How to Build Credit

Point of Interest: Building Your Credit

Learning how to build your credit is an important step to financial wellness. Having good credit opens many opportunities for better interest rates, lower down payments and even renting houses or apartments.

The process behind building credit doesn’t have to be a mystery — and it shouldn’t be. But, before you learn how to build credit, you need to understand why credit is important.

Your credit determines your ability to open bank accounts and get loans with favorable rates. For example, if you apply for a loan, any reputable lender is going to review your credit before deciding to move forward or not. Even if you’re approved, the terms of your loan, like its interest rate, will be set based on your credit. The higher the credit score, the more likely you’ll be approved with low rates.

Your credit can also impact other areas of your life, like finding housing or applying for jobs. That’s why it’s important to be aware of and build your credit.

If you want to learn how to build credit, you must first understand why credit is important.

How to build credit

Lenders prefer to lend to people with good credit, which is understandable. Good credit suggests less risk — and lenders don’t like risk. But this creates a circular problem. If lenders don’t like riskier loans, how are people with no credit or bad credit supposed to improve their situations? Well, several alternatives can help you figure out how to build credit.

Credit cards are powerful financial tools, but they are forms of debt. If misused, credit cards can put you in a financial hole.

The good news: there are several ways you can build your credit.

Apply for a credit card

Even if you have a limited credit history, you can still apply for a credit card. Expect a low limit at first, but you’ll be able to raise it with time and use.

The goal is to demonstrate your ability to manage debt. If you can prove that you’re capable, you’ll see your credit improve.

To build credit, use your card to make small payments. If you want to keep it simple, only use it for certain types of purchases at first — like groceries or gas. Pay your total balance every month, and make sure you pay on time. Two mistakes you must avoid if you want to build credit are only paying the minimum balance and missing payment due dates. If you don’t pay off your last statement balance, you’ll start owing interest, which can add up quickly. If you miss payments, you’ll be hurting your cause, as your credit will decline.

If you’re a student with no credit history, you can apply for a student card, which is designed to help you build credit.

If you have bad credit or no history, don’t worry — there are other avenues you can take.

Apply for a secured credit card

If you’re having trouble getting a standard credit card, a secured credit card might be a better alternative.

Secured credit cards are effective tools for building credit when you have bad credit or don’t have a credit history. With secured credit cards, users put down a deposit that acts as collateral in case the balance can’t be paid off. Usually, this deposit determines the credit limit of the card.

Similar to a normal credit card, the goal is to prove you can manage debt. So, you’ll build credit in the same fashion: making responsible purchases, maintaining a low balance, and making on-time payments. In time, your lender may be willing to convert your secured line of credit into a standard credit card.

Apply for a joint account or be an authorized user

If you’re unable to obtain your credit card account, you can open a joint account with someone who has good credit.

Another alternative to opening your account is to become co-applicant on someone else’s.

It’s not uncommon for parents to help their children build credit by opening a joint credit line with them. Both account holders are responsible for credit card payments, so both parties will be impacted by late and missed payments.

Apply for a credit-builder loan

If you’d prefer to sidestep credit cards at first, you can also build your credit with a credit-builder loan. As the name implies, it’s a loan specifically designed to help no credit and low credit individuals increase their credit score.

How? By helping you demonstrate your ability to make on-time payments over the loan’s term, which is usually between 6 and 24 months.

With credit-builder loans, the lender puts your loan in a bank account that’s under the lender’s control. To access the funds in this account, you’ll need to make payments each month until you’ve covered the amount of the loan (principal and related interest). As you make payments, your lender will report your activity to major credit bureaus.

Larger banks and financial institutions generally don’t offer credit-builder loans, so you’ll have to rely on credit unions, community banks, online lenders and Community Development Financial Institutions (CFDIs).

In most cases, credit unions have membership prerequisites — like being associated with certain companies or living in specific areas. However, these smaller financial institutions offer low-interest rates, so it’s worth researching this option.

