Establishing a credit history isn’t hard, but building good credit takes time and dedication. Here’s how to do it.
Your credit history is essential to your financial health. Without it, you might have trouble qualifying for any type of loan, get higher interest rates and insurance premiums, and pay a bigger deposit when renting an apartment. Not to mention, the majority of rewards and travel credit cards are only available to those with good credit.
See related: Tips for renting an apartment with bad credit
Building credit requires time and learning good financial habits. Read on to find out about the ways you can build credit – even if you’re starting from ground zero.
Steps to building your credit
What affects your credit?
Before diving into building credit, it’s crucial to understand how it works.
See related: The factors of a FICO credit score
The five primary factors that affect your credit and are used to calculate credit scores are the following:
Payment history is the most important component of credit and accounts for 35% of a FICO score that’s widely used by lenders. Even one missed payment can negatively impact your score, and more severe delinquencies like charge-offs may be hurting your credit for years. That’s why it’s so important to pay at least the minimum on your loans and credit cards.
Credit utilization ratio – a credit card’s current balance relative to its limit – accounts for 30% of your credit. Credit utilization higher than 30% can damage your score, as lenders see it as an indicator of overspending. It’s best to keep your ratio as low as possible – ideally, in single digits.
Credit history length accounts for 15% of a FICO score. When it comes to credit, the older your accounts are, the better. It shows lenders that you’re an experienced borrower and know how to manage your debt long-term.
Credit mix – a variety of loan types on a credit report – makes up 10% of a consumer’s FICO score. Ideally, you want to have different kinds of installment loans and revolving accounts on your credit file. For example, if you’re successfully managing a mortgage, a car loan and a few credit cards, it’s a sign for lenders that you can handle multiple types of debt well.
Finally, new credit also determines 10% of a FICO score. Applying for a new credit card or loan triggers a hard inquiry that can ding your credit, but will come off your credit reports after two years. However, it will begin to have less impact on your credit after a year, and as you’re making payments, your scores will bounce back.
Knowing how credit scoring works allows you to learn good credit habits and start building your credit.
Steps to building your credit
Next, let’s take a look at the steps you can take to get your credit where you want it to be.
1. Get a credit card
A credit card is one of the most invaluable tools for credit building. Credit cards are the most common type of revolving credit – accounts that let you borrow whenever needed up to a certain limit. Opening a credit card doesn’t just add to your credit mix, but it also provides an excellent opportunity to establish a positive payment history.
Choosing the right credit card
Before you apply for a credit card, do some research and find a card that fits your needs and credit standing.
For instance, there are rewards credit cards that can give you cash back or points for spending in categories like groceries, dining or travel. However, you typically need good to excellent credit to qualify.
If you’re at the beginning of your credit journey or working on rebuilding your credit, you might want to look into secured credit cards. This type of card requires a deposit that typically becomes your credit line. Retail credit cards also have less strict credit requirements and can be a good starting option.
Managing your credit card
Paying your credit card bills on time is crucial to building credit. Even one 30-day late payment can be problematic, as it will stay on your credit report for seven years. It’s critical to make at least minimum payments, but the more you pay, the better for your credit utilization. Ideally, you want to pay your credit card bill in full every month. Besides helping your credit, it will allow you to avoid paying interest.
See related: What happens when you miss a credit card payment?
Finally, it’s typically better to keep your credit cards open to continue extending the length of your credit history and avoid hurting your credit utilization. If you’re not happy with your current credit card, there are ways you can address the issues and keep it open.
For example, if you have a secured credit card you’re ready to graduate from, you can call your issuer and ask to upgrade it without closing the account. Or, if you have a card with an annual fee that doesn’t justify itself in your situation, you can request to downgrade.
2. Apply for a loan
An installment loan is another type of credit that you can add to your credit portfolio. It allows you to borrow a set amount of money and repay it over a fixed period. The payment amounts are often fixed as well – though some allow you to pay off your balance early.
Some common examples of installment loans include auto loans, mortgages, student loans and personal loans. If your credit score isn’t in the best shape, you can still qualify for many of these, but your interest rates might be considerably higher.
Note, the new FICO Score 10 credit launching this summer might factor in personal loans differently. However, it may take lenders a long time to adopt the new credit scoring model. FICO Score 8 is still considered the most widely used model.
See related: How FICO’s new credit score changes will affect you
Using a co-signer
You can get sometimes better rates if you use a co-signer – a family member or close friend who agrees to share responsibility for the loan. If they have a well-established credit history, it may positively impact your approval chances and interest rate.
However, it’s important to remember that co-signing is considered a significant financial risk. Any late payments will appear on the co-signer’s report, too. If someone puts their trust in you to help you with your credit, make sure to pay on time – and thank them for their help.
Taking out a credit-builder loan
A credit-builder loan can be a handy tool for building credit if you have poor credit or none at all. It allows you to borrow a relatively small amount of money – usually up to $1,000 – that will be held by the lender until you pay off the loan in full. After that, you get access to the money you borrowed.
Think of it as a certificate of deposit – a fixed-term savings account – only you’re paying interest and improving your credit history while doing so. The term length is typically between six and 24 months.
3. Look into alternative credit data
While the three major credit bureaus most commonly get data from lenders, there are other ways to contribute to your credit history.
According to Experian, 65% of lenders use alternative data to make a lending decision. The majority of them verify income and employment, but more and more lenders start to consider things like rent, phone and utility payment history.
There are various tools you can use to self-report these types of payments. For instance, last year Experian introduced Experian Boost, which allows you to add utility payments to your credit file. The service exclusively uses positive history, meaning that if you forget to pay your gas bill, it won’t cause your credit score to drop.
Some credit scoring models, including FICO Score 9 and VantageScore 3.0, also incorporate rental payments. Many landlords don’t report to credit bureaus, but you can add the data to your credit file yourself by using third-party services like RentTrack, Rock the Score, Rent Reporters or Rental Kharma.
4. Keep an eye on your credit
To be fully aware of your credit health, it’s a good idea to start tracking your credit scores and check your credit report regularly. It will not only allow you to see your progress but also to make sure there are no inaccuracies on your credit report. Errors on your report can be a sign of identity theft and hurt your credit standing.
See related: 10 things you should know about identity theft
There are multiple ways you can check your credit for free. Many major credit card issuers offer free credit scores and monitoring, and with some of them, you don’t even need to be a cardholder. You can also get free monthly credit reports and scores from two of the three major credit bureaus – Experian and Equifax. Additionally, you have a right to request a free credit report every year from each bureau, including TransUnion, at AnnualCreditReport.com.
How long does it take to build credit?
It doesn’t take long to establish a credit history if you don’t have any. For a FICO score to be calculated, you need to have an active account on your credit report for at least six months. With VantageScore, it can happen much quicker. As long as you have at least one account on your credit report, it can start to factor in your VantageScore.
Good credit, however, doesn’t happen overnight. It may take you years of dedication and practicing good credit habits to get there, especially if you’re rebuilding your credit. Most negative entries can stay on your credit reports for seven years, and bankruptcies up to ten. That’s why it’s essential to keep your credit healthy.
The road to good credit is a long one. Still, with patience and a responsible approach, you can get your credit where you want it to be and unlock all the benefits that come with it.