How To Build Credit:
The Definitive Guide
If you're trying to build your credit from scratch, you can basically take two different routes:
- 1Build your credit with a credit card. This involves tactics like signing up for a secured credit card, becoming an authorized user on someone else's account, and getting a co-signer.
- 2Build your credit without a credit card. This involves using other types of credit—such as student loans, car payments, and a mortgage—to help establish your credit.
This guide will walk you through both of these options, as well as cover things like the best practices for using credit, why building credit is so important, and the different types of credit.
Let's get started.
How to build credit with a credit card
Whether you're just starting out, or it's been awhile since you borrowed money, establishing credit takes a bit of work.
One of the easiest ways to start building a credit history is to open a credit card.
This puts you on the credit map because it prompts creditors to start reporting your payment history to one or more of the credit bureaus, and once at least one credit bureau has a record of your history, they can assign you a FICO score.
Of course, if you lack a credit history, you might struggle to get that first credit card. But there are several strategies that can help.
1. Start with your bank account
If you don't have a credit card, how can you prove you'll pay your credit card bill on time?
When you think of it this way, establishing credit can feel like a dog chasing its tail.
While you may not have a credit card, chances are you've got a savings or checking account.
If you've built a good relationship with your bank over the years, try to build on that trust by opening a credit card with the same provider.
2. Consider a secured credit card
When you're building a credit score from the ground up, there's a good chance you'll have to start with a secured credit card.
When you open a secured credit card, you put down an up-front cash deposit as a guarantee—this is typically a few hundred dollars, which puts secured credit cards within reach for most people.
From there, a secured credit card works like any other credit card. You can use it to make purchases, and then make sure you pay your bill on time every month. As you build a solid credit history, you can move up to a regular credit card.
When choosing a secured credit card, don't be afraid to shop around. Because secured cards are often marketed to people with a bad credit history, some of the terms might be unfavorable.
Avoid secured credit cards with high interest rates or unreasonable fees, and also try to pick a card that lets you convert your secured credit card into an unsecured card once you prove you're a responsible credit user.
3. Become an authorized user
Another option to build your credit history is to piggyback on someone else's.
To do this, ask a relative with a good credit history to add you as an authorized user on one of their credit cards—this gives you a chance to start establishing a credit history without being on the hook for any payments.
Even though you'll have no official obligation to pay the bill, it's still a good idea to come to some kind of informal arrangement with the cardholder. After all, they're giving you a chance to establish credit and possibly risking their own to help you do it.
If you go this route, however, make sure the cardholder's credit card company reports the activity of authorized users to the credit bureaus—that way you'll get credit for being on the account.
4. Get a co-signer
In some cases, you can open a credit card as long as someone is willing to sign on with you.
Unlike an authorized user, however, a co-signer is fully responsible for the card's balance.
If you don't pay, the credit card company will come knocking at their door.
How to build credit without a credit card
Credit cards aren't the only way to establish a credit history—in some cases, a student loan, a new car, or even a cell phone contract can help you start building your credit.
Let's take a look at six ways you can get started with establishing your credit history.
1. Student loans
Heading to college? Your student loans could be a great way to help establish your credit history—but you have to make your payments on time. Few people can pay cash for a college degree, which means borrowing from family or taking out a student loan.
Just as making timely payments boosts your credit score, however, missing them or paying late can hurt it. The last thing you need as a new grad is a credit report littered with missed student loan payments, so make sure you don't overextend yourself when borrowing.
2. Auto loans
Auto lenders report borrowers' payment histories to the credit bureaus, which can help establish your credit history. As with student loans, however, it's critical to make sure you stay on top of your monthly payments, as even one or two late payments can tank your credit score.
It might be tough to qualify for a mortgage if you have a scant or nonexistent credit history, but if you can borrow with a co-signer, a mortgage can be a good strategy for building your credit.
The majority of landlords don't report tenants' payment histories to the credit bureaus, but some will agree if you explain how it can help you—and credit bureaus are happy to include the information once it's submitted.
If your landlord won't report your payments, you can also try using a third party site that will let you pay your rent online and will also submit your payment history to the credit bureaus on your behalf. Most of these sites charge a small fee, but many tenants find that the convenience and credit building perks are worth it.
