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Building up good credit is important for creating a strong financial future. In order to get a loan for a house or a car, individuals need to show a strong credit history. Unfortunately, having a credit history is generally required in order to get a loan. For many consumers, this creates a "chicken or the egg" situation where it is difficult to build credit unless they already have credit.
Whether individuals lack a credit history or have a poor financial history, it is possible to build credit. Having good credit is necessary for buying a car or getting a home. Additionally, employers will often look at an applicant's credit history to decide if they are reliable enough to work for the company. Even insurance rates can be determined based on the driver's credit score. For all of these reasons, it is important for consumers to work on building a credit history and a strong FICO score.
What Does It Take to Develop Good Credit?
One of the main factors in having a good credit score is the individual's credit history. This history shows all of the times that the consumer borrowed money over the last seven to ten years. When a credit score is compiled, 35 percent of the score is based on the applicant's credit history. An additional 10 percent is based on their new credit lines, and 30 percent of the score is based on the amount owed. Another 10 percent of the credit score is based on the type of credit used, and the last 15 percent of the score is based on the length of the credit history.
With all of this information, the credit reporting bureaus create a credit score that is between 300 and 850. A higher score indicates that the consumer possesses a better level of credit worthiness. Once consumers realize the way that their credit score is created, they can use this information to figure out techniques to improve their score.
Start With Getting a Credit Card
When someone lacks a credit history, it is difficult for them to get a mortgage or a car loan. Fortunately, credit cards tend to be easier to obtain. Individuals who do not have a credit history may have to give a deposit to get the credit card, but having a credit card of any type will help them to build credit. Normally, people who have a stable job history and a decent income can get a credit line. In some cases, they may also need to get a cosigner to get the card. Student credit cards and secured credit cards are always an option as well. While a secured card requires a deposit that equals the credit limit, student credit cards do not normally require a deposit. Instead, they normally offer a lower credit limit.
Once the individual gets their card, they should start by making small purchases. A monthly trip to the grocery store or paying off a phone bill will work well for this purpose. After using the card for a small purchase, the balance should be paid off every month. Using the card for too many purchases can backfire because it can end up adding up to more than what the buyer can pay off each month. Easing into credit card purchases and paying off the balance every month is the best way to ensure that having a credit card does not become a problem.
Other than making sure that having a credit card does not become an issue, paying off the balance at the start of the month will keep interest from accruing. Even secured cards have high interest payments, and interest costs add up quickly. A $1,000 balance at a 20 percent interest rate ends up accruing more than $200 over the course of a year, so paying off the balance each month will help to save money in the long run.
Keep the Balance at a Minimum
Credit cards are for emergencies, but it is important to avoid dipping into a credit account too often. It is extremely tempting to use a credit account when money is low one month, but this can quickly add up. People tend to get in trouble with credit cards when they carry a balance from one month to another. Over time, the balance starts to snowball until it is too difficult to just pay off in full. Even in an emergency, a credit account balance should be kept at as low of a level as possible. A debt-to-limit ratio makes up 30 percent of the credit score, so keeping balances low is the only way to ensure that an individual maintains a good credit score over time.
Avoid Opening New Accounts
Opening an initial credit card account or getting a car loan can help to boost a credit score. Having too many new accounts will actually drop the score. Credit card companies look at the number of new accounts, so suddenly opening up five credit cards will hurt an individual's rating. In addition, 15 percent of the score is calculated based on the length of credit history. Due to this, individuals should try not to close any accounts. Having an account open for multiple years will help to improve the consumer's credit history, and closing the account will drop their score. In addition to dropping the length of the credit history, closing an account means that there is less available credit to make up the debt-to-limit ratio.
After getting a credit card, the main goal should be to use it minimally and pay off the monthly balance. By staying the course and avoiding new credit lines, individuals can boost their credit score. As an added step, each consumer should make sure to check their credit report regularly. The three main credit bureaus offer a free credit report each year, and there are other companies that offer credit monitoring services. By checking the credit report regularly, consumers can make sure that they are not victims of identity theft and prevent black marks from hurting their credit history.