People often say there's a catch-22 when it comes to credit. You need credit to qualify for credit, they say. Well, having a good history certainly makes it easier to get credit when you need it. But think about this: We all started out with no credit and many of us managed to build a good score.
So it's a quandary, for sure, but it doesn't require previous credit or smoke and mirrors to build a good history. But it does take time, some good old-fashioned patience, and knowledge about how to work the system to your benefit.
Here are five ways you can build good credit:
#1: Pay all your bills on time
This is the first step toward a good credit score. Think of your score like a house. Paying bills responsibly is the foundation. This is the basic action required to achieve a good score.
Some folks think it's no big deal if you pay your utility bill late. But it's possible that the late payment could be reported to the credit bureaus. About 35 percent of your score is payment history. So it's a very big deal to pay all of your bills on time.
And yes, this is one of those things that seems one-sided. You could get in trouble for not paying your utility bill on time, but you don't get extra points for making timely payments. You're just expected to make payments on time because that's part of being a responsible adult.
#2: Monitor your credit reports
This is important because errors on your reports can lower your score. And don't worry about the cost of getting your reports because you're entitled to a free report from each bureau every 12 months. Even better, LendingTree's credit product (which is 100% free - forever) not only provides you with your credit file, but updates it at least monthly. In addition, you'll have a comprehensive analysis of your credit file to identify where you're spending too much on loans and credit cards.
Review your report carefully and make sure your account information and personal data is correct. You also want to look at negative items and confirm that each item is accurate. If you see new accounts listed and you didn't open them, this is a sign of identity theft. You'll want to take action immediately by following the steps listed here by the Federal Trade Commission.
#3: Keep low balances on your credit cards
Payment history (35 percent) and credit utilization (30 percent) are the biggest factors considered by the FICO score. You have a credit utilization ratio, which is the amount of credit you've used compared to the amount of credit you have available. You should keep your ratio below 30 percent, but if you really want to kick your credit score up a notch, keep it below 10 percent.
Now, be aware that the utilization ratio is also calculated on a per card basis and a high ratio on one card can affect your score. So even if you have a low ratio overall, if you have a high ratio on one card, this is not ideal. To build a good history and score, you need to keep low balances on all of your cards.
#4: Use secured credit cards, if necessary
If you're trying to recover from bad credit, using a secured card will really help. Using one of these cards can also help you build credit if you're just starting out. There are a lot of misconceptions about secured cards so let's set the record straight.
When you use a secured card, you are actually using credit. This is not like a prepaid card at all. With a prepaid card, you're using your own money from an account you funded. You don't build credit using a prepaid card.
But with a secured card, you're actually using credit. You "secure" the card with a deposit, but that deposit stays untouched in a bank account. You get a credit card that looks like other credit cards and you use the card while purchasing items. When the bill comes at the end of the payment cycle, you pay the bill from your checking account or whatever way you choose to pay. Your deposit during these transactions? The deposit stays put in the bank. When you close the account, you get your full deposit back unless you have a balance on your statement.
The key is to use a secured card from a financial institution or bank that reports your payment history to the credit bureaus. This is how you build a good score. When you've used the card about 12 to 17 months, you might have improved your score enough to get approved for an unsecured card. You can monitor your score by using LendingTree's free credit score to help gauge your progress as you get closer and closer to good credit!
#5: Track your spending
It might seem odd to include this, but this relates to #4 above. If you don't track your spending, then you can't possibly know if you're going over budget when buying things. You might think you can remember everything you buy, but this isn't an effective way to manage your money. If you overspend, you can easily end up with a high credit utilization ratio and that impacts your credit in a negative way.
So take advantage of all the free money management websites out there. You can set up category limits on many of these sites. And the number of smart phone apps for tracking spending and budgeting is steadily increasing.
If you aren't interested in using technology, that's fine, too. Track expenses the old-fashioned way with a pencil and paper. Just make a decision about how you want to do this. And be sure you choose a method that makes you comfortable. Picking the right method makes it far more likely you'll stick with it.