Like studying for exams or writing that important research paper, building credit is something that some young adults in college seem to prefer to put off doing until the last possible moment.
Maybe you’ve heard horror stories of credit cards gone wrong: people getting toppled by mountains of debt that take years to pay off or even having their debt sold to a collection agency. Maybe you’re already worried about paying off your student loan debt and don’t want to risk adding anything else to that. Maybe you just don’t trust yourself with a credit card.
Whatever the situation, young Americans are opting to hold off getting their first credit card, and by doing so are missing out on prime credit-building years.
Taking the time to build credit while you’re young can help set you up for a strong financial future. Putting it off can make things difficult for you down the road, as your credit report can be used to verify your trustworthiness in all sorts of situations.
Ready to start building a solid credit history? It’s important to first do your homework so you can go into the process fully prepared. Read on to learn about the basics of building credit, as well as how to avoid some of the common pitfalls of credit card ownership.
The world of credit can be kind of confusing if you’re new to it. Maybe you know what a credit card is but aren’t sure how it works or where your credit score comes from. Don’t be embarrassed if there’s something that you don’t know. Here are a few terms you might want to know:
- Annual Percentage Rate (APR): This is what you will pay in interest. It can be kind of confusing for first-timers, who might assume they’ll be paying interest only monthly, not annually. You will pay interest monthly; however, companies are required by law to show you your annual rate. In fact, you’ll be charged interest daily. You just won’t see it until you look at your statement. To calculate what your APR will look like per day, just divide the rate by 365.
- Credit limit: The maximum balance you’re allowed to have on your line-of-credit account at any given time. Once you hit this number, either your card will be declined or your account will accrue fees until you make a payment to get your credit card balance to below your limit.
- Credit report: A detailed report of your credit history, compiled by the three major credit reporting bureaus: Equifax, Experian and TransUnion. These reports contain every facet of your financial past – the good, the bad and the downright irresponsible. Negative information, such as missed payments, stays on your report for seven years, on average; although, bankruptcy can remain on it for up to 10 years.
- Credit score: This measures how financially trustworthy you are. FICO scores, the most widely relied upon credit scores, range from 300 – 850. According to the credit reporting bureau Experian, a score over 800 is considered exceptional; a score between 740 – 799 is rated very good, 670 – 739 is good, 580 – 669 is fair and 300 – 579 is very poor. Your score is determined by evaluating your credit report and looking at your payment history, amount owed (your utilization ratio) and length of credit history, as well as how often you open new accounts and types of credit used.
- Credit utilization ratio: The percentage of available credit that you use. For example, if you have one credit card with a $1,000 limit and you have a balance of $100, your credit utilization ratio is 10%. Credit reporting agencies use this as a factor to calculate your credit score.
- Grace period: The period between when you receive your monthly credit card statement and when payment is due. If you pay your balance in full during this time, you won’t be charged interest fees for that balance. If you don’t pay off the full balance, you’ll be charged interest on the remaining balance on your next statement.
- Minimum payment: The minimum amount of money you’re required to pay on your monthly balance. By only making the monthly minimum payment, it’ll take you a long time to get out of the debt, and you’ll end up spending a lot of money on interest.
Do I Really Need Credit?
Not having a credit history isn’t going to do you any favors. While it is possible to live your life without ever touching a credit card, you may find it to be a serious barrier to some of the things you want to do.
If you ever need a loan, you’ll likely need a good credit score to get one, unless you’re able to prove your financial trustworthiness in other ways, such as having someone with good credit co-sign the loan. Not having a credit history can also lead to you paying higher auto insurance rates and could affect your ability to rent an apartment. Cellphone providers may also check your credit when you’re getting a phone and may not allow you to enter into a contract without a cosigner if you have poor credit.
Beginning to build credit in college is a great way to start off on the right financial foot as you move into adulthood. By not waiting until after graduation, you can take advantage of any special offers geared toward college students. Plus, starting early can be a boon in itself, since the length of your credit history is factored into your score – the longer the history, the better.
Where to Start
While it can be difficult to get approved for a credit card without previously existing good credit, young adults have options to help get around some of the hurdles to building credit when you have none.
Qualifying for Your Own Card
If you’re just starting out, you’ll have limited options for the types of credit cards you’ll be eligible for. Your best bet is to either get a student card or a secured card.
Not having a credit history isn’t as big an obstacle when it comes to applying for a student credit card, as companies typically don’t expect you to have one. Because of the risk of lending to someone without credit, however, the card will likely come with a high percentage rate and a low limit.
When looking for a student card, look at many different options and compare them. Look for cards with no annual fee and pay attention to any rewards or stipulations. Some cards offer incentives for having a high GPA, while others may raise your limit after a certain number of on-time payments.
If you don’t qualify for a student card, look into a secured card. Secured cards require a down payment (usually of around $200) that serves as your credit limit. That way there’s no risk to the credit card company.
To apply for a credit card of any type, you’ll need to report your income. This can include money you make at a job, as well as any scholarships or grants.
Don’t apply for too many cards at one time, as that can negatively impact your credit score.
Become an Authorized User
If you don’t qualify for your own card, or you don’t have any independent income, consider asking a money-savvy adult in your life if you can be added to their credit card account as an authorized user. Before you do this, ask them to check with their issuer to make sure authorized user activity is reported to the three major credit bureaus; otherwise, your efforts will be wasted.
