Whether you have great credit, bad credit or you’re somewhere in between, the principles you must follow to build your credit are generally the same. Improvement takes time, but if you follow best practices you can create a strong credit history that will help you access the financial products and services you want.
Attaining better credit doesn’t have to be complicated. Here’s how to build credit.
1. Understand the basics of credit
Before you begin, it’s helpful to understand the basics. In simple terms, your credit is comprised of information about your history of managing debt and making payments. When you apply for a financial product such as a loan or credit card, the company will pull your credit to assess your risk. Rental applications and job applications may also run your credit.
People with the best credit will have an easier time getting approved for the financial products they want, and they can also access better terms and lower interest rates. They even pay less for insurance. So there is a real financial incentive to building strong credit.
When creditors are evaluating your credit, they look at two main factors:
Your credit report contains information about your history of managing debt. The three major credit bureaus, Experian, Equifax and TransUnion, each have their own version of your credit report. The report includes your current and past debts, credit applications you’ve submitted, whether your accounts are in good standing and negative items such as late payments, accounts in collections, bankruptcies or court judgments.
Your credit score is a numerical grade that is calculated based on the information on your credit report. FICO and VantageScore are the most popular scoring models, and your score can change depending on what model is being used. Credit scores fall within a certain range (usually between 300 to 850), and a higher number represents stronger credit.
2. Open a credit account
The fundamental way to build credit is to demonstrate, over time, that you can successfully manage debt. To do this, you will need to open a credit account such as a credit card or loan.
For credit beginners
If you’re just getting started, consider opening a student credit card or secured credit card. Student credit cards have low credit limits and sometimes offer rewards like cash back and incentives for maintaining a good GPA. Secured credit cards require a security deposit that establishes your credit limit, but otherwise operate just like a traditional card. Both options are accessible to people with a limited credit history.
If you aren’t ready to apply for a credit card, you could ask a trusted friend or family member to add you to theirs as an authorized user, letting you piggyback on their card to build credit history. This strategy comes with some risks, however; essentially, your credit will be tied to the activity on the card whether or not it is used responsibly.
For those with established credit
If you already have a credit card in your name, you can improve your credit mix by adding another type of credit such as a mortgage, auto loan or student loan, which can boost your credit score and demonstrate that you are capable of handling more than one type of debt. But it’s not a good idea to take on additional debt solely for the purpose of building credit, as it won’t have a huge impact - better to wait until you have an actual need.
Remember, you shouldn’t submit too many credit applications in a short time frame, as the resulting hard inquiries can cause your credit score to dip when they’re too close together. Try to space your credit applications out over time.
3. Pay your bills on time
Payment history is the single most important factor in building credit, as it makes up 35% of your credit score. Paying your bills on time and in full each month is the best way to maintain healthy credit, said Amy Thomann, head of consumer credit education at TransUnion.
Payment history includes the payments you’ve made on all credit cards and loans that appear on your credit report. It also factors in late payments including the amount owed, how late the payment is and how many accounts you have past due. Late payments can appear on your credit report once they’re 30 days past due, and they are not restricted only to credit payments (medical bills have 180 days to settle before they’re considered late). Payment history also includes negative items such as accounts in collections, bankruptcies and court judgments.
Reliably paying your bills on time boosts your credit and builds a positive payment history, which will continue to grow. But missing a single payment can drag down your credit score, and repeated missed payments could result in an account in collections which would do further damage.
If you think you’re in danger of making a late payment, call the company to see if you can negotiate an alternative arrangement.
4. Maintain a low credit utilization
Revolving credit accounts, such as credit cards or a home equity line of credit, are characterized by credit limits and fluctuating payments based on your balance. To build credit, you should stay far away from the credit limit and aim to keep your overall utilization low.
That’s because your credit utilization plays an important factor when calculating your credit score. At a certain point, having too much of your available credit tied up in debt can be a detriment to your credit score.
One frequently repeated recommendation is to keep your credit utilization below 30%. For example, if you have two credit cards with a total limit of $10,000, you should aim to keep your balance between both cards below $3,000, which is 30% of your available limit. There’s no hard science behind the 30% number - it’s just a way to keep yourself from getting overextended.
In fact, the best way to use a credit card is to pay off your entire balance each month. This helps you avoid interest charges and racking up too much debt and it keeps your utilization low. To do this, you would need to treat your credit card like a bank account balance, and only make purchases you can afford to pay off in full each month.
5. Check your credit report
Because the information contained in your credit report dictates your credit score and determines your creditworthiness, you should always know what’s inside. You can request free copies of your credit report from all three credit bureaus once a year for free.
Knowing what’s in your credit report will help you avoid any surprises when you apply for credit. If there are any mistakes in your report, you’ll want to dispute them and get them removed. If your report contains accounts you never opened and other inaccurate information, it could even be a sign you’re a victim of identity theft.
Check out our guide on how to read your credit report.
“In terms of good credit habits, it’s smart to check your whole credit report regularly to make sure lenders are seeing the most current and up-to-date version of your financial picture. If you see something you think is inaccurate, you can dispute it with the appropriate credit reporting agency,” said Thomann. “You can get one free report from each credit reporting agency each year at AnnualCreditReport.com.”
6. Play the waiting game
Time is another important factor in building your credit. The longer your history of making on-time payments on your credit accounts, the stronger your credit will be. The age of your accounts also matters, so consider keeping old accounts open to maximize the length of your credit history.
“Closing a line of credit can reduce the length of your credit history and increase credit utilization - both factors that often negatively impact your score,” said Thomann. “If you have a credit card you don’t need anymore, but it has a high credit limit or has been open a long time, you might want to consider keeping it open.”
If you’ve made some mistakes and you have black marks on your credit report, don’t worry - the impact of negative items will lessen over time, and most fall off of your report after seven years.
Need tips on how to build credit faster? Here’s a guide on improving your credit score quickly.