How to Build Credit

How to Build Credit

You probably know by now that credit is important, but do you truly know what credit is, how it’s used, and why it is so important? Unfortunately, this isn’t something that everyone learns in school unless they go out of their way to take finance classes.

We’re here to help you make up for the things you didn’t learn in school. Focusing on your finances as a teenager gives you a tremendous head start. As fragile or intimidating of a process as it may be, establishing credit and building up a solid credit history is not all that difficult. The key is arming yourself with the knowledge to make smart and strategic financial decisions.

What is “Credit”?

Credit scores, credit reports, credit checks – what does it all mean and why is everyone so focused on it? Here’s our take on credit in its simplest form:

Credit is a measure of your trustworthiness and risk in the eyes of lenders. It helps determine your ability to borrow money or resources now and pay for them later or gradually over time.

It might help if you think of things from the eyes of a lender. You want to make money by lending to others, who will pay you back with added interest. The key piece there is “who will pay you back”. Lenders need to gauge the risk of lending to each and every borrower. A person’s credit score and credit history helps potential lenders know how they’ve handled their finances in the past.

Types of Credit

Throughout your credit building journey, you’ll encounter different types of credit – installment and revolving. Installment loans are lines of credit with a finite amount borrowed that is paid back gradually, in installments (payments), plus interest. Revolving credit does not have a set amount given by a lender, but rather has a credit limit that the borrower must stay within.

Why is Credit Important?

Establishing and maintaining a good credit rating is important when making some of life’s larger purchases such as a home or car. As important as it is to find a job for an 18 year old it is equally as important to start building credit. The world we live in just isn’t built for living on cash alone. You’ll need to use credit at some point in your life and you want to be set up to do so when that time comes.

Repairing damaged credit can be extremely challenging and/or expensive. You have the advantage as a teen to start off on the right foot. You won’t have a perfect credit score right out of the gate – and you don’t need one. Just focus on contributing positive credit history as you go.

There is more to consider than just loans when it comes to credit as well. Like we mentioned before, in a way, credit is a measure of your financial trustworthiness. Here are some people that may take a look at your credit to help in their decision making.

  • Lenders – to either approve or deny loan inquiries
  • Landlords – to determine if they want you living at their property
  • Potential Employers – to gauge your eligibility for employment
  • Insurance companies – to influence your rates
  • Utility companies – to judge your likeliness to pay for your electricity, water, phone, etc. consistently

Prepare for Good Credit Habits

Credit can be a slippery slope if you don’t think things through. Arming yourself with knowledge about credit scores and reports will better prepare you to make smart and informed financial decisions, which will leave you in good credit standing.

When it comes to establishing credit, you need to think long-term. If you’re too stuck in the short-term and make ill-informed decisions, you’ll end up doing more harm than good.

How to Build Credit Fast

There’s no such thing as a “build perfect credit overnight” solution, sorry. The fastest way that you can build credit is to learn about the things that will be most impactful. Knowing how credit scores are calculated is essential in building credit quickly.

Here’s a general distribution of what things impact your credit score, and to what degree.

Payment History

Payment History

35%

Credit Card Utilization

Credit Utilization

30%

Hourglass

Age of Credit

15%

Credit Mix

Credit Mix

10%

New Credit Card

New Credit

10%

So let’s break this down – the two most important things to keep in mind are arguably common sense.

  1. Make your payments on time, every time
  2. Don’t use all of your credit – try to keep it under 20% of your available credit

The other items will come with time. Don’t make hasty decisions to open new lines of credit when you don’t need to.

Building Credit with a Credit Card

If you’re not opposed to getting a credit card, we’d recommend this as a great way to start contributing positive credit history. You’ll need self control though. This is real money that you will have to pay back.

Become an Authorized User on a Credit Card

Believe it or not, you need credit to get approved for a credit card. Seems kind of backwards since your whole goal is to build credit, but it makes sense. The credit card company needs to be confident that you’ll make your monthly payments.

Here’s where becoming an authorized user can be an excellent option. This is essentially when someone, such as a parent who already has a credit card, adds you as a user to their account. You’ll get your own card and can spend just like them, but it all rolls up to their account.

You’ll have to work out your plan for making payments with the original cardholder. But, assuming that the payments are being made, your credit will also benefit. On that note, you’ll need to make sure that when you ask someone to add you as an authorized user to their credit account, they are also reliable and make their payments on time.

Secured Credit Cards

A secured credit card is a great low risk credit option, especially for first time credit builders. With this type of card, you make a deposit upfront, which then becomes your credit limit. By having this boundary and not falling into the unhealthy credit habit of “I’ll worry about the payment later”, this can be a good way to start building history and aging your credit.

This method essentially removes the main source of danger that comes with standard credit cards – overspending. You can think of it like you’re making your payment before you spend any money.

