How to Build Credit

Your credit report and score can impact nearly everything you do, from applying for a credit card to renting an apartment to getting a job. 

There are few shortcuts to building good credit, but anyone can do it with enough patience and dedication. 

Here’s how to pull it off:

How to Build Credit: Understand Your Credit Score

A credit score is a numerical representation of an individual's creditworthiness, providing a snapshot of their credit risk to lenders. Credit scores are used by creditors, such as banks, credit card companies, and mortgage lenders, to assess the risk of lending money or extending credit to you.

To understand your credit score — and how to build a great one — you have to know how the credit scoring models work. 

Your Credit Report 

Three main credit bureaus — Equifax, TransUnion, and Experian — collect and maintain consumer credit information. This information is complied into your credit report. The data typically includes:

• Open and closed credit and loan accounts
• Payment history
• Balances
• Degatory information such as charged-off accounts and collection accounts
• Public reports like liens, bankruptcies, and judgments

Typically, information stays on your credit report for seven to 10 years. During that time, good and bad information factors into your credit score. 

Your Credit Score

The information in your credit report is used to determine your credit score. There are two main credit scoring models: the FICO score, developed by the Fair Isaac Corporation, and the VantageScore, created by the three credit bureaus. Both credit scoring models give you a three-digit credit score ranging from 300 to 850 based on information in your credit report. 

You’ll have a credit score for each report from Equifax, TransUnion, and Experian. While the scores may differ slightly, they should primarily be in the same ballpark. Typically, the higher the score, the better. 

Components of a Credit Score 

The specific formula may vary slightly between credit scoring models. For FICO, your credit score is calculated based on:

1. Payment History (35%): This includes your history of making on-time payments, late payments, and any accounts in default.
2. Credit Utilization (30%): This is the ratio of your current credit card balances to your credit limits. Lower credit utilization is generally viewed more favorably.
3. Length of Credit History (15%): The length of time your credit accounts have been established. A more extended credit history is generally beneficial.
4. Types of Credit in Use (10%): The mix of credit accounts, such as credit cards, installment loans, and mortgages. A diverse blend may positively impact your score.
5. New Credit (10%): This considers recently opened credit accounts and recent credit inquiries. Opening multiple new accounts in a short period can be viewed negatively.

And your VantageScore breaks down like this:

• Payment History: 41%
• Depth of Credit History: 20%
• Credit Utilization: 20%
• Recent Credit: 11%
• Balances Owed: 6%
• Available Credit: 2%

Keep in mind your credit scores are fluid. Typically, lenders report to the credit bureaus monthly, meaning your credit score could update at least once per month. 

Start Small

Building credit can be a simple strategy. Start small by applying for a credit card or loan. Use your credit limit responsibly and pay your bills on time. Your credit score will rise as you model good behavior, and you can apply for more financial products as needed. 

Consider Tailored Credit Products

Tailored products like credit builder loans, credit builder cards, and secured cards can be helpful for those with no credit history. However, you’ll need to weigh the pros and cons and consider key factors like annual fees and interest rates to ensure you get the best deal. 

How Credit Builder Loans Work

Credit builder loans are structured to encourage responsible borrowing and repayment behavior. Here's how credit builder loans typically work:

• Secured Savings Account: The borrowed amount in a credit builder loan is not provided upfront. Instead, the loan amount is typically held in a secured savings account or certificate of deposit (CD) during the loan term. 
• Repayment Terms: Credit builder loans have a fixed repayment term, usually ranging from six months to a few years. Monthly payments are reported to credit bureaus, contributing to your credit history.
• No Upfront Funds: Unlike traditional loans, where you receive the loan amount immediately, credit builder loans involve making payments into a savings account, effectively "saving" the loan amount over the loan term.
• Interest and Fees: Credit builder loans may have associated interest charges and fees, similar to other loans. 
• End-of-Term Payout: Once the borrower completes the repayment term, they receive the accumulated funds from the secured savings account. 

How Credit Builder Cards Work

A credit builder card is a specific type of credit card designed for individuals with little to no credit history. The primary goal of these cards is to help users establish or rebuild their credit profiles. Here's how they typically work:

• Low Credit Limits: Credit builder cards often come with low credit limits, making them more manageable. This encourages responsible credit use without risking high levels of debt.
• Security Deposit: Some credit builder cards may require a security deposit, although this is not a universal feature. Unlike secured credit cards (explained below), the deposit might not determine the credit limit.
• Regular Reporting to Credit Bureaus: Credit builder cards report your payment activity to major credit bureaus, helping to establish a credit history. 
• Interest Rates and Fees: Credit builder cards may have higher interest rates and annual fees than traditional credit cards. These terms reflect the increased risk associated with individuals with limited or no credit history.
• Limited Rewards and Benefits: Credit builder cards often offer limited or no rewards and benefits. 

