How to build credit

Summary

•  Understanding how credit works can help you track your credit score and make better financial decisions.
•  Paying your bills on time can have a big impact on your credit score, so it's worth setting up reminders or automatic payments.
•  A secured credit card can be a good way to start building credit, especially if you're just getting started.
• Keeping your credit balance low, ideally under 30%, can help you maintain a healthier credit score over time.
•  Applying for too many credit cards or loans in a short period can hurt your credit score, so it's best to apply when you really need it.

Credit is the ability to borrow funds to make purchases with the promise that you'll repay the money later with interest. Lenders review your credit history to help determine whether to lend you money, how much and at what interest rate. If you don't have credit or have a thin credit profile, it might be challenging to get approved for a new car to commute to work or the luxury apartment you've had your eyes on.

Building your credit starts with establishing and maintaining good money habits that will show lenders you're a reliable borrower. Check out these 6 tips to get started on your credit-building journey.

 

1. Understand how your credit works

A credit score is a 3-digit number that helps lenders, landlords and even some employers decide how responsibly you manage debt. Most credit scores are calculated by companies like FICO (Fair Isaac Corporation) , an analytics software company that developed the original credit score model, known as FICO scores. Scores generally range from 300 to 850, with higher numbers being more favorable.

The base FICO score ranges and categories are:

•   800 – 850: Excellent
•   740 – 799: Very good
•   670 – 739: Good
•   580 – 669: Fair
•   300 – 579: Poor
  

Your credit score is calculated based on your credit reports, compiled by the three major credit bureaus: Equifax, Experian and TransUnion. There are five factors that affect your FICO score:

•   Past payment history (35%).
•   Amounts owed (30%).
•   Length of credit history (15%).
•   New credit (10%).
•   Credit mix (10%).

When you have little to no credit, you’ll have to work to build up each of these areas to get a good credit score.

It’s also a good idea to check your credit reports regularly. You can get a free copy from each of the three major bureaus mentioned above every 12 months. Review your report to make sure all of the information is accurate and to keep track of your credit profile.

 

2. Pay your bills on time

When you pay your bills has the biggest impact on your credit score. Try to pay at least the minimum on your credit card balances, and consider setting up automatic payments or alerts to help you keep up with due dates. The more consistently you make your payments on time, the more likely you’ll build a good credit score.

 

3. Open a credit card

Opening a credit card is a great way to start building your credit, but qualifying for one can be challenging if you're just starting out. Luckily, there are options designed for borrowers who are building their credit, like secured credit cards. If you use them responsibly, these cards could help you establish a credit history and demonstrate to lenders that you’re a reliable borrower.

Secured credit card

A secured credit card  requires a refundable cash deposit, which acts as your credit limit. This type of card is ideal for beginners since payment activity is typically reported to the credit bureaus and can help you build credit over time.

4. Become an authorized user

If you don’t qualify for a credit card right now, becoming an authorized user on someone else's account is an option. You'll receive your own card, and while you don't need to use it for activity to be reported on your credit, any positive history from the account will still benefit you. However, it's important to note that if the primary cardholder misses payments or carries a high balance, it can also negatively impact your credit.

 

5. Maintain a low credit utilization rate

Your credit utilization rate is a percentage of the money you owe compared to the amount of credit you have access to. For example, let's say you have one credit card with a $500 limit. If you carry a balance of $50 on that card, your credit utilization rate is 10% of your credit limit.

Generally speaking, the lower your credit utilization is, the better. Experts recommend keeping your credit utilization rate below 30 percent. If your credit utilization rate is higher than that, you’ll want to work on a plan to pay the balance down so you can maintain a good credit score.

For example, let’s say you have three credit cards, each with a $10,000 limit. One card has a balance of $1,000, another has $2,000, and the third has no balance. That means your current credit card debt is $3,000. Since your total available credit is $30,000, your credit utilization is 10 percent.

6. Limit credit applications

Every time you apply for new credit, whether it’s a credit card or a loan, that inquiry ends up on your credit report. Lenders might be concerned if you’ve applied for a lot of credit in a short amount of time. However, scoring models can identify the differences between rate shopping for one type of loan — like comparing car loan offers — and applying for multiple lines of credit.

Build your credit one step at a time

Building your credit history doesn’t happen overnight. Maintaining good financial habits, like consistently making on-time payments and keeping your credit utilization low, are some ways to help build your score.

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