Financial success is largely determined by your credit score. After all, having good or excellent credit will lower your interest rates, access perks like rewards, and gives you more negotiating power. And, it can also give you more opportunities to build your credit.
What if you have poor credit? Well, for the 16% of Americans with a FICO score 300 to 579, it might be difficult for you to obtain a line of credit, rent an apartment, or even land a job. And, if you are able to get approved, your interest rate will be much higher.
It is for these reasons that understanding how to build credit is so crucial. In fact, without a credit history lenders can’t determine if you’ll be able to pay your bills or not. So, in a way, it’s just as bad as bad credit.
In short, credit building should be a priority for everyone. Whether you’re trying to apply for a credit card with more favorable rates or just want to avoid credit history baggage, let’s explore how you can build credit.
Credit Basics
Since 22% of Americans don’t have a credit score, let’s go over the basics.
A credit score and report reflect your past debt management. In order to calculate your credit score, your credit reports contain information reported by your creditors. You’re evaluated based on your three-digit credit score, which ranges from 300 to 850. Often, more risk is associated with lower scores and vice versa.
When you apply for credit from a potential lender, your credit becomes more significant. And, even though you may not be aware of this, it can happen for both the small and big things in life. For example, do you want a shiny new iPhone? Credit reports may be checked if you finance the phone. For large purchases, such as buying a home with a mortgage, it is absolutely required.
Over time, as you demonstrate your ability to manage your debt obligations, you earn good credit. When you manage your debts responsibly, there are rewards to be had. Most notably, good credit scores increase your chances of loan approvals and more favorable terms. For example, securing a credit card with a lower interest rate.
Types of Credit
Various types of credit are available. However, there are three major types of credit that will show up on your credit reports and scores.
- Revolving credit. Account holders with revolving credit may borrow money repeatedly up to a set dollar limit while repaying a portion of the current balance due in regular installments. As each payment is made, the amount available to the account holder is replenished, minus the interest and fees charged. Both credit cards and lines of credit operate on the principle of revolving credit.
- Installment credit. Typically, installment credit involves borrowing money and paying it back in fixed monthly installments. Mortgages, auto loans, student loans, and personal loans fall under this category.
- Service credit. Basically, service credit is an account that you have with anyone who provides you with a service and bills you every month. Accounts with service credit include utilities and cell phone bills. When you miss payments, your account could be turned over to a debt collector. Having a collection account opened in your name can negatively impact your credit score.
How to Build Credit Using a Credit Card
When you apply for credit cards, you’re asking for a type of open-ended loan from a lender. As your application is considered, the lender may take into account your credit history by looking at your credit report.
If you have no credit history, there may not be much for a lender to consider. And that, could make it more difficult to secure loans, housing, and employment.
Thankfully, there are some credit cards designed with this in mind. The following cards can be used to help establish and build credit, but only if they’re used responsibly. That means making on-time payments each and every month and not overspending.
Secured Credit Cards to Build Credit
Secured credit cards are a lot like traditional cards, with one main difference. They require a deposit.
If you’re approved for a secured card, you put money down to open the account. That money acts as collateral, similar to a security deposit for an apartment rental. Your deposit is usually refundable.
Other than the deposit, secured cards function like traditional cards. But keep in mind that credit limits on these cards may be lower. And, they may not have rewards or bonuses.
Student Cards to Build Credit
There are some credit cards designed with college students and recent graduates in mind. And like other credit cards, responsible use of these cards may help you build credit.
Some student credit cards offer cash back rewards and other perks, too. In some cases, you may not even need to be a student to apply for one of these cards. Check with your lender for more details about eligibility and benefits.
Cards for Average and Building Credit
If you’ve begun to build credit, but it’s still not perfect, you may still have options. In fact, many credit card companies offer cards for exactly these cases. A good starter card, when you use it wisely, may be a good tool for you to use to help you build your credit. And it may even have features like no annual fee or cash back rewards.
