Credit is an essential subject that we, unfortunately, don’t learn much about in school. Most of us learn how to start building our credit from our parents. Or, we dive headfirst into credit cards and different loans, where we end up hoping for the best.
When I was 18 years old and began building my credit, I experienced the latter of the two situations above. I didn’t learn anything about credit in school. Nor did my parents ever make a single mention to me about it.
Being the finance-minded gal that I am, I read up on credit and how to build my score before starting. Not only did I learn a lot while researching these topics, but I was also able to get myself off to a good start, credit-wise, which has helped put me in good-financial standing regarding my credit.
If you’re a person looking to start building credit, here’s what you need to do to get the process underway.
The Top 6 Credit Score Factors
To build good credit, you must first understand credit.
There are various factors that affect your credit score. Some having a greater impact than others, yet all are important and help determine your overall score.
Hard Inquiries
This is the first thing that factors towards your credit score, and it’s also one of the least impactful. Hard Inquiries essentially come from the amount of times that you apply for credit within a given period.
Now, this period of time can differ depending on where you applied for the credit. But typically, a hard inquiry will stay on your credit report for about 2 years. After that, it falls off and will no longer impact your score.
As you might have guessed, the less hard inquiries you have on your report, the better. Credit cards and loans are essentially a way to spend money that you don’t already have, so Credit Bureau’s look at more attempts to receive credit as irresponsible.
If you have 10 credit cards that you’re using, chances are you’re less responsible with the money that you do have than someone with only 1 or 2 credit cards. This relates to the number of times that you apply for credit, i.e., your hard inquiries.
Total Accounts
The Total Accounts that you have is the second thing that affects your credit score, also being a low impact factor. Your Total Accounts is affected by how many accounts you have open and the variety within those accounts.
Credit Bureau’s would prefer to see a lot of accounts, as long as each account is being used responsibly. They prefer to see variety in your total accounts, meaning a mix of different types of loans and credit cards.
This factor is hard to construct when you start building your credit. But, in my experience, it seems that having a little bit of variety within your first couple of accounts is sufficient enough to have a positive impact on your credit reporting.
Credit Age
This is the third factor of credit reporting, having a medium impact on your overall credit score. Credit Age is determined by adding up the ages of all your different credit cards and loans combined, then dividing by the number of credit cards/loans, you have to get the average age.
The older your average credit age is, the better. Credit Bureau’s like to see a long history of credit use to prove that you know what you’re doing.
Because credit age is important, it’s smart to keep your oldest accounts open for as long as possible. If you grow out of the need to use a certain credit card, it’s smart to use that card for at least one small payment once a year to ensure it will stay open and continue benefiting your credit age.
On the same note, you can’t keep your loans open forever. If you have a loan that is relatively old in comparison to other loans/credit cards, your credit score may drop a few points when the loan is paid off due to the older credit age falling off your report.
This is a credit factor that’s impossible to build up quickly. But, as long as you get off on a good foot at the beginning of your credit reporting and you keep your oldest credit card accounts open, your credit age should grow to help you as the years go on.
Derogatory Marks
These are a big no-no. They are an accumulation of any collections, tax liens, bankruptcies, or civil judgments on your report and are rated high impact regarding how much they affect your credit.
Any huge financial mistakes made will be represented on your credit report as a Derogatory Mark. Considering these stay on for 7–10 years and will always affect your credit negatively, when you start to build a credit score, it’s essential to avoid having Derogatory Mark’s at all costs.
Credit Card Use
This is another high impact factor attributing to credit. Credit Card Use is measured based on how much credit you’re using compared to your total credit limits.
Essentially, the smaller the percentage of your Credit Card Use, the better. This goes to show that even though you have access to spending this money available to you (remember, money on a credit card isn’t your money), you’re responsible enough to not take advantage of it.
Overall, you want to make sure you’re spending less than 30% of your available credit at all times. However, even less is better.
Also, try to remember that you don’t need to have any credit card debt at all to build your credit. You can get a credit card and keep it at a zero balance, and still improve your credit score. If you’re going to do this, my recommendation is to use the credit card at least once a year. Pay it off within the same month to ensure that the company your credit card is with does not close the account.
Payment History
This is the last thing that factors into your credit score, also having a high impact. Your Payment History is given as a percentage, helping display your payments made on time.
The only acceptable goal for payment history when starting as a new credit-user is 100% payment history. If you drop even one percent in your payment history, your score will start being impacted negatively.
Make sure to have a good payment history by knowing when each of your payments is due every month and setting up automatic payments, if necessary.
How to Start Building Your Credit
Those are the different factors that will affect your credit as you begin to build a score. Now, let’s get into how to start building your credit.
You want to do two things, as close together as possible, at the beginning of your credit-building career. The order in which you do these two things doesn’t necessarily matter, but it will make a big positive difference if you do them both close together and do them well.
Get a Credit Card ASAP
As Amardeep Parmar writes, “Credit cards themselves are not evil. It all depends on how you use them.” My recommendation is to get one as soon in life as possible. If you’re 18 years old or older, you should be able to get a credit card entirely on your own. If you are younger than 18, you will likely need a cosigner on the card. Someone you trust, for example, your parent or another family member.
My recommendation for your first credit card is to get it at whichever bank or credit union your regular checking account is with. They will likely approve you for a relatively small amount, which is nothing to be concerned about. This is perfect for a new credit-builder.
Credit cards may be a better option than loans to begin building your credit score because they allow you to attribute all 6 of the factors above into building your new score. This same concept doesn’t hold true for loans, as loans don’t give you an option to showcase responsibility when it comes to Credit Use.
When picking your first credit card, I would try to steer clear of store credit cards at places like Victoria’s Secret, Lowe’s, or Macy’s. Store credit cards create a higher temptation to spend unnecessary money, a bad habit to partake in if you’re trying to build credit responsibly.
Store credit cards also have substantially higher interest rates than credit cards from banks and credit unions. The average store credit card has an interest rate in the mid-20s. Banks average more-so in the mid-teens. If you’re actively using a bank credit card and waiting more than 1 month to pay it off, you will save substantial money in interest compared to store credit cards.
Another good option is to pay it off within the same month you made the purchase. This lets you avoid interest rates and extra fees associated with the credit card completely, considering interest usually doesn’t hit until a month after a purchase is made.
Another credit boosting hack is to increase the limit of your credit card.
Take Out a Loan
The second thing you should do to begin building your credit score is to get some type of loan. Two good options for young people are auto or student loans. (Though it may be time to take advantage of the breaks in repayments that are currently available.) This allows you to add some diversity to your credit portfolio. This is a factor that will help you regarding your Total Accounts.
After you have received your loan, make sure to make payments consistently on time. If possible, pay a little bit more than your necessary payment. Even paying a mere $5 more than your required payment on your loan each month will help. It shows the Credit Bureau’s recognize you’re responsible when it comes to making payments. Plus, your loans will get paid off more quickly by paying slightly more than your minimum payment, something that could end up saving you a ton of money in interest in the long run.
And that’s it! Those are the main factors that affect your credit score and the two main steps that you should take when you start building credit to assure long-term credit success.
By following the above steps, your score should grow reasonably quickly at the beginning. The beginning of your credit score growth is potentially the most important time you’ll ever have attributed to your overall credit score.
Credit is important. One day, your credit score will affect your ability to buy a house or get a business loan to start that career you’ve always dreamed of.
Educate yourself and learn how to be financially responsible, and start building your credit from the get-go. If you do, you’ll be sure to succeed in whatever endeavors you decide to pursue.
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