How to Build Credit: A Beginner’s GuideSeptember 12, 2016
Building credit is a topic that isn’t always in the forefront of young adults’ minds. Up until a certain point in life, it is just something that they have never really had to worry about (or knew that it actually existed). However, with the transition from student to full-fledged adult comes an abundance of new responsibilities, and one of the most important challenges recent graduates and young professionals will face is establishing good credit. Having a good credit score is crucial for many adult decisions, including purchasing a car, becoming a homeowner, and even getting hired for a job. However, a solid credit score does not just happen. It must be built and maintained over a period of time. That is right — you will have to start from the ground up. Fortunately, there are several tools you can take advantage of as a college student, recent graduate, or young adult to begin the process.
First, we will cover some basics about credit scores. There are different types of scores, but the FICO score is the one most widely used by lenders. These scores are calculated by the three credit bureaus — Experian, Equifax, and TransUnion — and scores range from 300 to 850. This score takes a variety of factors into account, including how quickly you pay your bills, how long you have maintained accounts over time, the percentage of your monthly credit limit that you spend, and more. The higher the score, the easier it could be to obtain a credit card, take out a loan, and get lower interest rates.
You now know how credit scores work, but how do you actually begin the process of building credit from scratch? There are three major tools you can use to do so: credit cards, loans, and rent payments.
- Credit Cards
One of the simplest ways to establish credit is through credit cards. Before taking out a credit card be sure to:
- Before making large purchases, develop a plan for how you will repay what you owe in a timely manner.
- Try to keep your balance below 35 percent of your monthly credit limit.
- You do not have to charge every purchase on your credit card in order to build credit. Using your card sparingly and for smaller purchases, such as groceries, and paying off your balance each month will raise your credit score.
- Never miss a payment. Failing to make a payment on time could negatively impact your credit score.
In addition to traditional credit cards, there are also a few alternatives you can use to boost your credit. For example, a retail or store card is a type of credit card that can only be used at a certain store. They typically are easier to obtain than a standard credit card, but they often come with higher interest rates. You can also get a gas card (credit card used specifically at certain gas stations), which is a great way to make sure you do not overspend while still boosting credit.
A slower (but still solid) way to establish credit is by taking out a loan — whether it be an educational loan, a home loan, or some other type of financed purchase. Many young adults have to borrow money at some point to help finance their education or purchase a home, to name a few, and having a moderate amount of loans in good standing can be a great way to build credit. However, because payment history is the most influential factor in calculating a credit score, it is absolutely essential that you pay your loans on time each month. A good way to ensure punctuality is to set up automatic payments (whenever possible), set reminders, or make your monthly payments as affordable as possible. Figure out what amount is feasible for you to pay based on your income, and talk to your lender about the possibility of lowering your monthly rate.
A third option for establishing credit, and one that is often overlooked, is making timely rent payments. Two of the three credit bureaus, Experian and TransUnion, now give the option to factor monthly rent payments into your credit score. If you are a renter, this is a solid way to build credit history in college, after college, and as a young professional (and without a credit card).
Establishing a good credit history can seem like a daunting process, and getting started can be challenging for young people who are just beginning to achieve financial independence. Just remember, everyone must start somewhere. If you can use one or more of the above tools responsibly, you will be well on your way to building credit and setting yourself up for financial success in the future.