If you get one, just be sure to use it wisely. Remember, the goal is to help, not hurt, your credit score. Again, that means paying bills on time and staying within your credit limit.
Become an Authorized User
If you’re struggling to qualify for a credit card on your own, there may be other alternatives. One option is to become an authorized user. You can become an authorized user if someone gives you access to their existing credit card account.
If you’re added as an authorized user, you get your own card. But the original card owner is responsible for payments. In other words, that account owner must trust you to use the card responsibly. Any negative actions, like missed payments, could reflect poorly on both your credit ratings.
If both you and the primary cardholder use the credit card responsibly, then it’s possible that being an authorized user may be a way in which you can work to build credit. But the opposite is also true.
A conversation about your potential account owner’s credit, and your own spending habits, may help you get off on the right foot. Some cards even allow the primary cardholder to set spending limits for authorized users.
In most cases, this is most useful for parents who want to teach their children healthy financial habits.
Build Credit With a Co-Signer
A co-signer may vouch for you to help you get your first credit card. By signing along with you on a credit card application, a co-signer agrees to pay the bills if you can’t. The only way to build credit with a co-signer is with responsible card use.
And like the authorized user scenario, irresponsible use has consequences. Again, both your credit and your co-signer’s credit could take a hit if you’re late or delinquent on card payments. Also, co-signers are required to pay missed payments, and even full loans, if the borrower doesn’t pay them back.
There are some differences, though. A co-signer may not get a card of their own, receive statements or have access to make any charges to the account without your permission.
Personally, this is how I established credit. When I got part-time job in high school, my grandfather co-signed my application for financing a computer. Not only did I make payments on time, I paid more then the minimum amount due. Because I took these steps, I quickly built my credit.
Open a Second Credit Card
If you already have a credit card, applying for a second one may be the next step. When you have multiple credit cards, you have more credit available to you. And, as long as you avoid running up high balances on your credit cards, your credit utilization ratio (which measures your current debt) and credit score can improve. Experts recommend keeping your balances under 30 percent of your credit limits to improve your credit score.
Aside from this, you can earn rewards from multiple credit cards. For instance, you might want a travel credit card and a cash back credit card, or a grocery credit card and a dining card.
Request a Credit Limit Increase
Increasing your credit limit is an easy way to boost your credit score. Credit limit increases can give you a slightly higher line of credit on each of your existing credit cards. If you don’t turn your extra credit into debt, that extra credit can help your credit score grow.
[Related: How To Rebuild Credit After a Financial Crisis]
How to Build Credit Without a Credit Card
Pay Your Rent and Utilities on Time
Without a credit card, you can build your credit without one by using the power of your other monthly bills. Check with your landlord to see if Experian RentBureau reports your payments. RentBureau works with a rent payment service that can report your rental payment history if it can.
It might be worth signing up for Experian Boost as well. It tracks your phone and utility payments and helps you boost your credit score. You could see your FICO score improve immediately if you pay those bills on time each month.
Get a Personal Loan
A small personal loan should be available to you after you’ve used credit cards for a while and made on-time payments. In addition to diversifying your credit report and showing consistency with your payments, personal loans can raise your credit score over a period of six to twelve months.
There are, however, some loans geared toward those with little or no credit history, such as:
Credit Builder Loans
The purpose of a credit builder loan (CBL) is different from that of a traditional loan, as its name suggests. As a result, they work a little differently. In this case, borrowers make payments before receiving funds.
Credit unions typically offer CBLs. There may be other places where they are available as well. To begin the process, the lender deposits a small amount, around $300 to $1,000, into a locked savings account. Over a set period of time, referred to as a term, borrowers make small payments. The money is paid out after all payments have been completed.
Credit bureaus receive progress reports as payments are made on a CBL.