5. Cell phone payments
In some cases, something as straightforward as paying your cell phone bill on time can help you build your credit.
According to Pew Research, 95 percent of Americans own a cell phone, and 100 percent of people between the ages of 18 and 29 have one. If you're looking to build your credit from scratch, your cell phone contract could be a good place to start.
Some lenders have special credit builder loan programs designed specifically for helping people without credit start establishing a good credit history.
Traditionally, these loans are for small amounts, such as a few hundred dollars—the lender puts the loan amount in a savings account or similar account, and then the borrower makes periodic payments at a low interest rate. When the loan is paid off, the borrower receives the money along with the start to an established credit history.
Best practices for using credit
No matter how you decide to start building your credit history, a bad credit history can sink your score just as much as having no history at all.
This is why it's important to adopt credit best practices right from the start.
Here are nine credit best practices you can take to the bank.
1. Make your payments every month
The golden rule of using credit and building a great credit score: make all payments on time, every time.
It might sound harsh (or impossible) to say "no exceptions," but even a few late payments on an otherwise spotless credit report can damage your score a lot more than you might think.
2. Don't pay interest
You don't need to carry a balance on your credit cards to have good credit.
If you can manage it, pay off your card balances in full every month—this way, you build up a good payment history while avoiding interest charges.
3. Keep your credit utilization low
Credit utilization is how much of a debt balance you have compared to your total available credit.
In other words, you don't want to creep too close to your credit limit, because this makes lenders think you're at risk of not being able to make your payments.
If your credit utilization is too high, try asking your credit card company for a limit increase.
4. Avoid opening too many accounts at once
Too many credit cards and other forms of credit can make it appear like your income isn't sufficient to support your lifestyle, which can be a red flag for potential lenders.
Too many new accounts can also lower the average account age on your overall credit report, which can in turn lower your credit score.
On the other hand, it's a good rule of thumb to open one new card approximately once a year—this will gradually increase your available credit, which can help your credit utilization ratio.
5. Don't close old accounts
People sometimes make the mistake of celebrating paying off a credit card by closing the account—this "throwing away the key" approach might seem like a good idea, but it can actually hurt your credit utilization.
If you pay off a balance and no longer wish to use the account, simply cut up the credit card but keep the account itself open.
There's an exception here, though: if you have a credit card with an annual fee, close it and then open a card with more favorable terms.
6. Vary up your credit types
Don't stick to just one type of credit—mix things up by having a good balance of credit types, including secured and unsecured debt, as well as revolving credit and installment credit.
7. Make sure your credit reports are accurate
As soon as you begin building your credit history, it's imperative to start checking your credit report on a regular basis.
According to a study conducted by the Federal Trade Commission (FTC), 1 in 5 consumers has an error on their credit report!
If you spot an inaccuracy, you should take immediate steps to correct it through the dispute process.
8. Make a budget
Before you can use credit responsibly, you need to understand how much you can afford to spend every month.
Creating a monthly budget will help you manage your expenses, so you don't take on more debt than you can handle.
9. Shop around for the best interest rate
When you're just starting out with credit, you might not get many options when it comes to interest rates.
But it's still a good idea to shop around—lower interest rates can help ensure you stay on top of your monthly obligations, so you don't rack up any late or missed payments on your credit report.
5 reasons why it's important to establish credit
In today's world, it's hard to get by without credit—so it's incredibly important that you have some type of credit history.
Never mind getting a loan or opening a credit card—in many cases, your credit history (or lack of it) can affect everything from your address to your job prospects.
1. Renting an apartment or buying a home
Excited to rent your first apartment or shop for a new home?
A lack of credit history can be a red flag for landlords and mortgage lenders—banks and landlords want to know they can trust you to pay your bills on time.
Even if you're looking to rent, a prospective landlord is basically extending you a loan by agreeing to enter into a rental agreement. They depend on credit reports to help them gauge your risk as a tenant.
2. Buying a car
Most people don't have enough money saved up to pay outright for a new vehicle, and if you need to take out a car loan, the lender will pull your credit history before agreeing to loan you the money.
And your credit score will determine how much interest you'll pay on your loan!
If you don't have a credit history, you could struggle to obtain financing. In most cases, lenders will ask you to produce a co-borrower who can step in if you miss payments.