Take your responsibility as an authorized user very seriously, as the person whose account you’re on is responsible for every payment.
Although credit cards are the most popular way to build credit, there are a few other methods you can use if you don’t qualify for a card just yet.
If you are currently renting an apartment, you may be able to get your on-time rent payments reflected on your credit report. Ask your property manager if they report payment data to any of the major credit bureaus. If not, there are a variety of third-party services, such as Rental Kharma, that will do this for you.
Reporting your rent will mean that you’ll have a positive payment history on your credit report, but many types of credit scores won’t factor it into your score. The FICO 8, the most widely used score, doesn’t factor it in. However, FICO’s newest version, FICO 9, does.
Another option for building credit is to take out a loan. It may seem silly to borrow money just for the sake of building credit, but certain lenders offer loans specifically for this purpose. It’s called a credit-builder loan.
Credit-builder loans are mainly offered at credit unions and are typically for smaller amounts, from under $500 up to $1,500, according to CreditCards.com. It will vary depending on the loan, but how the process usually works is the lender puts the loan into a locked savings account that the borrower will be able to access after making their final payment. This is ideal because it is low risk for the lender and doesn’t require cash up front. The caveat is that you’ll need to be sure you can make every payment; otherwise, it defeats the purpose of the loan.
How to Build Credit
Though it may seem like a huge pain by itself, applying and getting approved for a credit card are only a small fraction of the battle. Now you’ve actually got to use it to start building credit.
Paying on time and in full is the biggest favor you can do for your credit score. While you might think it’s not a big deal to carry a small balance from one month to the next, you’ll end up having to pay interest, which, depending on your balance, can be significant. When you pay your full balance on time, you won’t pay any interest.
Watch your credit utilization ratio as well. Ideally, you want to be using somewhere between 10 – 30% of your total available credit. Although, the less you can use, the better your credit score will be. So, if you have a credit limit of $500, try not to charge more than $50 a month.
Be patient if you don’t see all your hard work immediately reflected in a 700+ credit score. It can take around six months of credit card activity before any score can be calculated.
Avoid the Pitfalls
Credit card debt in America is a problem. The average amount owed for credit card owners was over $6,000 in 2017, according to Experian. Too many people are racking up debt they can’t afford to pay off at the end of the month.
As a new credit card user, this can seem frightening. Luckily, knowing what some of the common pitfalls of credit card ownership are can help prevent your own slip-ups.
You already know the big one: Don’t miss payments. Pay attention to your due dates, or better yet, set up auto-payments so you never miss them. Sign up for any account alerts so that you get notifications when your statement is available.
If you know you’re not going to be able to pay your full balance, pay what you can as soon as possible. The longer you wait, the more daily interest you’ll accrue.
Another mistake that people commonly make is closing their accounts too soon after they’ve opened them. Closing a card could shorten the overall length of your credit history, which is a factor in determining your credit score.
You’ll also want to avoid making only minimum payments each month. While it may seem ideal because you’re making payments and not having to strain your bank account too much, only paying the minimum required can indirectly affect your credit score and get you caught in a never-ending cycle of debt.
Depending on your balance, it can take years to pay off your debt – and that’s if you don’t continue to use the card. For example, if the average American, with a balance of $6,354, only makes minimum payments, it could take more than 30 years for them to pay the debt, and they’d end up paying thousands of dollars in interest.
Having a large balance month after month raises your credit utilization ratio, which is the second most important factor in determining your credit score. So, although you’re making your monthly payments (the most heavily weighted factor), you could be hurting your efforts if you keep a balance that’s more than 30% of your limit.
For some people, the biggest difficulty of having a credit card is the temptation to use it. If this sounds like you, it’s probably a good idea to come up with some methods for keeping yourself in check.
To start building credit, habitually buy one or two small things a month using your card. Make it something you need that you would’ve had to buy anyway; don’t use the card for any non-necessities or luxury items. Never use your card to buy anything you’re not absolutely sure you have the money for.
Mentally designate the card for something specific, such as toilet paper or groceries, and only use it for that. Leave the card at home when you go out so you can’t be tempted to use it for something else.
When You Mess Up
Life is tough, and nobody is perfect. Maybe you fell on hard times, had an emergency or just spent more than you had without realizing it, and now you can’t pay your bill. What happens next?
First and foremost, if you believe you’re going to be unable to make a payment, be proactive and communicate that to your credit card company. They will be much more willing to work with you if you keep them in the loop. Give them a call, explain your circumstances, and ask if there are any ways you can work together to get them the payments they need without this hurting your credit.
If you don’t let them know what’s going on, you’re getting yourself into trouble. Once you’re 30 days past due, your credit card company will reach out. At this point, if you haven’t talked to them and come up with a mutual plan, you might be charged a late fee. Once you hit 60 days late, it starts getting serious. Your interest rate will increase, sometimes substantially. This is where your credit rating can start to drop. At 90 days, you’re at risk of having your account shut down and your debt sold to a collection agency. You can face serious legal consequences. Waiting until this point can do significant damage to your credit score for up to seven years.
When you find yourself going through difficult times, the best way to minimize damage is to ask for help, either from your credit card company or from a credit counseling service, like the National Foundation for Credit Counseling. Don’t let it spiral out of control.
Do you have any pointers for first-time credit users? Share them in the comments!
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