How to Build Credit When You’re Young
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Young people getting started with credit face a common predicament: you need credit to start building your credit score, but you can’t get that credit until you have a decent credit score. This chicken-and-egg situation doesn’t have to hold you back. There’s more than one way to build credit when you’re young.
Building your credit score when you’re getting started
First, let’s get clear on the basics of a credit score and why it’s so important.
A credit score is a number lenders use to decide how likely it is that you will repay money loaned to you.
The most commonly used credit scoring company is FICO. FICO scores range from 300 to 850. The higher your number, the easier it is to get approved for credit and the more likely you are to get favorable terms when you borrow.
|300-579||Very Poor||You may be rejected for credit. Lenders that are willing to extend credit may require you to pay a fee or deposit.|
|580-669||Fair||You are considered a subprime borrower. Getting credit may be difficult, and interest rates are likely to be higher than average.|
|670-739||Good||You are considered an “acceptable” borrower and may receive average rates from lenders.|
|740-799||Very Good||You will likely receive above-average rates from lenders.|
|800-850||Exceptional||You may expect a smooth approval process when applying for new credit and receive your best rates from lenders.|
Your FICO score is based on your credit history. Credit scores are calculated based on five factors:
- 35% — Payment history. Paying your bills on time is the most important factor in your FICO score. A history of paying your bills on time will positively affect your score. Late or missed payments will negatively impact your score.
- 30% — Amounts owed. This part of your score has to do with your credit utilization ratio. That’s the amount of credit you’re using divided by how much credit you have available. A common rule of thumb is to keep your credit utilization ratio under 30%, but it’s actually best to keep it as low as possible, especially when you’re building credit.
- 15% — Length of credit history. FICO takes into account how long you’ve been using credit, including your oldest and newest accounts. It’s generally better to have a longer credit history than a short one.
- 10% — New credit. When you apply for new credit, the lender will order your credit report, which places a “hard inquiry” on your credit report. Too many hard inquiries in a short period of time can lower your score.
- 10% — Types of credit used. Your score considers the type of credit you’re using, including installment loans, mortgages and credit cards. Having a mix of different types and managing them responsibly is generally better than having only one kind of account. But that doesn’t mean you should take out loans or credit cards you don’t need just to improve this slice of your credit score.
5 steps for young people to build credit
1. Lay the foundation for good credit management
Beverly Harzog, a credit card expert and consumer finance analyst at U.S. News & World Report, stresses that before you apply for your first credit card or loan, you should ensure you have a proper financial foundation in place by having a budget, a way to track your spending and a system for making all of your payments on time. “If you don’t have these things, you probably won’t succeed with credit,” Harzog said.
2. Check your credit report annually
Even if your credit file is very thin, Harzog recommends setting yourself a reminder to check your credit report annually just to see what’s there and verify that your personal information is correct.
You can order one free copy of your credit report every year from each of the three major credit reporting agencies at AnnualCreditReport.com.
3. Apply for a secured credit card
Secured credit cards require a security deposit and give you a line of credit roughly equal to your deposit. Once you start using the card, the issuer will send you monthly statements. If you don’t pay your bill, the issuer can take the money from your deposit.
“It’s like a credit card on training wheels,” Harzog said. “It lets you practice using credit, but because the credit limit is usually equal to your deposit, you can’t go crazy with it.”
While many major banks offer secured credit cards, some come with lots of fees. Shop around for a good one.
Use your secured card to make purchases every month, but remember to keep your credit utilization ratio as low as possible. Pay your bills on time, every time, and in about six months you should qualify for an unsecured card. You may request an upgrade from the issuer who gave you the secured card, or you can apply for a card from a different credit card company.
4. Apply for a credit builder loan
Local banks, credit unions and many online lenders offer credit builder loans or accounts to help consumers build credit. The financial institution “loans” you money, but you don’t actually receive any cash. Instead, it’s deposited into a secured savings account on your behalf. Then you pay small monthly installments, plus interest, over a set period of time. At the end of the loan term, you’ll receive the total amount of the loan, plus any interest earned, in a lump sum.
As long as you make your payments on time each month, the lender will report a favorable payment history to the credit reporting agencies.
If you want to build your credit on two fronts, Harzog suggested getting a secured credit card and a credit builder loan at the same time. This way, you’re using two types of credit — a secured card is a revolving account, while a credit builder loan is an installment loan. Just make sure that if you do both, you’ve got the means to make both payments.
5. Pay other bills on time
Remember that keeping your credit score healthy isn’t just about on-time payments to credit cards. Other types of accounts can impact your score, including student loans, utilities, cell phone bills and rent.
Although your utility company and landlord might not report on-time payments to the credit agencies, if your account goes into collections, that will negatively impact your credit score. In other words, your positive behavior when it comes to those bills might not benefit your credit score, but bad behavior will hurt it.
A couple of other things happening in 2019 could help young people build credit without taking on debt, Harzog said.
- Ultra FICO. Consumers will be able to give FICO access to information from their checking, savings or money market accounts. If you manage your checking account responsibly and keep a few hundred dollars in your savings account, it could positively impact your score. According to FICO’s website, seven out of 10 consumers with average savings of $400 and no negative balances in the past three months could see their score increase.
- Experian Boost. Paying your utility and phone bills on time each month could have a more significant impact on your credit score under this new program. If you authorize Experian to factor those payments into your credit record, a history of on-time payments may help boost your score instantly.
While these options may not turn a poor credit score into an excellent one, Harzog said they could help people with lower scores bump them up just enough to get approved for a loan or credit card.
Building credit is Adulting 201
Getting off on the right foot with credit is an important part of being an adult, even if you never use a credit card.
You may need credit to pay for college, buy a home or car, start a business, lease an apartment, get a cell phone contract or get a job. A strong credit score can even help you get lower premiums on insurance and pay a smaller deposit when setting up utilities.
“Fair or not, employers, lenders and insurance companies see people with good credit scores as less risky,” Harzog said. “With an excellent credit score, you can really save a lot throughout your life.”
For that reason, it’s essential to get started with good credit habits early in life so you can build and maintain a good credit score, get the credit you need and benefit from wealth-building opportunities.
Do yourself a favor and work on setting up a foundation of healthy credit habits while you’re young. Mismanaging credit can land you with a mountain of debt and a damaged credit score. Building credit is typically much harder the second time around.