How Secured Cards Work

Secured credit cards are another option for individuals looking to build or rebuild their creditg. Here's how secured cards typically work:

• Security Deposit Requirement: Secured credit cards require a security deposit, often determining the available credit. This deposit acts as collateral, providing security to the card issuer.
• Credit Reporting: Like credit builder cards, secured credit cards report payment activity to credit bureaus. Responsible use of a secured card can contribute positively to a good credit history.
• Interest Rates and Fees: Secured credit cards may also have higher interest rates and fees, similar to credit builder cards. 
• Graduation to Unsecured Credit: Some secured credit card issuers offer the opportunity for cardholders to "graduate" to an unsecured credit card after a period of responsible credit use. This often involves returning the security deposit and receiving an upgrade to a traditional credit card.

Pay Your Bills on Time

Punctuality is key when it comes to credit. Your payment history has the most significant impact on your credit score. 

To ensure you always pay on time, consider setting up automatic payments. You can pay the minimum, a set amount, or the entire balance each month with many creditors. 

Keep Balances Low

Understanding credit utilization is crucial. Most experts recommend keeping balances below 30% of your total credit limit. However, paying your credit cards in full each month is the best strategy. That way, you’ll avoid paying interest payments. 

You'll have two kinds of credit utilization if you have more than one credit card — your individual credit card utilization and your overall credit utilization. Keeping your balances below 30% is a good idea, keeping your overall credit utilization low. 

Only Apply for What You Need

Overextending yourself with unnecessary credit can be counterproductive. It's essential to apply for new loans and credit only when needed, preventing potential pitfalls associated with excessive debt.

Keeping your number of applications down also has a negligible impact on your credit score. 

Build up a Mix of Credit Over Time

A diverse credit portfolio can positively impact your credit score. It doesn’t have a huge impact, but building up different kinds of credit over time is a good idea. For example: 

• Revolving Credit: Revolving credit is a type of credit with no fixed number of payments, such as credit cards. The account holder can use the credit up to a specified limit. The outstanding balance can be paid in full each month or carried over (revolved) with interest charges.
• Installment Credit: Installment credit, such as auto loans, involves borrowing a fixed amount of money and repaying it in equal installments over a specified period. Each payment consists of both principal and interest.

Consider Being an Authorized User

Becoming an authorized user on someone else's credit card can be strategic.

This arrangement involves being granted permission to use someone else's credit card account, typically that of a family member or close friend. Here's how becoming an authorized user can significantly contribute to building your credit score:

• Piggyback on Established Credit History: When you become an authorized user, you essentially "piggyback" on the primary cardholder's established credit history. If the account has a positive payment history and a low credit utilization rate, these factors can positively impact your credit score.
• Accelerated Credit Building: The authorized user status can lead to a quicker improvement in your credit score compared to building credit from scratch. This is particularly beneficial if the primary account holder has a long and positive credit history.
• Impact on Credit Utilization: Credit utilization, the ratio of credit card balances to credit limits, is a crucial factor in credit scoring. By being an authorized user on a credit card account with a low credit utilization rate, you indirectly benefit from this positive aspect, which can enhance your credit score.
• Limited Financial Responsibility: As an authorized user, you're not legally responsible for repaying any debts incurred on the account. This arrangement allows you to build credit without taking on the financial risks of being the primary account holder.

To pull this strategy off, you’ll need to think strategically. Consider:

• Choose the Right Primary Account Holder: Choosing the primary account holder wisely is crucial. Look for someone with a strong credit history and responsible credit habits. Your credit report will reflect both positive and negative aspects of their financial behavior. 
• Monitor Credit Activity Regularly: Even though you're not financially responsible for the account as an authorized user, it's essential to monitor credit activity regularly. Ensure that the primary account holder continues to manage the account responsibly.
• Communicate Expectations Clearly: Before becoming an authorized user, communicate openly with the primary account holder. Discuss expectations regarding card usage, payment responsibilities, and how the arrangement will benefit both parties.

Check Your Credit Reports

Knowledge is power, especially when it comes to your credit. You are entitled to one free copy of your credit report from each of the three major credit bureaus — Equifax, Experian, and TransUnion — once every 12 months. To access your free credit report, you can use the official website authorized by the U.S. government. Here's how to obtain your free credit report:

1. AnnualCreditReport.com:

• Website: AnnualCreditReport.com
• Process:
• Visit the official Annual Credit Report website.
• Click on the "Request your free credit reports" button.
• Fill out the required information, including your details, and verify your identity.
• Choose which credit reports you to request (Equifax, Experian, TransUnion, or all three).
• Complete any additional steps or security measures.

2. By Phone or Mail:

• If you prefer not to access your credit report online, you can request it by phone or mail:
• Phone: Call 1-877-322-8228 to request your free credit reports.
• Mail: Download the Annual Credit Report Request Form from the website, fill it out, and mail it to Annual Credit Report Request Service, P.O. Box 105281, Atlanta, GA 30348-5281.

Be cautious of websites or services that claim to offer free credit reports but may require you to sign up for paid services. AnnualCreditReport.com is the only website authorized by the U.S. government for free credit reports.

Building and maintaining good credit is essential for life. Understanding your credit score, monitoring your credit report regularly, and practicing responsible credit habits are fundamentals that will take you far. 

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