How to build credit: The basics and more

In a nutshell

Your credit score is a three-digit number that reflects your creditworthiness. Building credit is the process of showing the companies that compile your credit score that you are a trustworthy borrower.

• Your credit score is calculated from data gathered on your financial interactions by the three credit reporting agencies: Equifax, TransUnion and Experian.
• There are different credit scoring models the credit bureaus use, including FICO and TransUnion.
• Several factors influence your score including how much you owe, your on-time payment history, and your credit mix. By improving your performance in these categories, you can build your credit score.

Your credit number is an important number when it comes to your finances, but figuring out how to build good credit can be daunting. Whether you’re starting from scratch or rebuilding good credit after a financial hit like bankruptcy or foreclosure, building up your credit, and boosting your score, can take time but is well worth the effort.

Learn how to build credit responsibly to help you qualify for lower interest rates and higher limits when it comes to your future loans and credit cards.

How to start building credit with no credit history

When you have no credit history, it can be a little overwhelming to figure out how to start building credit. Lenders generally avoid issuing credit cards or granting loans to customers with no credit history because they don’t know whether the customer will be responsible and make on-time payments. That makes customers with no credit history a risk to lenders since if they default on a card or loan, the lender will lose money.

However, there is hope. If you have no credit history to your name, there are a few options to help build a healthy credit history that will open the door for future credit cards with lower interest rates or higher limits or for larger loans to buy a home or a car. By using a credit card or loan designed specifically to build credit, you can go from no credit history to a healthy history that shows on-time payments and responsible behavior. You can also enlist the help of a family member or close friend to help you build credit by agreeing to be a cosigner or to add you as an authorized user to an existing credit card.

How to build credit with a credit card

One of the best ways to build credit is through the use of credit cards. However, getting a credit card without a credit history can be difficult. From the perspective of the credit card company, it’s very risky to approve a credit card for a customer who has no history to show they can make payments on time and handle the credit responsibly. For this reason, most people will have to start out by opening a secured credit card.

Secured credit card

A secured credit card is simply a credit card that requires a deposit. This deposit acts as a type of insurance for the credit card issuer since if the borrower defaults, the credit card company can recoup some of their losses through the deposit. Depending on the company, the deposit may be refundable. Generally, the credit limit on a secured credit card is lower than the limit on an unsecured card, again to help protect the issuer from potentially losing money if the borrower defaults on their card.

Student credit card

Some credit card companies may also offer cards specifically designed for college students or recent grads who don’t yet have a credit history. These cards may have no annual fee and offer cash-back rewards at stores college students frequent. Student credit cards typically also come with lower credit limits and higher interest rates. Proof of income will be required or you will need a co-signer. Do the research to see which cards are available to help build credit.

Increased credit limit

Another way to improve your credit using a credit card is to ask the issuer for an increase in your credit limit. If you’ve been diligently paying your bills on time, your credit card company may approve a higher limit, which can, in turn, decrease your credit utilization ratio, which is the amount of credit you are using out of the total amount of credit available to you. A lower credit utilization can mean a higher credit score.

Authorized user

Finally, you can ask to be added as an authorized user to a parent or other family member’s credit card. As the card owner makes on-time payments, it can have a positive effect on the authorized user’s credit history. However, the effect on an authorized user’s credit will be much smaller than that for the main owner of the credit card. Despite this, being added as an authorized user can help if you’re starting with no credit history and want to have something to show on your credit report.

Pay on time

When building credit with a credit card, it’s vitally important to make payments on time and to always pay at least the minimum balance required by the card, and pay over the minimum balance if possible. Failure to make timely payments can be detrimental to your credit score and may prevent you from getting secured cards or loans in the future. By purchasing everyday items like groceries or gas using a secured credit card and paying off the balance each month, you can build up a positive credit history that will open the door for unsecured credit cards or lower-interest bank loans.

How to build credit without a credit card

A credit card can be a useful tool for building credit, but not everyone wants to take out a secured credit card with the goal of building credit. Luckily, there are also options to build credit without needing to use a credit card.

Take out a credit-builder loan

A credit-builder loan is designed to help people build credit without a credit card. This type of loan is most commonly offered by credit unions and community banks and can have a term between six months and two years.

At the beginning of the loan, the lender will make a small deposit (generally between $300 and $1,000) into the account, and the customer will make monthly payments toward the loan amount. Once the borrower has made all the monthly payments and the loan term is up, the money is theirs to do with as they please. This makes a credit-builder loan more like a savings account than a traditional loan.

