Many young people are of the mindset that they want to avoid debt at all costs. This has built some good financial habits. They don’t buy anything they don’t have the money for, and they understand the importance of budgeting and savings. However, unless you’re independently wealthy, odds are you won’t be able to pay cash for a car or home. You’ll need a loan.
In order to borrow from a lender in the future, ideally, you’ll start establishing credit at an early age. But it’s not too late whenever you get started. This post will go over some tips for people who are establishing credit at any age.
What Does It Mean to Establish Credit?
Establishing credit is the process of showing someone you’re financially responsible by paying off credit cards or loans. Although your credit is commonly used in the lending process for something like a car, home or personal loan, it can be important in other situations as well.
A potential landlord may choose to check your credit in order to determine whether you’re likely to pay your rent on time every month. Depending on the industry, a credit check may also be commonly required to get certain jobs. It’s common in the finance industry where you give people financial advice and handle their money.
Preparing for Credit
In order to establish credit, there are a few steps you’ll want to take before getting started. Let’s run through them quickly.
Start a Checking and Savings Account
Having bank accounts establishes your relationship with a financial institution. This is key to getting credit because if you have an account at the bank, that’s one of the first places you can look to start on your credit journey.
From a practical standpoint, in order to pay the bills for things like a credit card or a personal loan in a convenient way, it helps to have a checking and savings account. If you go to a check cashing establishment, they also take a portion of the check, which is less than ideal.
Checking accounts also come with debit cards, so you can carry less cash on you, which is better for physical safety. If someone does steal your wallet, maybe you’re only out like $100 and you can just call and freeze the cards, requesting replacement. You can also buy things and pay bills online with either your debit card or bank account information.
Understand the Way Credit Works
Before you get credit, it’s a good idea to understand the way it works so that you can be intentional about the moves you make in establishing your credit. One of the easiest ways to go about this is to take a look at what makes up your credit score. When approving credit and loans, lenders most often use some version of a FICO® Score.
Because different models are used depending on the lender and the type of loan or credit in question, the models may have slightly different weights, but FICO does make some data available in order to give a rough breakdown of the way scores are calculated.
Payment history is 35% of your credit score. They want to see that you make your payment on time on a regular basis. This is a big predictor that you can handle credit or a loan. If you make your payments on time, it helps your score. If you consistently make late payments, it can hurt.
In terms of credit, a late payment isn’t reported to the credit bureaus until it’s at least 30 days late. If you go 60 or 90 days late, these late payments hurt your score even more. If you go beyond that, the payment could end up going into collections or charge-offs, which can have a major negative impact on your score. If it’s a house payment, your house can be foreclosed if you don’t make a payment after a certain amount of time, which depends on your state.
The next thing that is looked at in formulating your score is credit utilization. Credit utilization is simply the amount of credit you’re using compared to the total amount you’re approved for.
Let’s say you have a couple of credit cards with balances totaling $1,000. Between the two cards, you have $5,000 in limits. Your total credit utilization in this case is 20%. Utilization higher than 30% in any given month will lower your score, so you shouldn’t let your balances run too high even if you pay the full amount off every month.
As a side note, there’s no reason not to pay off the full balance every month if you can afford to do so. That way, you can rack up points and avoid paying interest.
The length of your history makes up 15% of your score. This is measured from the time you open up a credit card or close on a loan. The longer your credit history, the better.
Credit inquiries make up 10% of your score. The idea is that if you apply for credit, lenders would worry that you might be overextending your finances, so when you apply for credit or a loan, your credit score goes down. It’s not a huge impact, but it does make sure you only apply for credit when you have good reason.
An exception to this rule is if you’re shopping around in order to try to get the best rate. Inquiries at multiple car dealerships or mortgage lenders for example all count as one inquiry if made within the same 30-day window.
The final 10% of your credit score is based on the credit mix. Ideally, lenders like to see that you can handle a couple of different types of credit. One type is revolving credit like a credit card where the balance changes each month based on your payments and how much you charge. The second is installment credit. These types of loans are typically paid off in monthly payments over time. Examples of this would be a car or personal loan as well as a mortgage. If you have a mix of different types of credit, it’s good for your score.
This article has a very detailed breakdown of credit and the way your score works. With that, let’s move on to things you can actually do to get credit.
How Do I Establish Credit?
There are several ways to go about actually starting to build your credit in a responsible manner. The following are tips from our sister company, the credit monitoring service Rocket HQSM.
Become an Authorized User
One of the things that might be helpful in establishing credit is to become an authorized user on someone else’s card. Parents sometimes choose to do this in order to give a child an allowance or a resource for emergencies. You don’t actually have to use the card at all, but each time the person makes a payment, your credit score rises as well.
If you have someone you know who makes their payments on time all the time, it doesn’t hurt to ask if they would be OK making you an authorized user. Just make sure you pick the right person. If they’re late with their payments, it hurts your score.
Get a Secured Card
Once you reach the age in your area, you can open up a credit account of your own. A good place to start is wherever you open your bank account. Because you’re new to credit, they’ll probably recommend you start with a secured card.