Choosing Your First Real Credit Card Account

If you don’t like the idea of a secured credit card or being an authorized user and want what most people could consider a standard credit card, you’ll have to decide whether you want a store-specific credit card or one that you can use anywhere.

Bank or Credit Union

Credit Union or Bank Credit Cards

If you have a good relationship with your bank or credit union and want a credit card that you can use anywhere – at various stores and online, this is the way to go. Beware of your spending. The freedom that comes with this type of credit card can be dangerous.

VS

Shopping Cart

Retail and Store Credit Cards

If you want a card that you can use only at a certain place, consider a store-specific credit card. The benefits of this are that it limits you and helps avoid unnecessary spending temptations. However, you may want to avoid getting one of these cards at your favorite clothing store, video game shop, etc. Grocery stores are typically a decent option.

Student Credit Cards

You can also be on the lookout for credit cards tailored for students. Some of these cards come with great rewards and perks. But beware – they tend to have lower credit limits and higher interest rates. 

If you’re able to consistently pay off your balance in full, you won’t have much to worry about. However, carrying a balance on a high interest card can become expensive.

Building Credit without a Credit Card

Maybe you’re not in love with the idea of credit cards in general. There are other ways to establish good credit as well. But be careful, as many of the same risks apply. Typically a credit card is a lower-risk route to take when establishing credit for the first time.

A credit card is considered revolving credit, so as you may have guessed, installment loans are the other way to improve your credit score. The primary way to build credit without a credit card is through various types of loans. 

Student Loans

If you’re attending a college and take out student loans to pay for your classes and books, on-time payments to them can help improve your credit. Keep in mind that this is simply an added perk of student loans – not a reason to justify taking one out. If you’re unable to make your payments on time, you’ll end up damaging your credit and set yourself up for potential financial hardship in the future.

Credit Builder Loans

Credit builder loans can be thought of as the loan-equivalent to a secured credit card. In these loans, you’ll pay the full balance upfront. Then, the bank or credit union from which you got the loan would deposit this into a savings account. 

You’ll make monthly payments, with interest charges just like a normal loan for the full loan term. These loans can vary, but usually have loan term options anywhere from six to twenty-four months. 

Credit builder loans exist for the purpose of helping people establish credit, as the name suggests. Making these on-time payments will help boost your credit score. At the end of the loan you’ll receive all of the money back and an improved credit score. You may even see interest gains depending on how your rates compare.

Auto Loans

By the time you’re 18 and ready to start establishing good credit, you may be looking into purchasing your own vehicle. You could choose to look for a cheaper car to buy in cash, but that will not impact your credit.

Getting an auto loan is one of the most effective ways to build or rebuild your credit. Obtaining approval for your auto loan from a lender can be challenging though. No credit is often viewed the same as bad credit when seeking approval from lenders. They don’t know your credit history, so they can’t accurately gauge the risk of giving you a loan. This may require you to get a cosigner or reduce your budget for a car.

Peer-to-Peer Lending

A lot of these ways to build credit without using a credit card are, unfortunately, rather expensive. Be careful not to get in over your head if you’re not quite ready or don’t have a job that pays well enough to support these methods yet.

Peer-to-Peer lending programs offer an excellent avenue for obtaining small personal loans on the borrowing side or investment opportunities on the lending side. This is essentially a service that matches lenders to borrowers. The lenders contribute investments that are then distributed to the borrowers, the borrowers make payments towards these loans plus interest, which is how the lenders make money. 

Cosign on a Loan

Becoming a cosigner for someone else’s loan can impact your credit score. However, this is a less likely scenario because typically a cosigner has good credit and acts as support for the primary borrower. 

This is also a bit risky because you’re relying on that person’s ability to make their payments on time. In the event they don’t, this will backfire and actually end up hurting your credit score. Not only that, but you’ll be obligated to make those missed payments.

For those reasons, we’d recommend avoiding this one and choosing another way to raise your credit scores.

Establishing Credit from the Ground Up with No Credit History

Whether you are establishing credit for the very first time, ramping up your efforts to improve your credit score, or rebuilding damaged credit – you’ll take a lot of similar steps. The general concept of it all is in with the good, our with the bad.

The advantage of having no credit history is there’s no bad! So you’ll need to simply focus on pumping in as much positive credit history as you can. When you’re building credit as a beginner, there are a few things you can do to make things a little easier on yourself.

Find a Cosigner

We’ve mentioned this already as a potential requirement for obtaining loans with little credit history. However, if you have someone reliable that is willing to cosign for you, it may be a good idea regardless. 

Having a cosigner can not only help with loan approvals, but they can potentially help you secure a better rate and ease the financial burden of a loan.

