The Ultimate Guide on How to Build Good Credit (even if you’re starting from Scratch)
A good credit score is important for success in life. When you’re just starting out, though, the credit bureaus don’t know whether you’ll be responsible or not, so they are on the side of caution by giving you a low score. This makes it harder for you to take out a car loan or get a credit card.
Fortunately, the formula that determines a credit score is not a mysterious secret. Once you know what the credit bureaus are tracking, it becomes easier to quickly build up your score.
Use our tips to start building up good credit.
Learn About Your Credit Score
Your credit score is based on a variety of factors. According to MyFICO.com, the breakdown looks like this:
- 35 percent of the score is based on payment history. On-time payments bring your score up; late payments bring your score down.
- 30 percent is based on your debt load. When you have a high amount of debt relative to the amount of credit you have available, it depresses your score. Reducing debt increases your score.
- 15 percent is based on the length of your credit history. The longer you’ve had credit, the easier it is for credit bureaus to gauge what your behavior looks like. There’s not much you can do about this except getting older.
- 10 percent is based on whether you have new credit lines available. Your score dips every time you get a new credit card or loan.
- 10 percent is based on the “mix” of credit. Credit bureaus like to see that you can handle different types of credit.
As you can see, the two things that you have the most control over play the biggest role in determining your score. If you’re able to manage those two things, you’ll be ahead of the game.
Order Your Credit Report
You need to be aware of what creditors see when you apply for credit. You can get a free copy of your report at AnnualCreditReport.com, but it won’t show the actual score. The report should list all of your credit accounts, including student loans, credit cards, mortgages, and auto loans. Under each account, you’ll see how much you owe and whether you’ve been making payments on time.
Most people who have never had credit before assume that their credit report is blank. That’s usually true, but scammers sometimes use a child’s Social Security number to start a new credit profile. Since the child isn’t using his number, he doesn’t discover this identity theft until years later. Even if you’ve never applied for a credit card or loan, it’s a good idea to order your report to be sure that no one else has used your Social Security number.
Fix Any Mistakes
Look for mistakes in your report. Some of the most common ones are:
- Credit accounts you didn’t open
- Incorrect loan amounts or credit limits
- Closed accounts showing as open
- On-time payments marked as late
If you find anything like this, you can resolve it by contacting the credit bureau or by contacting the creditor. The Federal Trade Commission has detailed advice on doing this, but it’s often as simple as writing a letter or making a phone call. Once you’ve done this, check your report again to be sure that the errors are gone.
1. Get Some Credit
If you don’t have any credit, it’s time to start applying. Look over some of the current offers for first-time credit cards. Ideally, you want something with a relatively low-interest rate and no annual fee. It’s usually easy to get approved for a store credit card, but you can also try to get the more traditional Visa or MasterCard.
If companies are turning you down because of your low credit score, you may need to apply for a secured credit card. In this case, you’ll have to give the company a deposit in order to get the card. That deposit becomes your credit limit. It’s not an ideal situation, but it may be necessary to build up your credit. Once you have a higher credit score, you can apply for better cards.
2. Use Your Credit
Simply having credit cards isn’t enough to increase your credit score. You need to use the credit responsibly. Make a few small purchases each month, then pay off the entire balance when you get the bill. You can even make payments the day after you make the purchase if you don’t want to wait. By doing this, you’ll avoid interest charges while showing the credit bureaus that you are able to use your credit responsibly.
Some people believe that you have to carry a balance in order for the activity to “count,” but this is just a myth.
3. Pay Bills on Time
Since timely payments play such a big role in determining your credit score, you’ll want to stay on top of things. Pay all of your bills as soon as you get each notice, or pay all of them at the same time each month. Your credit score should go up a little each month by doing this.
If you’ve made late payments in the past, don’t fret. The information your report lasts seven years and creditors care more about your recent history than the past. Eventually, those late payments fall off the credit report.
4. Automate Your Payments
Go even further by automating your payments. Most creditors will allow you to set up your account to automatically take out payments on a specified date. This works especially well with installment loans like a car payment or student loan because you pay the same amount each month. When it comes to credit cards, you can set up automatic payments for the full amount due or the minimum amount, but you have to make sure the money is in your bank account. The easiest way to avoid insufficient funds is to schedule the payment on the day after payday.
5. Get Rid of Your Debt
Since the debt load is the other big piece of the puzzle, you’ll want to work hard to reduce or eliminate your debt. Paying off your debt requires focus. You’ll probably even have to make a few sacrifices. Debt reduction is beyond the scope of this blog post, but keep these tips in mind:
- Make a budget to track your expenses.
- Always pay more than the minimum due on your credit cards.
- Reduce frivolous spending and apply that money toward debt.
- Don’t incur more debt while trying to pay off your debts.
As your debt decreases, you should start to see an increase in your credit score. Use this as motivation to keep going.
6. Ask for a Credit Limit Increase
On the flip side, you can also reduce your debt ratio by asking for a credit limit increase. With a current credit card limit of $1,000 and a balance of $850, you’re using up 85 percent of your available credit. That looks risky to creditors. If the credit card company were to increase your limit to $2,000, though, you’d only be using 42.5 percent, even though you owe the same amount. That percentage isn’t great, but it’s still better.
This method may not work for those who have a low credit score, but it’s definitely something you can try once the score starts to increase.
7. Find Some Balance
The credit bureaus like to see you using different types of credit – installment loans, retail credit cards, and traditional credit cards. While you wouldn’t necessarily want to buy a house or a car just to have an installment loan on your report, it’s good to mix it up when you’re able. Retail stores often give you big discounts for using their credit cards, and you won’t pay extra if you pay the full balance off each month. Plenty of other credit cards offer rewards such as cash back. If you’re worried about being tempted by having too many cards, simply keep one of each type.
8. Partner Up
If you’re an authorized user on someone else’s credit card, their good credit score can rub off on you. This is dangerous territory because the person is ultimately claiming responsibility for any purchases you make. It’s not something that you should ask of a friend or even a sibling. However, if a spouse wants to help you increase your score or if you simply want to consolidate your accounts to make life easier, it’s an easy way to start building up some history.
Of course, the opposite is true as well. When your spouse adds you as an authorized user to his or her account, their score is going to take a slight dip as well. Be mindful of this if you will soon be applying for mortgages or other big purchases together.
9. Monitor Your Credit Report
Don’t let your efforts go to waste. Once you’ve started the process of building up your credit score, keep track of your report. You’re entitled to a free copy of the report from AnnualCreditReport.com once per year. Check it each year for mistakes.
If you want to take things even further, look into services that track your credit score on a monthly basis. Your credit card or bank may offer this service for free, but you can also get it through sites like Mint.com or CreditKarma.com. Sometimes, the score they show isn’t exactly the same as the ones that each of the three credit bureaus has, but you can definitely pay attention to the trends. Seeing your score go up a little bit each month can be motivating. Discovering a sudden drop may indicate an error in the report.
10. Keep Plugging Away
Unfortunately, you can’t get good credit overnight. Creditors need to see consistent patterns of good behavior over the years. The good news is that as long as you make on-time payments and keep your debt in check, you should see your score continue to rise.