A secured card is one you actually fund with a deposit of your own money. Whatever amount you deposit is used as your credit limit. This is less risky for the creditor because if you don’t make your payment at any point, they just fund it out of the deposit. But if you make the payment on time for six months, this is a good signal for lenders that’s you might be trustworthy in the future.
One thing to know is that banks will typically charge a monthly maintenance fee in order to administer a secured card. While you wouldn’t normally cancel a card because it impacts your credit mix, you might consider canceling your secured card after you have two or three regular credit cards for that reason. When you pay off your balance and close your card, you get the deposit back.
Get a Store Credit Card
Another great thing to do when building credit is to get yourself a store credit card. The store wants your business, so they’re going to be inclined to approve you, even if you have a limited credit history. This can be a great way to dip your toe into the credit game. Often, you’ll get a deal for signing up and you may be able to get discounts or rewards points when you shop at the store. The points may even build when you buy things at certain other retailers.
So next time you have a chance to get 10% off those new Nike kicks, it could be worth signing up for that store card. Just don’t open a new card every other day.
Get Credit for Bills You Already Pay
One of the things that’s a struggle for people trying to build credit is that one of the factors that goes into a credit score is the number of accounts that you have open. This is a factor in showing that you can manage your credit effectively because you’ve shown enough mastery of your finances to be able to juggle several different items.
If you pay rent, there are several companies who will process your rent payments and report it to the credit bureaus so you can get credit for monthly on-time rent payments. Rent and housing history is one of the items that becomes key, particularly when applying for a mortgage.
The way these services are set up, they’ll report the rent payment on your credit. There’s a one-time setup fee and many of these companies will let you go back in and input up to 24 months of history at that time. There will also typically be a small monthly fee. Sometimes your landlord will pay these fees or split them with you, but you shouldn’t count on it. Still, if you have a light history otherwise, it could be helpful.
At least one credit bureau also wants you to get credit for other bills you pay. The Experian® Boost™ service allows you to link your bank account known to the bureau so they can see when you pay bills like utility, cable and phone bills that don’t typically show up on your credit report. Currently, this is supported by the FICO® Score 8 model. Not all lenders use this model, so your score won’t necessarily go up everywhere, but it’s a start. This one is a freebie.
There’s significant interest in the concept of getting better visibility into more of the bills you pay for credit purposes. The UltraFICO™ Score is an attempt by FICO® to get a better look at not only your bill paying, but also your spending and saving habits by linking to your bank account. Although it hasn’t been widely rolled out yet and it has to gain lender adoption, the idea is to help people with little to no credit build their score by showing responsible management of their financial affairs.
Get a Cosigner
Another thing that can help you secure financing if you’re newer to the process of getting credit and loans is to get a cosigner. Getting someone to cosign with you will let the lender take into account both your credit scores as well as both incomes, which can help you qualify for better lending terms or a bigger loan if you need it.
Of course, as with the caution about becoming an authorized user on someone’s account, you want to make sure the person who is cosigning with you has good credit habits of their own or it can negate the beneficial aspects of this strategy.
Credit Builder Loans
Some institutions offer personal loans that you can take out with their primary purpose being that you can show you can pay it back over the term in a responsible manner.
You can use the money for everyday expenses or a big purchase. It’s really up to you. The important thing is having the income and ability to pay it back.
Taking Your Credit to the Next Level
Once you’ve started your credit journey, how do you take the next step on the ladder to that perfect 850 FICO Score? Here are some tips to get you a black belt in credit karate.
Monitor Your Credit
One of the things that’s incredibly important is monitoring your credit. Rocket HQSM allows you to see your free VantageScore® 3.0 credit score and report from TransUnion® every week. This score is also designed to give you information on the items they see in your report as well as things you can do to improve your score over time.
It’s unfortunate, but there are some people out there who will take advantage of you for their own gain. One of the biggest ways to prevent identity theft is to keep a constant eye on your accounts. If you’re routinely monitoring your credit report, you’ll know in a much shorter amount of time when someone tries to open an account that you don’t know about in your name.
Rocket HQSM also has a robust credit score simulator so that you can see the impact of things like opening a new account or a late payment on your current credit score. This allows you to be educated and make the right financial moves.
Increase Your Credit Limit
Once you’ve been making consistent payments for a while, one of the things you can do is request that credit card companies increase your credit limit. This has a distinct advantage.
As we discussed earlier, one of the major factors in your credit score is your credit utilization, which you want to keep at 30% or lower. By increasing the credit limit, it gives the most flexibility if you ever need to charge more.
Steady as She Goes
Probably the most important thing you can do is just maintain your momentum. Keep making your payments on time. Maintain a diverse credit mix including installment loans and a few credit card accounts. Just don’t go overboard opening 57 credit accounts.
If you’re interested in getting a look at your credit and seeing where you can go in the future, we encourage you to check out Rocket HQSM and sign up for an account. If you have questions, you can leave them for us in the comments below.
Quicken Loans, Rocket Homes Real Estate LLC, Rocket Loans® and Rocket HQSM are separate operating subsidiaries of Rock Holdings Inc. Each company is a separate legal entity operated and managed through its own management and governance structure as required by its state of incorporation, and applicable legal and regulatory requirements.
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