 15%
- New credit or inquiries (this hurts!) — 10%
- Types of credit/Credit Mix — 10%
In order to start building a credit history, you’ll need to have an open line of credit. Your credit history is important because it’s how your credit score is calculated.
Your credit report contains your credit history. More specifically, it’s a document that tells “a person’s credit history including personal information, payment history on credit accounts, and information from public records such as liens, judgments, and bankruptcies.”
Once you’ve started building your credit, it will take about six months to have enough history to give you a score. If you continue to following good credit habits, you’ll be building a strong financial future for yourself!
What Are My Options For Building Credit
If you’re starting from scratch and don’t have any credit yet, it’s unlikely you’ll be approved for something like a car loan or a home loan. Otherwise, you have a few options available to you:
1. Use a secured credit card.
A secured credit card will uses a deposited sum of money as collateral to establish a line of credit. You’ll probably find that most cards require at least a $200 deposit, possibly have an annual fee, and can have a high annual percentage rates for overdue amounts. You should essentially treat this like a debit card.
2. A student credit card.
If you’re a student, you’ll likely be able to apply for a student credit card that is designed for college level students over 18. They typically have lower annual percentage rates and competitive rewards programs.
3. A store credit card.
Many stores offer their own credit card which you may be approved for with a low limit. Be careful though, these cards tend to have very high interest rates. Remember it is your financial responsibility to pay your card off on time to avoid interest payments and build your credit.
My first credit card was a store card I opened when I was 19. It had a $300 limit and I was diligent about paying it off on time — one thing I attribute to having the excellent credit score I have today.
4. Become an authorized user.
This will help give you standing with the credit bureaus but might not help you build a significant history. As an authorized user of the card, you’re not liable for paying the debts or fees but can make charges to the account. Ask a parent or guardian if you can become an authorized user on one of their accounts to establish a history.
5. Have a co-signer.
Having a co-signer means the person signing the legal documents with you is making themselves liable for payments. If you failed to make the payments, their own credit score and history would be on the line as well.
When you’re first establishing your credit history, the easiest way to do so is with a credit card. Below, we’ll cover how to build credit with a credit card, plus credit do’s and don’ts to keep improving your score over time.
Overall, using a credit card is the easiest way to build credit if you’re just starting out.
How To Build Credit With a Credit Card
1. Apply for a credit card.
The first step to establishing credit with a credit card is applying for one. As someone who is trying to build their credit, you’ll want a card with no annual fee.
WalletHub has a list of the best credit cards for people with no credit based on what will best suit your personal situation.
2. Slowly begin using your card responsibly.
The best way to begin building your credit and avoiding debt and worries is to use your card slowly. For the first 6-12 months that you have it, only charge one thing per month to your card.
Whether it’s your phone bill or only your gas purchases for the month, do not use it for anything more than that. By doing so, you’ll be spending within your means, avoid charging excessive debt, and be able to make all of your payments on time.
3. Make all of your payments on time.
Remember, your payment history makes up 35% of your credit score. Making on-time payments will show you are a reliable borrower. This will help you establish a solid credit history.
Late payments can be devastating to your score. There are also degrees of delinquency that can do varying degrees of damage to your score.
To avoid late payments:
- Set up automatic payments to avoid late payments.
- Set calendar reminders for when your bill is due.
- Use budgeting software like Mint to keep track of your spending and budget.
Going at a slow and steady pace is the safest way to build your credit. You don’t get bonus points for opening multiple cards. It will take some time to build your credit score. Just continue to spend responsibly and you’ll get there!
1. Always make your payments in full.
This is important so you avoid paying interest! Carrying a balance does not earn you more credit points. To the contrary, you are a less reliable borrower. Contrary to some beliefs, you don’t only build credit when you carry a balance.
And when it comes to minimum payments, our friends at Lexington Law say,
If you cannot afford to pay off the balance in full, then you should pay the minimum and treat it as such: a minimum. If you can pay more than you should. Carrying it around will demonstrate to lenders that you used maybe more than you can afford to use, which is never a situation you want to be in.
2. Start with one card.
Don’t rush into applying for a ton of credit cards. Do your research and pick one that best suits your needs. You don’t need more than one card to begin building credit.
Having one card will keep you from being overwhelmed with your finances as you begin to build your credit. Having more than one isn’t going to help you build your credit faster. There’s no need to complicate it with multiple cards!
3. Stay below 30% of your available credit.
We’ll go into more detail on this below, but as a safe rule of thumb, don’t go above more than 30% of your available line of credit.
4. Keep your accounts open.
The length of your credit history plays a role in your FICO credit score. The longer you have a card open, the longer your credit history is. This makes up 15% of your credit score.
While it’s not something you can go back and change, having a long, positive credit history will benefit you in the future. When you want to buy a house, a car, or take out a loan, your credit history length will aid you in lower interest rates.
Credit Building Dont’s
1. Don’t open a bunch of new accounts.
Start with one card and work your way up. Opening lines of credit as-needed is the safest way to build credit over time.
2. Don’t spend more on the card than you can afford.
As recommended above, start with making one recurring type of purchase on the card every month. This will help you avoid spending more than you can afford.
Pretend like your card is a debit card. Don’t use it for emergencies because the funds aren’t there! Don’t use it to treat yourself because you don’t have the money for that either. If you don’t have the cash in hand, you don’t need to buy it when it comes to credit cards.
3. Don’t use more than 30% of your line of credit at any given time.
In the FICO score breakdown, you’ll see that your utilization ratio makes up 30% of your credit score. Utilization is how much of your available credit that you’re currently using. The ratio is determined by dividing available credit by used credit to get a percentage.
For example, if your credit card has a $9,000 dollar limit and you have charged $3,000 to the card, your utilization ratio is 3,000/9,000 or about 33%. When it comes to utilization, both Line Item Utilization and Aggregate Utilization affect your credit score and could have a huge impact on your overall strategy if used incorrectly.
Your total utilization should generally not be higher than 30%. Read more here on how to keep your credit utilization low (tip number four is a total game-changer). There are also ways to improve your utilization ratio if necessary.
As a safe rule of thumb, just pretend that your credit limit is only a third of what it actually is.
4. Don’t let your card sit there — actually use it!
Opening a card and not using it isn’t going to help you establish a credit history, unfortunately. You need to be showing lenders that you can pay back what you borrow. That’s how you will prove that you are reliable!
Just use your card slowly and responsibly. Maybe for you that is charging your $100 phone bill or $50 in gas every month. Using it and then paying it off will help you build your credit safely over time.
5. Don’t make late payments.
As we covered above, don’t make late payments. This will do more damage that you will have to spend time recovering from. It’s worth repeating, though!
How Do I Know I’m Building My Credit Right?
After you have been using your card for six to twelve months, check your credit report! You’ll be able to tell because you have a credit score now. You can check your credit report for free once a year from AnnualCreditReport.com.
Now that you’re pulling your credit report and credit history, take the time to look for anything that seems suspicious. Are you aware of everything on your credit report? If you do notice anything suspect or unfairly negative, reach out to the consultants at Lexington Law. They can tell you what your credit rights are and create a plan of action for removing the unfair or incorrect items on your report.
When it comes to your credit, you need to protect it and strengthen it. It’s up to you to take action on building your credit and improving your situation. Your future self will thank you for it. Good luck!