The bank or credit union reports the payments to the credit bureaus, which helps build credit history. As with any other type of loan or credit card, the borrower must make on-time payments each month in order to build a positive credit history.

Get a loan with a co-signer

Another option for building credit without a credit card is to take out a loan with a cosigner. The cosigner should have a good credit score and will be expected to repay the loan if you fail to make payments. For this reason, it’s important to make timely payments every month so as not to affect your cosigner’s credit. If you default on the loan and the cosigner is unable to pay, their credit will be negatively affected as well. Many younger people ask their parents to be cosigners, which can be a good strategy, but failure to pay off the loan can lead to strained relationships with your cosigner.

Report your rent payments to credit bureaus

If you’re a renter, you can opt-in for certain services that report your on-time rent payments to the credit bureaus, which may reflect those payments in your credit history. Since you’re already paying rent each month (and hopefully paying it on time), this can be an easy way to potentially boost your credit score without the need for a credit card. Note that there may be a fee to have your rent payments reported.

How are credit scores calculated?

Credit scores, such as FICO, are calculated using several factors that signal responsible financial behavior. Some factors have more of an impact on your credit score than others, but for a well-rounded credit score, it’s important to focus on all factors. The main factors in calculating a credit score include payment history, credit utilization, length of credit history, credit mix, and new credit.

Payment history (35%)

Payment history is one of the most influential factors in determining your credit score and makes up 35% of FICO credit scores. A person with a history of on-time payments is a much more appealing customer for a lender than a person who has multiple missed or late payments shown on their credit report. That is why it’s so important to make payments on time, especially when building your credit history from scratch. And even once you’ve built up a good credit history, making on-time payments will ensure that your credit score remains positive enough to get a loan or credit card when needed.

Credit utilization (30%)

In addition to payment history, credit bureaus will look at your credit utilization or the percentage of available credit you are using when determining your credit score. FICO counts credit utilization as 30% of your credit score. While it’s not bad to owe money on credit cards, owing too much or maxing out your credit cards makes you look risky to lenders. A borrower who has overextended their credit will likely have a lower credit score than one whose credit utilization is on the lower end.

Length of credit history (15%)

The length of your credit history also has an impact on your credit score and makes up 15% of your overall rating. While a short credit history doesn’t necessarily equal a low credit score, someone with a longer credit history has more proof of responsible credit utilization and is therefore less risky in the eyes of a lender. The credit bureaus will look at the age of your oldest account, the age of your newest account, and the average age of all of your accounts when determining your credit score.

Credit mix (10%)

Another factor that goes into determining your credit score is your credit mix, which makes up 10% of your credit score. There are several types of credit, including revolving (your typical credit card), installment (any kind of loan such as a mortgage, student loan, personal loan, or car loan), and service (bills such as your cell phone and utilities). A good credit mix includes a little of each. While it’s not necessary to have all types of credit in order to have a good credit score, it certainly helps show that you are capable of managing multiple types of debt and credit responsibly.

New credit (10%)

While using credit cards can help build credit, opening too many at once can be a red flag on your credit report and impact 10% of your score. Even if you don’t open a bunch of accounts in a short amount of time, having a large number of hard credit inquiries on your credit report can signal that you’re risky to lenders, and that can decrease your credit score. Try to avoid applying for too many credit cards or loans at once to prevent a negative blow to your credit score.

How long does it take to build credit?

If you are building your credit from scratch, it can take as little as three to six months to reach a good credit score. However, if you’re starting with a poor credit score, it can take much longer to build it up into a good score; as much as a year or more of dedicated good financial behavior, in fact. If you slip up and have a couple of months of missed loan or credit card payments, you could find yourself starting from scratch.

No matter why you’re building your credit, it’s important to keep tabs on your credit report using a service like Credit Sesame so you can identify any potential issues before they become larger problems. For example, identity theft can have a seriously detrimental effect on your credit score, and you may not find out until it’s too late. By checking your credit score regularly and addressing any potential issues quickly, you can help protect your credit score and your financial future.

The AP Buyline roundup: Be consistent and patient

The best way to build credit is to be consistent and patient. There is no way to go from having no credit history to having a good or excellent score overnight. It takes dedication and responsibility, but the good news is that it is possible to build good credit, whether you’re starting from scratch or starting with an undesirable credit score.

You can start by creating an attainable budget, and then sticking to it diligently until it becomes automatic. Prioritizing your payments and committing to not overspending can help set you up for a lifetime of financial health and good credit.