Ask your Landlord to Report Payment History to Credit Bureaus

In most places, landlords don’t report rent payment history to credit bureaus by default. For something that may be your largest expense, you want some credit for that, right? There are a few different options you can take to get your rent payments reflected on your credit reports.

  1. Ask your landlord if they may already be reporting these payments. If not, inquire if there’s an opportunity to do so. The worst they can say is no.
  2. Rent reporting services can also be an option.Typically, you pay them a fee and they will report rent payments on your behalf.
  3. Using a credit card to pay rent is another route if the above two methods are not an option. While this may not specifically list rent payments, you will still be contributing positive payment history to your credit card account.

Continue to Grow Your Credit

Your credit score is something that will need to be maintained over time. Using the same methods of building credit can be used to continuously improve your credit scores and maintain an excellent credit rating.

Here are some things you can do throughout your credit building journey to boost your score over time.

Make Your Payments on Time

We’ve said this a lot, we know – but that’s how important it is. Payment history is the most significant credit factor and can lead to further problems if neglected.

Diversify Your Credit

Once you’ve started to get your sea legs in the world of credit, you’ll want to diversify the types of credit accounts you have. This is what’s called “credit mix” that makes up approximately 10% of your score. 

Credit cards, auto loans, home mortgages, and student loans are all different types of credit that you can add to the mix.

Check Your Credit Scores and Reports

Staying up to date on your credit health is essential in improving your scores over time. You can do this through various credit monitoring apps and services, as well as by requesting your credit reports each year.

A popular credit myth is that checking your own credit will lower the score. Thankfully, that is not true. The difference in whether or not a credit check will impact your score is if it is considered a hard or soft inquiry. Checking your own credit is considered a soft inquiry, whereas something like applying for a line of credit is a hard inquiry and will impact your score. 

Request a Credit Limit Increase

Having a higher credit limit – more available credit – can help in your mission for an excellent rating. This will lower your credit utilization, which is also an essential component to credit score calculations. This is, of course, assuming you don’t increase your spending simultaneously (which we absolutely do not recommend).

Avoid These Mistakes When Building Credit

Everyone makes mistakes. The important thing is that you learn from them and try to avoid as many as you can. You have the knowledge to make smart credit decisions. Here are some of the credit “don’ts” to keep in mind.

Don’t Rush

You don’t need an excellent credit rating by tomorrow. Trying to rush things will lead to mistakes 9 out of 10 times. Take what you’ve learned and raise your credit score gradually by continually adding positive history.

Don’t Pay Interest

That may sound odd at first, but you can avoid interest payments on your credit accounts if you handle them effectively. The way to do this is by paying your balance in full every month, rather than just covering the minimum payment or slightly more.

Regardless of your interest rate, if there’s no balance to apply it to, you won’t accumulate any interest on the account.

Don’t Spend Beyond Your Ability to Pay Back

This is an extremely common problem that’s not unique to teens. Getting in the habit of spending more than you can afford to pay back will lead you down a bad path when it comes to credit.

If you can’t pay the balance in full at your due date, you’ll end up carrying a balance. This will cause you to pay interest, leaving you with less money than before. If you don’t change your spending habits, that balance will grow and grow – with less money to pay it off each time.

Don’t Overdo It

Building good credit can make your future financial decisions and obstacles a heck of a lot easier to handle. However, that doesn’t mean that you should make unnecessary and emotional financial decisions in an effort to raise your credit score.

Also keep in mind that you have a tremendous advantage by being a finance-conscious teenager – TIME. You shouldn’t be pouring all of your hard earned money into credit cards and loan payments if you don’t need to. Instead, start investing a portion of that money and build wealth and credit in tandem. 

Credit Building Tips & Tricks

Ultimately you’ll need to figure out what works best for you because everyone’s situation is a little different. We’re here to help you figure all of that out and guide you in your finances. 

Set a Schedule and Know Your Accounts

Having a solid schedule can help ensure your payments are on time and your credit is headed in the right direction. At a minimum you should outline the following for each account.

  • Due date
  • Interest rate
  • Minimum payment
  • Available Credit (revolving)
  • Balance (installment)

Setting reminders and getting into a habit of taking care of your finances at a certain time will make you more efficient. This is far easier if you get paid on a set schedule.

For example, if you’re paid every two weeks, take care of your banking and credit accounts every pay day. This provides an added advantage because if you’re making payments every two weeks instead of every month, you’ll be sure to never accidentally miss a payment!

Use a Spreadsheet

Many of you are probably already using a spreadsheet to keep track of your budget, payments, and other aspects of your finances. We highly recommend that you continue to do this or start if you’re not already. Not only does a method like this help to remind you of what you’re responsible for, but it allows you to look back historically to track how your spending habits change over time and make adjustments where they’re needed.