Get the best tips on how to build your credit, which will help you obtain a car, home, or other large assets to engage in the economy to your full potential and use financing and other services. If you are new to building credit, then this might seem like a challenge that is difficult to overcome. However, it is not as complicated as it might seem. Many of the things that you will have to do to build credit are rather simple and require that you simply be a productive member of the economy that pays their debts. We’ll go over the specifics, but here is what you need to know about this brief overview before we get started talking about building credit.
The Top Line
- Credit scores are measures of how good of a borrower you are, how well you pay back your debts, and how much history you have with taking out loans.
- It is important to build credit because it is what lenders will look at any time that you apply for financing for large purchases, homes, vehicles, and more.
- Building credit is a simple matter of paying off your debts on time and managing your debt to income ratio. With responsible spending habits, it’s not so hard to build credit.
- There are a few relatively unknown strategies to building credit, which we will go over.
Why Is Credit Important?
Building credit is extremely important because there are several things that you will need to purchase in your life that will need to be financed. This refers mostly to large assets such as your home and vehicle, but also applies to any other large purchases that you might make.
When you apply for a loan, the lender that you use will undoubtedly look into your credit history to learn about your history taking out debt and repaying the debt. This is what they use to evaluate whether it would be risky to give you a loan. Not only will they use this to decide whether to issue a loan at all, but they will also use your credit history to determine what kind of interest rate you will be getting.
In other words, your credit is not only important for obtaining the loan in the first place, but also making sure that you will be able to borrow money at an affordable rate and that your debt doesn’t cost you more than it should.
It’s important to build credit because you will likely use it for:
- Large Purchases
With a good credit and history of repaying your loans, it will be an easier road to getting the lending power that you need and getting the money at a rate that you can afford to pay back and that won’t hinder you financially.
Factors in Credit Score
Though nobody knows the exact way that credit scores are calculated (they likely take into account hundreds of different factors), we do have an idea of the main aspects that will affect your score as you go through life. With attention being paid to these factors, you can ensure that you maintain a good credit score and that you don’t stray in any of these categories. Knowing these factors will help you to prepare for applying for borrowing and ensure that your credit profile is appealing to the lenders that you’ll be using.
Age of Accounts
The first main factor in your credit score is the average age of the accounts that you have open. Lenders want to see that you’ve been taking out loans and repaying them for a while. They’ll use this to gauge how likely you are to continue the trend of paying back any loans that you do take out. If you don’t have a good, long history of being responsible with money, your application might look less appealing. You will need to build your credit history with responsible spending habits for years before applying to finance something large like a house. It is recommended that you avoid closing old accounts and instead just paying them off and keeping them open because this could reduce the average age of your credit.
Not only do lenders want to see that you have been repaying debt responsibly for a while, but that you’ve been paying on-time. As you can imagine, on-time payment is a very important part of the process for a lender, and they want to be sure that you will be repaying your loans without trouble. Even one late payment on your account can raise some eyebrows. You can build your credit by making on-time payments on your accounts and always keeping them up-to-date.
Diversity of Accounts
Lenders love to see that you can use a variety of different credit options responsibly and that regardless of what you have borrowed money for, you can repay it. This means that you should try to get a good mix of different accounts in your credit profile such as retail store cards, auto loans, student loans, and other types of loans that show the lenders that you have experience paying off a variety of different financing options.
If you take one thing away from this guide on building credit, it’s that you should avoid accounts going into collections at all costs. If you have a debt that you cannot pay, talk with the lender instead of going radio silence on them. If you have an account that goes into collections, you may find it very difficult to get a loan and work with a lender that is going to trust you. An account in collections can have an extremely negative impact on your credit.
Debt To Income Ratio
The final factor that they may look at is your debt to income ratio. This is calculated by taking your debt and representing it as a percentage of your income. Lenders want to see that you can handle debt responsibly and that you don’t bite off more than you can chew. If you can keep your income high and your debt expenses low, you’ll be setting yourself up for success.
Credit utilization is how much you use of the credit that you have available to you. Lenders want to see that you spend responsibly enough to not use all of the credit that you have available, or that you don’t max out your borrowing. This means that the lower your credit utilization, the higher your credit score.
Ways to Build Credit
Getting a Credit Card
If you’re able to, get approved for a credit card (ideally one without an annual fee). Then, charge a small amount on it, and pay it off in full each month. By doing so, you will lengthen your credit history, have low credit utilization, and demonstrate that you can use credit responsibly by paying off teh card each month. These are all factors that will help improve your score.
Obtaining a Secured Credit Card
Secured credit cards are designed for consumers who have little or limited credit history. The banks require a security deposit that they will use in case you don’t pay your bill. This means that the cards are easier to qualify for. If you apply for a secured credit card, be sure to ask if the credit history will be submitted to the credit bureaus or if the card will be changed to a regular credit card in the future. Otherwise the card will not help build your credit.
Credit-Builder Loan or Secured Loan
A credit-builder loan is designed to do as the name suggests. A borrower takes out a loan for a specified amount of money, but the bank actually holds on to the amount borrowed. The borrower makes payments on the loan, and the funds from the loan aren’t released until the loan is paid off. The purpose is to allow the borrower to build up credit by making on-time payments to the loan rather than have access to the funds immediately.
With a secured loan, a borrower provides something owned such as a car or house as collateral. While this makes it easier to qualify for a loan, it does put the collateral at risk if the borrower doesn’t make on-time payments. This is another way for a borrower to build credit history.
Become an Authorized User
If you are not able to qualify for your own credit cards, one of the easiest ways to build credit is to become an authorized user on an existing cardholder’s account. The existing cardholder must give the bank permission to add you as an authorized user. As an authorized user, you may spend on the credit card in the same way as the cardholder. Your usage and the on-time payments on the card will be added to your credit report even though you aren’t the cardholder.
Get a Co-signer
Another option if you are having trouble qualifying for a credit card on your own is to obtain a co-signer. A co-signer is someone such as a friend or relative with a stronger credit history who applies for the card with you. They will be equally responsible for making sure that the credit card bills are paid, and the payments for the bills will appear on both of your credit reports.
Build Your Credit from Other Bills
Making on-time payments for other bills such as student or auto loans will help build your credit. In addition, there are services that will report rent payments on your credit report. Experian Boost is a service that allows you to have your cell phone and utility bills put on your Experian credit report.
Investigate Non-profit Lenders
There are non-profit lenders that offer programs to assist those with limited credit histories. For example, Mission Asset Fund (https://missionassetfund.org) disburses more than $8 million in zero-interest loans to more than 9,000 clients a year.