How to Build Credit
Some ways you can build your credit report are by opening a secured credit card, getting a cosigner on a credit account and maintaining good credit habits. However, there is a lot more you need to know about each of these approaches. It is also important to have an overall understanding of the importance of a good credit report and how the credit reporting agencies operate.
Some Basics About Credit Reporting Agencies
There are three major credit reporting agencies: Experian, Equifax and TransUnion. Each of these agencies, which are also referred to as credit bureaus, collects information from creditors on consumers’ credit accounts, including payment history and public records such as bankruptcies and financial judgments. Both positive and negative accounts appear on credit reports.
The credit reporting agencies must follow the rules outlined in the Fair Credit Reporting Act (FCRA), which is a federal law enforced by the Federal Trade Commission (FTC) and the Consumer Financial Protection Bureau (CFPB). The FCRA regulates how information is reported, collected, and shared by credit bureaus, medical information companies and tenant screening services.
The FCRA provides direction to the credit bureaus, including how long they can report on certain data. Simply put, there is a limit to how long certain items can remain in credit reporting agencies’ files. Bankruptcies, judgments, paid tax liens and other unfavorable information, such as repossessions, late payments and charge-offs can remain on your report for up to seven to ten years.
Under FCRA, Experian, Equifax and TransUnion are required to provide you with a free copy of your credit report once a year, which can be ordered from AnnualCreditReport.com.
It is recommended to check your report from each agency at least once a year and to review the information to ensure it is accurate. Sometimes errors show up on credit reports, so checking yours annually or before applying for new credit will help in addressing errors if they occurred. Under the Fair and Accurate Credit Transactions Act (FACTA), you are allowed to dispute any inaccurate information you might find on your credit report. View the FTC’s article, Disputing Credit Card Charges, for steps on how to dispute credit entries.
Why You Should Care About Your Credit Report
At this point, you might be asking yourself: Why should I care about what the credit reporting agencies are reporting? Having good credit can open a lot of doors, including the ability to get approved for new financing, such as a mortgage loan or auto loan. Employers, landlords, insurers and utility companies are among the many that often use credit reports when making decisions. Your credit report could be the deciding factor in getting that new job or obtaining that great interest rate.
Be sure to read our other article that goes into great depth about the importance of good credit, as well as the factors that go into credit scoring: What is a Good Credit Score?. Also, watch this helpful video that further explains credit scores.
Two Ways to Build Your Credit
Now that you have an idea of how credit reporting agencies work and why it is important to have good credit, it’s time to dive into ways to build your credit. These techniques apply whether you are establishing credit for the first time or trying to rebuild your credit after not using it for an extended period of time, a bankruptcy or other events that may have negatively affected your credit. If you are building credit for the first time, it will generally take about six months to see an improvement in your credit score. If you are rebuilding your credit, there are many variables considered, which makes it difficult to give an estimated timeframe to see an improved score. Regardless, the following techniques will put you on the right track.
1. Obtain a Secured Credit Card or Loan
When you don’t have a credit history or your credit history shows late payments or other adverse information, it can be difficult to get approved for a non-secured credit card. That is where a secured credit card can help you. A secured credit card works and looks like a typical credit card. The biggest difference is that it is “secured” by a security deposit held by the card company. This money is eventually refundable and is used as the basis to determine your credit card limit. The financial institution will generally give you a credit limit up to a percentage of your security deposit. In some instances, the financial institution will give you a credit limit equal to the entire security deposit. For example, if you deposit $200, your credit limit on the secured card will be $200.
Not all secured credit cards are reported to the credit reporting agencies, so be sure to check before you apply. Also, many of these secured credit cards can be converted into traditional credit cards after a certain amount of time has gone by. Keep this in mind when choosing a credit card.
Once you have been approved and received your secured credit card, try to stay below 30% of your credit limit. This habit shows the credit reporting agencies that you can be responsible with the credit that they’re providing. If you rise above the 30% utilization rate, you may be charging too much to your card and that can be perceived as a sign of poor financial management. To build credit on the card, be sure to pay off charges as they occur. The goal is to show a good payment history on your credit report.
A secured loan is another great option to build credit. With this type of financing, the loan is secured by some type of financial asset, which acts as collateral for the loan.
2. Apply for a Joint Credit Account
If you cannot be approved for credit on your own, you might consider opening an account with someone who has good credit. The account would be considered “joint” and both parties would be fully responsible for the amount owed. Even though a joint account can help you build credit, co-signing can be risky. If payments are late or missed, the negative activity will be reported on both account holders’ credit reports. Do your research and be aware of the obligations of having a joint credit account.
Maintain Good Credit Habits
Whichever route you go in building your credit, the most important thing to remember is to pay your bills on time. Payment history makes up 35% of your credit score and is a critical factor in maintaining a good credit report. Payments that are made 30 days or more past the due date will likely show up as late payments on your credit report and may substantially lower your score.
It may also be a good idea to open a checking and savings account at your financial institution. These accounts won’t be reported to a credit bureau, but they can show the institution that you can be responsible with your money. The bank or credit union may refer to this information when you apply for a loan.
If you are using a credit card, keep track of the total amount charged each month. It is recommended to not carry a balance on a credit card and to pay it off in full each month if possible. Unlike other loans, credit cards do not require a balance to build credit. Utilizing a small percentage of the credit limit generally has a better impact on your credit score and experts recommend you stay below 30% of your credit limit. The total amount owed across all of your credit accounts is a major factor in your credit score, comprising 30% of the total score. Lenders want to see that if you borrow money, you are responsible and financially stable enough to pay it back.
Once you have established your credit, don’t be quick to close the accounts you used. The length of credit history is also considered when scoring your credit. The longer the positive history, the better. Closing older accounts like credit cards may negatively affect your credit score.
Over time, your good credit will continue to build as you make payments on time and keep your balances low. With your positive credit history, you will find it easier to get credit approvals and better loan rates. Working to improve and build your credit is vital to meeting your financial goals.