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A two-step plan for building young credit

By

Speaking of Credit
Speaking of Credit columnist Barry Paperno
Barry Paperno is a freelance writer and credit scoring expert with decades of consumer credit industry experience, serving as consumer affairs manager for FICO (formerly Fair Isaac Corp.) and consumer operations manager for Experian. He writes "Speaking of Credit," a weekly reader Q&A column about credit scoring and rebuilding credit, for CreditCards.com. His writings about credit scoring have appeared in The Huffington Post, MSN Money, CBS Money Watch and other consumer finance websites.
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Question Dear Speaking of Credit,
Hello! So I have had a credit card for about seven months now and wasn’t exactly using it how I should have and now have a low credit score. Since I found this out, the card has been paid off.

I just opened another account thinking I can use both and keep them under 30 percent of their limit and pay them off monthly to help. Is this a good idea or not? I have already been approved for the new card and it is on its way. Afterward I read that having two cards with a low balance can actually hurt your credit. If so what should I do? Neither of them have fees and both have low interest. Thank you! – Alyssa

Answer

Dear Alyssa,
When saying you weren’t “exactly using it how I should have,” let’s assume you were 1) late on at least one card payment, and 2) running a high balance, as late payments and high credit utilization tend to go hand-in-hand. This is especially true when the credit file is thin and the length of history short.

It can also be helpful to know that with a relatively young credit history such as yours with only a single account on your credit report, that one account provides the entire basis of your credit score. A single blemish, whether it is a late payment or high card balance, will have a lot more weight on your score than it would for someone with multiple accounts and a longer history.

You could just let the bad credit heal slowly. On-time payments and the passage of time will eventually do that. But let’s look at a simple two-step process to help move that process along more quickly.

Your two-step score rebuilding plan

1. Keep cards active, paid on time and balances kept within the 1-9 percent utilization range.

2. Add a new type of account to enhance credit mix.

Let's look at each step in more detail.

Step 1: Low utililzation is key
To your question of whether you should keep both cards under 30 percent before paying in full each month – absolutely. But keep in mind, there is nothing magical about 30 percent credit utilization. It is better than 35 percent and worse than 25. Upon reaching 30 percent, shooting for 20 percent would be good, and so on, as the balance goes down.

Seeing as how your current utilization is 0 percent after paying the card in full, you can do better for your score than settling for 30 percent. In fact, you now have the opportunity to achieve the ideal utilization percentage where balances make up only 1-9 percent of your credit limits. People with the best credit scores tend to have credit utilization in single digits.

Does this mean you can never use 10 percent or more of your credit limits? Fortunately not, but it takes a little more work. If you need to use credit to where your balances exceed the 1-9 percent range, simply make an additional payment before the next closing date to restore that single-digit utilization.

Along with the additional credit availability making it easier to keep utilization this low, adding the new card is also likely to add points to your score in a way you probably had not anticipated – diluting the bad with some good.

One lesser-known scoring factor measures the proportion of accounts that have never been late (good) to those that have been late at least once (bad). The higher this proportion, the higher the score. Now that your collection of card accounts has doubled from one to two, this proportion has gone from zero (1 account/a bad one) to 50 percent (2 accounts/1 good, 1 bad).

Step 2: Add to your mix of credit
Along with that new card making it easier to both maintain low utilization and raise your proportion of good-to-bad accounts, you can now look to another set of scoring calculations for a few more quick points – credit mix.

Credit mix evaluates your range of experience among the two major types of credit – revolving and installment – with the idea that the better you are at handling different types of credit, the less of a credit risk you’ll be. Assuming you don’t already have an installment loan, such as a home, auto, student or personal loan, adding this kind of credit could expand your credit experience in the eyes of the score.

But what if you’re not in the market for a home or car, and you don’t go to school? A secured personal credit builder installment loan could be just what you’re looking for.

These loans, commonly offered by credit unions and for small amounts to be repaid over relatively short periods of time, are designed for people in your situation who have a low score and limited credit history. Opening a credit builder loan simply requires a deposit in the amount of the loan to protect the lender against default. Then equal monthly payments reported to the credit bureaus each month will provide your credit report with a better mix and another “good” account, raising your good-to-bad proportion to an even-better 67 percent (3 accounts/2 good, 1 bad).

See related: Sticking to the long, slow credit rebuilding process, Rebuild credit, sleep better, How to remove old debt from credit reports

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Published: March 2, 2017

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Updated: 03-30-2017

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