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How to Build Credit
By Chris Pearson MONEY RESEARCH COLLECTIVE
The ability to reach many financial goals hinges upon your credit. Lenders want to know the likelihood you’ll pay them back if they let you borrow money for cars, homes or everyday expenses. If you don’t have a credit history, you must build it to prove to lenders that you are a trustworthy borrower. Building credit refers to establishing a record of responsible borrowing and repayment, which is reflected in your credit score.
It doesn’t happen overnight — the process takes time and involves various strategies. A solid credit profile can give you various financial opportunities, including better loan terms and interest rates. Read on to learn more about what credit is, why it’s important and how to start building credit.
Table of contents
- What is credit?
- Why is credit important?
- The best ways to build credit
- Credit building tips and tricks
- How to build credit FAQs
What is credit?
In financial terms, credit is a contractual agreement where a borrower receives a value now and agrees to repay the lender later, usually with interest. Lenders record and report this borrowing and repayment process, which influences your credit score. This process can occur in various forms, such as credit cards, loans or lines of credit.
Your credit score, a three-digit number derived from your credit history, signifies your trustworthiness as a borrower. Lenders, landlords, creditors and insurance firms look at your credit to determine the risk associated with lending to you. They determine how likely you are to repay your debt.
Factors such as your ability to pay bills on time, the length of your credit history, the types of credit you have and your credit utilization ratio contribute to your credit score. If you have a low score, lenders may not want to lend to you, or you may have to pay a higher interest rate for the heightened risk they are taking on.
Why is credit important?
Credit is a crucial aspect of your financial health. It influences your ability to borrow money and the conditions under which you can do so. A solid credit score can lead to preferable interest rates and better terms for loans and credit cards. It also impacts things like renting an apartment or setting up utilities. Without a good credit score, these can become difficult and expensive.
Furthermore, your credit may come into play for other things. For instance, employers might run a credit check as part of their hiring process, particularly for financial positions. This check won’t reveal your score to your employer, but they’ll see other financial details like your credit utilization ratio and payment history.
Additionally, some insurance companies may use a credit score check to help determine your premiums, though they can’t base your rates and approval for a policy only on your credit. Many other factors affect your insurance rates, including your driving record and location. Your credit can even impact your ability to start a business, as lenders often check personal credit when deciding whether to approve a business loan.
The best ways to build credit
Building credit requires a strategic and consistent approach. Incorporating some or all of the suggestions below can help you improve your credit score and build credit.
1. Use a secured credit card responsibly
A secured credit card is backed by a cash deposit you make upfront; the deposit amount is usually the same as your credit limit. If you don’t have a healthy credit history — or any history of borrowing money — you may have to get a secured credit card rather than an unsecured one that isn’t backed by a deposit when starting.
Making your payments on time helps build credit and increase your credit score. However, if you miss payments, it will negatively impact your credit, so make sure to use the card responsibly by staying on top of your payments.
2. Lower your credit utilization ratio
Your credit utilization ratio — how much of your available credit you’re using — is a significant factor in your credit score. A good rule of thumb is to keep your utilization below 30%. Lenders may see you as a high-risk borrower if you consistently max out your credit cards. Knowing how to pay off your credit card debt regularly can help lower your utilization ratio and improve your credit score.
For instance, if you have a total credit limit of $10,000 across all credit lines and use $2,000, your utilization ratio is 20%. Aim to keep this percentage as low as possible. If you use your credit well, you can request a credit line increase from credit card companies. If granted, you can use a larger credit sum while still maintaining a favorable ratio.
3. Become an authorized user on someone else’s credit card
If you’re struggling to get a credit card or loan due to a lack of credit history, becoming an authorized user on someone else’s credit card can help. As an authorized user, you’ll have access to a credit card, and the account’s payment history and credit line can help you build credit. However, make sure the primary account holder has a good credit history and habits, as their actions will also reflect on your credit report. If the primary cardholder has poor practices, such as not paying bills on time, it could negatively impact your credit score.
4. Look into credit builder loans
Credit builder loans are also a valuable tool in your credit-building journey. These loans work differently than traditional loans. You will borrow a certain amount from a lender, which will be deposited into a locked savings account. You make payments towards the loan, and once you pay it off, you will receive the total amount back. It’s a practical method to build credit fast while also saving money. It shows future lenders that you are a responsible borrower and you can make your payments on time.
5. Monitor your credit report
Regularly monitoring your credit report might turn up errors or fraudulent activity that could harm your credit score. If you spot any, it’s essential to get those items removed from your credit report as soon as possible. Inaccurate information on your credit report could damage your credit score without your knowledge. You can request one free credit report each year from each of the credit bureaus.
Credit building tips and tricks
Although establishing credit may seem like a challenging endeavor, there are some proven tactics that can help you see progress. Here are some tips to keep in mind.
How to build credit fast
Building credit takes time and effort. The fastest way to build credit is by paying down your debt and lowering your credit utilization ratio. If you’re trying to repair your credit history, the process may take longer than if you were starting from scratch with no history.
Consider getting a secured credit card or becoming an authorized user on someone else’s card. If you already have credit cards, consider asking for higher credit limits (lowering your overall credit utilization rate). Continue to pay all your bills on time and pay down balances on any debts you carry to lower your credit utilization rate and see improvements. Ignore common credit score myths that might misinform your strategies as you navigate this process.
How to build credit without a credit card
Building credit without a credit card might seem challenging, but it is possible. Other ways to build credit include getting credit-building credit cards, credit builder loans, student loans, auto loans and mortgage loans. Make payments on time and minimize any outstanding debt.
How to build business credit
To start building business credit, follow these steps to establish a separate credit identity for your business. This distinct credit identity can help shield your personal credit from potential business risks or financial downturns. It also improves your business’s credibility and trustworthiness in the eyes of lenders, suppliers and potential investors. With a sound business credit profile, your business could qualify for better loan interest rates and increased financing opportunities.
Here are some things that can help you build business credit:
- Register your business with your Secretary of State and request an employer identification number (EIN) from the IRS. This number identifies your business, similar to the way a Social Security number identifies an individual.
- Open accounts with vendors that report payment history to the credit bureaus.
- Get a business credit card.
- Pay creditors on time or early.
- Keep your credit profile free of errors. Review your credit reports often to ensure they are error-free. If you discover mistakes, file a dispute with the appropriate credit bureau.
Summary of Sacramento Bee’s guide on how to build credit
Understanding how to build credit is an essential part to your financial success. Taking steps to improve your credit score can significantly impact your financial health, influencing everything from loan eligibility to the interest rates you’re offered. Understanding how credit works is the first step toward building a strong credit profile.
Whether you are looking to build personal or business credit, as you navigate the path of credit building, make sure to understand the critical aspects: what a good credit score is, how to check your credit score and how to improve your credit score. With patience, consistency and responsible financial habits, you can reap the financial benefits of greater access to credit with favorable terms.