Your credit history is possibly one of your most valuable assets. A good credit score enables you to qualify for loans, save money with lower interest rates and fees, get certain jobs, and qualify for an apartment. As important as good credit is to your quality of life, the sooner you start to build good credit, the better.
Because creditors are reluctant to trust consumers without a track record, building good credit from scratch can be difficult. Even once you start to establish a credit history, you will need to understand how your credit score is determined, in order to maintain a good credit score. This article provides advice on both points: getting started and understanding what you need to do in order to build good credit.
Getting Started on the Path to Good Credit. Building good credit usually requires time and diligence. The idea is to demonstrate that you will pay your bills reliably over time, slowly increasing the dollar amounts and number of accounts that creditors are willing to trust you with. Unfortunately, getting your first few accounts can be difficult. Here are a few tips for getting started more quickly and easily.
- Get a co-signer. Having a co-signer benefits you in two ways. The first way that a co-signer benefits you is quite obvious: A co-signer helps you get an account you couldn't get on your own merits. However, in some cases, having a co-signer also allows you to "piggyback" off their credit: Your credit score may be calculated as similar to theirs, even if you don't have a previous credit history yourself. Of course, this can backfire if your co-signer has poor credit, so choose your co-signer carefully!
- Apply for credit when you are in college. College students typically find it easier to qualify for credit than young adults who have already entered the workforce. This is most likely because college students, whether rightly or wrongly, are still associated with their parents' households. Credit card companies expect that Mom and Dad can still bail you out if necessary. With this in mind, though, be careful - it is easier to get started during this stage of your life, but it is also easier to get into serious trouble.
- Apply for gas cards and store credit. Gas cards, store credit cards, and buy-now-pay-later plans (such as on furniture and home theater equipment) are generally easier to qualify for than major credit cards. However, remember that these accounts also tend to carry higher interest rates than regular credit cards, making it easier to get in over your head without realizing it!
- Get a secured card. Most credit cards are unsecured, which means that you don't pay any money up front. A secured credit card is often offered as an alternative for consumers who still need to prove their credit-worthiness. With these cards, you make a deposit that you borrow against. Before applying for a credit card that is secured, make sure you will be able to upgrade to a regular (unsecured) card once you have proven yourself!
- Set up checking and savings accounts. Believe it or not, this does make a difference, especially if you are just starting out. Having both checking and savings accounts demonstrates that you are stable and reliable, especially if you have had the accounts for a long time.
- Apply for a small loan. Many people think of credit cards as the only way to build credit. Actually, your credit history will benefit most from having both types of accounts on it. Your first loan should be for a small amount and have a short loan term, so that your payments are small and you can pay it off relatively quickly.
- Use your cards regularly, but not too much! Don't forget that your goal with these initial cards is to establish a credit history for yourself. You don't want to run up a balance right off the bat, so make sure you don't charge more than you can pay off in full. The last thing you want to do is to have to repair your credit score when you're just starting out. However, you should also be sure to use your card every month, as the creditor may stop reporting to the credit bureaus if your account becomes inactive.
Understanding What Good Credit Means. Your credit score is calculated using five main factors: your payment history, how much you owe, how far back your credit history goes, what types of accounts you hold, and how many new accounts and/or inquiries you have on your report. However, each factor carries a different weight in determining your credit score, with payment history and amount owed making up about two-thirds of your score.
- Payment history. Your payment history accounts for approximately 35 percent of your credit score. This means that making even one late payment can significantly lower your score. In general, the better your credit score, the more damage a late payment will do. For instance, a score above 700 can suffer a 100-point drop for a single late payment.
- Amount owed. The amount you owe determines about 30 percent of your credit score. When applying for a mortgage, loan or another credit card, creditors want to see that you are not already maxed out. In general, you should not apply for any more credit than you need, and your total credit card debt should remain under 50 percent of your total available credit.
- Credit history length. About 15 percent of your credit score depends on the length of your credit history. Accounts that you have held for many years demonstrate your ability to pay your debts reliably and consistently over time. Any time you consolidate debt or cancel excess credit cards, you should keep your older accounts open to maintain the longer credit history.
- Types of accounts. There are two main types of credit: installment, which refers to mortgage loans and other loans that have set payments, and revolving, which refers to credit cards. The types of accounts on your credit report determine about 10 percent of your score; a balance of both types of accounts looks the best to creditors.
- New credit and/or inquiries. The number of new accounts recently opened and/or the inquiries made into your report determines the remaining 10 percent of your credit score, with each inquiry and/or new account dinging your score a little more. If you have recently been trying to accumulate lots of credit, lenders will wonder how dependable you are.
Keeping this hierarchy in mind, the most important things to remember are to always make your payments on time, and to not spend too much. However, this should also demonstrate how important other factors are in building good credit. Paying attention to all five factors will ensure a well-rounded credit history and the highest possible credit score.
The Role of Good Credit in Your Life. Before a creditor will trust you with a large sum of money, they want to see that you have a track record of being able to manage your finances and pay your debts. Although getting started is half the battle, you also need to know what it takes to build good credit - and maintain it once you've got it. The quality of your credit history can determine your quality of life. Unfortunately, no one is born with good credit, any more than they are born with an education, a career or an income. The sooner you start to build good credit, the better and more secure your life will be.