3. Getting a job
It's crazy to think about, but a lot of employers will look at your credit report before extending a job offer.
If you work in a field where you handle money or have some kind of financial responsibility to the company, it makes sense that a business will want to see proof that you look after your personal obligations.
If you can't take care of your own money, how will you take care of theirs?
4. Keeping the lights on
You might be surprised to learn that some utility companies consider your credit history before agreeing to extend a service contract.
If you want to start electricity service or enter into a cable agreement, the utility companies in your area might check your credit history to find out whether you pay your bills on time.
5. Starting a business
Got a great idea for a business? Some of the most successful entrepreneurs in history got their start at a young age.
But most businesses need a significant financial boost to get off the ground, and if you want to take out a small business loan to launch your idea, lenders will want to check your credit history first.
The reality is that any new business is a risk—if you lack a credit history, you pose even more risk to banks.
The different types of credit
Remember that your credit score is an assessment of your risk based on a number of factors, including the kinds of credit you have.
Just as it's important to establish a credit history, it's also important to have the right balance of credit types—as too much of one kind can affect your score.
Secured credit is just that: secured by some kind of collateral.
For example, when you take out a car loan, you give the lender a lien on your vehicle in exchange for the money you need to pay for the car.
If you fail to make your car payments, the lender can seize the car.
Home mortgages are another common type of secured credit.
On the flip side, unsecured credit isn't backed up by an asset.
Rather than having the ability to seize collateral if you fall behind on your payments, the lender's only option is to pursue collection against you—either by selling your account to a collection agency or suing you in civil court.
Common examples of unsecured credit include credit cards, student loans, and medical bills.
When you have revolving credit, it means a lender has extended a specific amount of credit you can use whenever you choose. The catch is that you have to pay a minimum amount toward your total balance each month.
For example, your credit card might have a $10,000 limit with a minimum monthly payment that changes depending on how high your balance gets.
As the name suggests, installment credit works on installment payments.
In exchange for borrowing money to pay for a car or a house, you agree to pay the lender a fixed amount of money each month, plus interest.
When you make your final installment payment, you assume full ownership of the item you financed.
Understanding your credit report
If you're looking at your credit report for the first time, the amount of information can quickly make your eyes glaze over. However, understanding your credit report is easy once you know what to look for and what the various sections mean.
As a whole, your credit report is a snapshot of how you've handled credit in the past, as well as a predictor for whether you'll use it responsibly going forward. Lenders use your credit score to determine what level of risk you pose.
Your credit report contains several sections: personal information, accounts, inquiries, and public records/collections.
The personal information section includes basic identifying information, such as your name, date of birth, telephone number, social security number, and your home address, and will also show past addresses and phone numbers.
Here's an example:
It may seem straightforward, but it's important to check this section for errors, especially if you have a common name.
If the credit bureaus have mixed you up with another person, your credit history may include accounts that don't belong to you!
The accounts section will list every account, one by one, along with who owns it, when it was opened, the terms behind it, and whether you've made your payments on time.
Depending on a person's credit history, this can be a lengthy section—and it's definitely the most important part of your entire credit report.
Inquiries come in two flavors: hard or soft.
Hard inquiries happen any time you apply for credit—for example, if you fill out an auto loan application, the lender will pull your credit report, which counts as a hard inquiry. Having too many hard inquiries can lower your credit score.
By contrast, soft inquiries don't affect your credit score at all. Examples of soft inquiries include a prospective employer requesting your credit report as part of a background check, or even you obtaining a copy of your credit report to check for errors.
Public records & collections
Your credit report will also list any past bankruptcies (which count as public records), as well as any accounts your lenders have turned over to collection agencies—both bankruptcies and collections can seriously lower your credit score.
How to build credit fast
When you're starting from scratch, building your credit can feel like a slog.
But persistence definitely pays off, and establishing a good credit history may not take as long as you expect if you're committed to working hard at it. On average, positive changes take between 30 and 60 days to show up on your credit report.
Above all, the best way to establish good credit is to pay your bills on time. Many factors go into calculating your credit score, including the amount of new credit you have, your mix of credit types, your credit history, your credit utilization, and your payment history.
You should pay attention to all of these factors, but keep in mind that your payment history carries more weight than any other variable.
By staying current on your bills, you can lay the foundation for a good credit score and a solid financial future.