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By Kathryn Pins
Building credit is critically important. A healthy credit score will help you when you need to take out large loans, such as a mortgage, and will help lower your interest rates. The importance of credit also goes beyond your finances. Landlords, cell phone companies, insurance companies and even future employers will likely pull your credit score. So you may be wondering how to build credit? Follow these tips to establish credit and set yourself up for future financial success:
First, check your credit score. This initial check will let you see where you need to establish credit and how to build credit. If you’re starting to build credit from scratch, don’t skip this step. You want to ensure that there isn’t anything inaccurate on your credit score. You may also be surprised to find that you have a score because you were an authorized user on an account or for another reason.
You can check your personal credit information for free, and it takes just a few minutes. All three credit bureaus, Equifax, Experian and TransUnion, are required to provide you with a full credit report every 12 months.
A “Good” FICO credit score is any score of 670 or higher. A “Very Good” or “Exceptional” credit score is a score of 740 or higher. If you’ve checked your score and you’re doing well, jump down to the “ how to build credit for life: establish credit and good habits” section in this post or check out how to score an even higher credit score. If your credit score needs some big improvements, don’t worry, we have some tips below on how to build good credit.
An authorized user is someone who can make purchases on someone else’s credit card. An authorized user has a card with their name on it, but they’re on the same credit card account as the primary account holder. The primary account holder simply adds the other person’s name on their account.
How to build credit as an authorized user: There’s a lot of trust involved when someone becomes an authorized user. The primary user is legally on the hook for making payments. As an authorized user, you can only build your credit if your primary account holder is their making monthly payments. You need to trust the owner to make payments, and the owner needs to trust you to make responsible purchases.
If you’re trying to help a young adult establish their credit, this strategy is a simple way to help them out. For example, if you have a child in college, you can add them as an authorized user on your card and establish an agreement that this is an emergency card. Sit down and have a conversation on the times that your student can use the card. Can it be used if they need to use a rideshare late at night? Is the card strictly for fuel getting to and from school? As an authorized user, your student can establish credit with your help, as long as payments are made each month.
If you don’t have a credit card already, opening a credit card could be a great way to establish credit. However, getting accepted for a credit card on your own with little credit can be difficult. Your application is more likely to be approved if you apply for a credit card at your current bank or credit union (if you’re in good standing). Retail credit cards with low spending limits are also sometimes easier to get accepted for. You could also try applying for a secured card. On a secured card, you deposit money on the card to cover your credit limit.
How to build credit once you have a card: It’s important to slowly ease your way into the credit card world. Open just one credit card and practice using it on smaller purchases. It’s easy to start spending up to your credit limit because you suddenly have access to more money. However, you’re trying to build your credit. That means you need to be able to make your monthly payments. A good rule of thumb: Don’t buy anything on a credit card today that you can’t pay for with a withdrawal from your bank account today.
Why is a credit card good for establishing credit? A simple low-interest credit card is a great way to establish credit because you can keep it for a long time. Age of your credit is how long you have had access to a line of credit and it’s an important part of your credit score. In fact, it makes up 15 percent of your score.
When people think of how to build credit, they don't often think of credit inquiries. Credit inquiries make up 10 percent of your credit score. The type of credit inquiry that impacts your credit score is called a hard credit pull. Examples of a hard pull include applying for a credit card, applying for a mortgage, or even a background check. If you have a lot of hard credit pulls in a short time frame, your credit score could go down temporarily. Since you’re working on building your credit, be strategic on what you are applying for and how often a credit pull is being requested. It’s also important for you to know when your credit is pulled and the difference between a hard and soft inquiry.
A history of various types of credit is important to your credit score and will help you build your credit. Credit types make up 10 percent of your credit score.
Different lines of credit and loans require different levels of responsibility, so having a mix of loan types is important. For example, someone who has successfully paid off an auto loan, made their monthly credit card payments, and is working on their student loans has a better mix of credit types than someone who only has a credit card.
That said, a healthy track record is a key to a good credit score. It’s important to not take out a new type of loan unless you are able to pay that loan. You also want to make sure that your debt-to-income ratio is reasonable. Too much debt can negatively impact your ability to take out new loans, such as a mortgage.
If you’re starting from scratch, getting a cosigner on a loan could help you establish credit. A cosigner with a good credit score could help lower your monthly payments and get you a larger loan amount. When you co-sign a loan, both you and your cosigner are legally responsible for making payments on that loan. It’s not uncommon for someone to get a cosigner on their first loan.
How to build credit with a cosigner: If you need a student loan or auto loan, consider getting a cosigner with good credit. Like an authorized user, this type of agreement requires a lot of trust. Both you and your cosigner's payment habits will impact both of your credit scores. An easy way to make sure there are no hiccups is to sign up for automatic payments. That way both of you will sleep well knowing the loan will be paid on time each month.
Why is it important to have a high credit limit? It comes down to credit utilization. Credit utilization is a ratio the looks at the amount of credit you use vs. the amount of credit that is available to you (your line of credit). An easy example is to look at your credit card. Say you have a credit limit of $10,000 and your average monthly payment is $1,200. Your credit utilization ratio on that card is 12 percent. This ratio is good; however, a percent to strive for is anything less than 10 percent.
Credit utilization is a big part of your credit score. It makes up 30 percent of your score. Request an increase on your line of credit to help your score. You can usually do this on your credit card’s site or app.
The most important thing you can do to build credit is to make your monthly payments on time. Payment history makes up 35 percent of your credit score. A strong history of on-time payments will help you establish your credit. In order to ensure you never miss a payment, set up automatic payments each month. When you set it and forget it, you’ll build your credit score each month with ease.
Keep an eye on your utilization and request an increase when needed. You can also help your credit utilization by making sure your reoccurring balance isn’t too high. A common myth is that you must carry a balance on your credit card month over month to build credit. You will not get penalized for paying your credit card in full each month. You can lower your balance by paying in full. This will help you keep your credit utilization low.
As you work on building credit, see if you start seeing improvement in your credit score. Refresh yourself on how your credit score is calculated, so you can know what areas need improvement.
Kathryn Pins is a marketing content specialist at Alliant. She’s passionate about finding and communicating meaningful financial information with Money Mentor readers. Kathryn is a saver who gets more excited about certificates and her Roth IRA than shopping. When she does spend her earnings, it’s on furthering her education, travel, unique experiences, and loved ones.