Other Loans
Loans such as mortgages, student loans, and car loans can also impact your credit score. You may already have some credit history if you have debt like this. Consequently, if you were trying to build credit from scratch, applying for them wouldn’t make sense. However, you can continue to build credit by making your payments on time.
Your credit score can be negatively impacted by falling behind on payments for secured loans, such as car loans or mortgages. This is because the collateral is a vehicle or property. The collateral can be lost if you fall behind on payments in a secured loan.
Maintain Good Credit Habits to Help Build Credit From Scratch
Having a FICO score requires at least one open credit account for at least six months, as well as a creditor reporting your activity within the past six months. FICO’s biggest competitor, VantageScore, however, is faster. To build your credit score, follow these good credit habits:
Don’t Miss Payments and Make More Than the Minimum
The most important thing you can do to help build your credit score is to pay your credit card or loan payments on time, every time. A higher payment will also benefit your score if you are able to make more than the minimum payment.
Create a Budget
In order to reach your financial goals, it’s essential to create a budget that compares your income with expenses. Setting aside payments for your loans or credit cards each month can help you plan your budget.
Monitor Your Credit Report
Be sure to monitor your credit report and dispute any errors you find so you can keep track of your financial habits. Keeping track of your credit score is also a good idea. And, there are several ways you can do it for free. For example, by visiting sites like AnnualCreditReport.com.
FYI, every credit reporting agency is required to provide you with a free credit report every year. The three agencies are Equifax, Experian, and TransUnion.
Don’t Use More Than 30% of Your Available Credit
Keep your credit card balances as low as possible. Your credit score is heavily influenced by how much you owe compared to your credit limit (or your credit utilization ratio). Despite paying your credit card bills on time, if you spend close to your credit limit each month, it can negatively affect your credit score. A real boost to your credit rating can be achieved by getting your spending down to 20% of your limit.
Keep Your Credit Accounts from Getting Overextended
Don’t apply for more than one credit account at a time. In addition to lowering your credit score, back-to-back inquiries may also result in lenders turning you down due to too many credit cards applied for in a short timeframe.
Don’t Make Unnecessary Inquiries into Your Credit History
When applying for a new credit card, avoid wasting credit inquiries on applications that are unlikely to be approved. If your credit history and background match your credit options, look for those designed specifically for you.
Maintain Existing Credit Accounts
To prevent your accounts from being closed for inactivity, use each credit card at least once per year. You may want to downgrade your credit card if you have an old one that charges annual fees. Why? By doing so, you will be able to keep your credit line open and increase your credit score without getting hit with a fee.
[Related: Building credit early with Ambition Card]
FAQs About Building Credit
1. What is credit?
Generally, “credit” refers to the borrowing and repayment history of a consumer.
Your credit includes loans, credit cards, and other financial products. A person with good credit has a better chance of receiving funding at good rates. Those with bad credit, on the other hand, are more likely to be rejected and have a higher interest rate.
2. How can I build credit?
In order to build credit, you must first establish responsible credit habits. In other words, you should always make your payments on time. Also, if you can, pay off your credit card balances in full.
Maintain a low utilization ratio (the amount of credit you use compared to the amount you have available to you) by using credit responsibly. You can increase the age of your credit history by keeping old credit card accounts open even if you don’t use them anymore.
3. How do you build credit with a credit card?
In order to build credit, credit cards are useful for two main reasons.
First, for young consumers without credit or loans, opening a credit card is the first step to establishing a credit history. In addition, when used wisely, credit cards can improve your score by reducing credit utilization and on-time payments
4. Does being an authorized user build credit?
Short answer? Yes.
Adding you as an authorized user to a credit card account shows your credit history as the account’s owner. When someone adds you as a user, their credit history gets updated with their five years of on-time payments and low utilization
5. Does paying rent build credit?
It’s possible. But it is not as easy as it seems, and there may be monthly fees involved. Consult your landlord about reporting your rent payments to the credit bureaus. If not, you can use a service that will report your payments to the bureaus for you.