If you’re unable to secure lending from a community bank or a credit union, you can work with CFDIs, which were created to assist low-income communities.

It’s important to keep in mind that too many credit card and loan applications will impact your credit score. Some lenders and credit card issuers perform a hard credit check when determining your eligibility for a product. Hard credit inquiries impact your score, so limit your credit applications to only two or three over one year. Otherwise, consider the next two solutions.

Pay off your existing debt

Your outstanding debt affects your credit. So, an easy way to build better credit is to pay off your existing debt. For example, if you have outstanding student loans, paying your monthly payments on time will prove you’re responsible and improve your score. Or, if you already have a credit card, you can pay off your outstanding balance. As a result, you’ll have a lower credit utilization ratio — which is a significant component of your credit score — and your score will increase.

Experts suggest keeping your credit usage under 30% to prevent major decreases in your credit score. If you have a large balance on a card or loan, try to budget frequently and resist charging extra expenses. Paying off debt isn’t an immediate solution, as debt is paid off over months or even years. However, the impact it will have on your credit score is extremely beneficial.

Check your credit report and correct blemishes

  • It’s important to periodically check your credit report and look for any mistakes that could be hurting your score. You can get your credit report from each of the three credit reporting bureaus in the U.S. for free once every 12 months at AnnualCreditReport.com. If you happen to find an error, here’s how to get it fixed.
  • Contact the credit bureau. Once you find an error, you’ll need to contact the credit bureau that produced your report. The credit bureau will then investigate your dispute, which could take up to 30 days to complete. Following the completion of the investigation, the credit bureau has another five days to report the results to you.
  • Contact the provider, if necessary. Depending on the error, you may need to contact the information provider as well (i.e. the financial institutions that provided your information to the credit bureaus). If the credit bureau made a mistake related to your identity, that’s the credit bureau’s problem to resolve. Otherwise, you’ll need to contact the provider, as it’s the one that can fix its errors. The provider’s investigation will also take up to 30 days to complete.
  • Review the results. The investigation will either rule that the disputed information is accurate or inaccurate. If it’s determined to be accurate, your report won’t be changed. If it’s found to be inaccurate, your report will be corrected. Make sure to routinely check your credit report until it’s correct, as this process can take some time.

What does it mean to have good credit?

Your credit score can simplify a lot of aspects of your life — or make them more complicated.

A good score doesn’t just demonstrate your ability to manage debt, it also indicates that you’re responsible. As a result, it’ll be easier for you to get approval for credit cards and other loans — like mortgages, student loans, etc. — with better interest rates and terms. It’ll be easier to apply for rental housing, as landlords and real estate agents will be more likely to approve your application.

Conversely, a bad credit score makes all of these processes much more difficult with higher interest rates, loan application rejections, and housing denials.

How to maintain good credit

Learning how to build credit is a key first step to maintaining good credit. Your credit is represented by a numerical score (i.e. your credit score), which consists of five factors. Having good credit means you have good credit habits. So, to maintain good credit, you’ll need to maximize each of these factors.

Payment history (35%): your track record of making on-time payments. Late and missed payments will harm your score.
Credit utilization (30%): the ratio of your outstanding credit balance to your credit limit. In other words, if you have a credit card with a $1,000 limit and you have an outstanding balance of $500, your credit utilization ratio is 50%.
Credit age (15%): your credit history’s age. The longer you demonstrate the ability to manage debt, the better your score.
Credit mix (10%): the diversity of your credit — such as credit cards, auto loans, mortgages, etc. Your credit score benefits from more diversity.
Credit inquiries (10%): the number of hard inquiries about your credit over the last year. Anytime a credit card provider, potential employer, or leasing agent submits a credit check, it’s logged on your credit report. More than a couple of hard inquiries will hurt your score. Note that soft inquiries, such as checking your score, are not a factor.

What does maintain good credit look like in reality? Always paying on time, never missing a payment, keeping your credit balance low (rule of thumb is a credit utilization ratio below 30%), and minimizing hard inquiries (don’t apply for a bunch of credit cards).

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