Everything You Need to Know About Building Credit

Woman using credit card at computer
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Bad credit can keep you from buying a home, financing your education, and even from getting a job. This is why it's so important to build good credit.

Starting with your first credit card, everything you do that involves credit becomes part of your credit history. To have a good credit history, you have to use credit responsibly. But what counts as using credit responsibly?

Start Building Credit By Getting Credit

Having good credit means you've demonstrated that you can handle credit responsibly — that you've managed your credit obligations and have paid on time.

The first step to building credit is to actually get credit. Getting credit for the first time can be tough since banks and credit card issuers will check your credit to approve your application. There are some ways you can get credit for the first time:

Apply for a Secured Credit Card

Secured credit cards are a type of credit card that requires you to make a security deposit against the credit limit before you can be approved. The security deposit is held as collateral for the amount you charge on the credit card and is refunded either when you close the account or it's upgraded to an unsecured account.
Credit card issuers are more likely to approve you for a secured credit card because the security deposit eliminates some of the credit risk.

Get a Retail Store Credit Cards

Retail credit cards often have less strict credit requirements. As a new credit consumer, you'll have a better chance getting approved for a retail credit card than other types of major credit cards.

 

Be aware that retail credit cards typically have low credit limits and high-interest rates and can only be used in a specific retail store. If you go this route, keep in mind that you're using this card to help you build good credit, not to go on a shopping spree at your favorite store.

Ask Someone to Make You an Authorized User

Being an authorized user can help jumpstart your credit if the credit card issuer reports the account to one of the major credit bureaus.

Verify the account is in good standing, doesn't have a high balance, and doesn't have a history of late payments. Otherwise, the negative account history will hurt and not help your credit score.

Get a Cosigner for a Credit Card or Loan

A cosigner who has good credit can apply with you to improve your chances of getting approved. Cosigners have joint liability for the account. That means late payments on the account will affect the cosigner's credit too.

Use cosigned and authorized user accounts to establish your first account. Then, once you can get approved for an account on your own, you don't need to rely on someone else to help you.

Make Your Payments on Time

Payment history is the biggest factor in your credit score. Make all your debt payments on time each month to build a good credit score. The more on-time payments you have, the more your credit score will improve.

You'll have some monthly bills that aren't listed on your credit report. This includes things like your cell phone payments, utilities, and insurance payments. They don't affect your credit as long as you're paying on time. However, if you default on your payments (to the point that your account is closed), the account will be sent to a collection agency and then it can wind up on your credit report.

At that point, it will hurt your credit score significantly.

Start With One Credit Card

Many first-time credit card users accumulate a collection of credit cards within their first few years of using credit. Don't make the mistake of opening up too many credit cards too soon. The more credit you have, the more you'll end up using and the harder it will be to keep up with your balances and payments.

Applying for several credit cards in a short period of time leads to too many inquiries into your credit. These inquiries can hurt your credit score. Not only that, too many new credit cards can negatively affect your credit score. It's better to first learn how to be responsible with credit before you apply for additional credit cards.

Watch How Much You Borrow

As a rule, you should never borrow more than you can afford to pay each month.

Borrowing within your means shows future lenders and creditors know that you're a responsible borrower. You'll find it easier to borrow money and get new credit when you show that you know how to only borrow what you can pay back. Not only that, only charging what you can afford helps you avoid excessive debt.

Maxing out your credit cards — or even coming close — is irresponsible, particularly if you don't plan to pay the whole balance off within the month. Lenders know that borrowers who max out their cards often have difficulty repaying what they've borrowed. Keeping your balance below 30 percent of your credit limit is best for building credit — the lower the better.

The same thing goes for loans. Only take out as much loan as you can afford to repay, regardless of what the lender says you qualify for. Before you shop for a loan, review your budget to see what monthly payment you can afford. Make sure your loan payment doesn't exceed the amount you've come up with.

Pay More Than the Minimum on Credit Cards

Your credit score isn't affected by the amount of your credit card payment — not directly at least. Your credit score considers whether you pay on time and the balances owed on your credit cards and loans.

Even though your payment amount isn't calculated in your credit score, you should ideally pay your balance in full each month. This prevents you from carrying too much debt. If you're only charging what you can afford to pay, this won't be a problem. Paying off your balance each month shows that you're capable of paying bills, something creditors and lenders want to see.

Making minimum payments won't hurt your credit score (unless it keeps your balance above 30 percent of the credit limit), but it keeps you in debt longer.

Keep Your Accounts Open

The longer you've had credit, the better it is for your credit score — 15 percent of your credit score is based on the amount of debt you're carrying. Leaving your oldest account open will help increase your credit age. Closing the account won't remove it from your credit report immediately. But, after several years, the credit bureaus will eventually drop old, closed accounts from your credit report.

Can You Do It Without a Credit Card?

Remember that your credit score is based on how well you handle your debt obligations, so building credit requires you to borrow money in some form. Credit cards are often easier to get, particularly if you're just starting out, but alternatives exist.

You can build good credit by borrowing out a loan and paying it back on time. It can be a mortgage, car loan, student loan, or personal loan. Generally, all loans borrowed from a major bank or credit union will help you build your credit score.

Payday loans and title loans are not reported to the credit bureaus and do not help you build credit. You should avoid these kinds of loans anyway because they're expensive and predatory.

How Long Will It Take?

There's no way to predict how long it will take you to build a good credit score. When you're first starting out, you'll need to have your first account open and active for at least six months before your credit score can be calculated. After that, it's just a matter of adding months of positive payments to your credit report.

How Do You Know If You're Doing a Good Job?

While your credit report holds all the information about your credit history, your credit score is the best way to measure your progress in building your credit. Your credit score is a numerical summary of the information in your credit report at a specific moment in time. It's the number that creditors and lenders use to decide whether to approve your applications and what interest rate to charge you.

Once you've had a credit account active for a least six months, you'll have a credit score. You can check your credit score for free on CreditKarma.com or CreditSesame.com. You can also purchase your FICO score from myFICO.com. The FICO score is the credit score most commonly used by lenders.

You can monitor your credit score regularly to see how it changes as time passes and timely payments are added to your credit history.

Four Big Mistakes to Avoid

It's much easier to build a good credit score than it is to repair your credit once it's damaged. As you're working to improve your credit, here are some things you should avoid.

Paying Late 

Once negative information, like late payments or debt collections, is on your credit report, it will stay for seven years. You'll have to work even harder to overcome the damage done to your credit. Pay all your bills on time to keep negative accounts off your credit report.

Letting Your Credit Card Go Unused 

You must have at least one account active for the past six months to have a credit score. If you fail to use your credit cards, not only will it affect your credit score, your credit card issuer may cancel your account. Use your credit card at least once every few months to keep it open and active.

Borrowing More Than You Can Afford 

Having too much debt can hurt your credit score, particularly since 30 percent of your credit score is based on how much debt you're carrying. The other problem with borrowing more than you can afford is that it can lead to more serious problems like foreclosure, repossession, or even bankruptcy.

Not Checking Your Credit 

The best way to take ownership of your credit is to check your credit report and score periodically. Checking your credit score helps you know where you stand, but it doesn't give you the complete picture. You should also check your credit report to verify that the information in is accurate — any errors could affect your credit score. If you do find errors on your credit report, you can dispute them with the credit bureau to have them removed.