Building credit is one of those proverbial Catch-22s: You need a line of credit to prove you’re a trustworthy borrower, but you have to prove you’re a trustworthy borrower before you can secure a line of credit.
But this Catch-22 has a loophole: Even someone with zero credit can start to build it, piece by piece.
It might be harder to take out a sizable loan or get approved for a certain credit card, but there are available avenues that can help you achieve your financial goals.
What Is Credit?
Credit, in the financial sense, is the measure of trust that a person can, and will, repay a certain amount of money on a designated timeline. People with good credit have demonstrated consistency, financial stability and prompt repayments.
While creditworthiness used to be a subjective assessment, the introduction of the FICO® score in 1989 helped to standardize the scoring system.
What Is a Credit Score?
A credit score is an impartial, logical assessment of your creditworthiness, ranked somewhere between 300 and 850.
By putting a concrete number to an individual’s financial dependability, your financial institution and other lenders can better predict the likelihood of default, missed payments and insurmountable debt. They can then make informed decisions about who to lend to.
Naturally, a credit score can only tell you so much, but it can provide a useful starting point based on vital borrowing and spending habits, including:
- Payment History – A big picture overview of how you’ve repaid your debts over time, including the promptness and amount of your recurring payments.
- Amounts Owed – The total amount of debt you have and the amount owed on each individual account, as well as your credit utilization ratio (how much of your credit limit you’re using).
- Length of Credit History – How long your accounts have been open, including your oldest account and their average age.
- Credit Mix – The variety of credit types you manage, from mortgages to credit cards to car loans.
- New Credit – Your recent history of new lines of credit and inquiries.
How Do Credit Scores Work?
So, how do the details of your credit history make their way to a lender on the other side of town? There are several steps between your monthly debt payments and the credit report sitting on some lender’s desk:
- Every month or so, your credit card company, bank, mortgage company, student loan provider, personal loan lender or other lender reports your financial behaviors to three independent credit bureaus:
- Upon receipt of your financial details, the credit bureaus create corresponding credit reports with four basic categories of information:
- Personally Identifiable Information (PII).
- Credit Accounts.
- Credit Inquiries.
- Public Record and Collections.
- Using these reports and complex weighted equations, credit scoring companies like FICO determine a three-digit number that encapsulates the quality of your credit history and your anticipated trustworthiness with future debt.
- Finally, when you apply for a loan or line of credit, the lenders request your credit score from FICO or VantageScore®.
What Is a Credit Score Used For?
Lenders look to credit scores to make vital determinations about a borrower’s risk and creditworthiness.
Your credit score might be scrutinized when you apply for:
- Credit cards.
- Personal loans.
- Automotive loans.
- Student loans.
- Home equity lines of credit.
- Cellphone installment plans.
Beyond just making a yes-or-no decision, the lender may use your credit score to determine the specific terms and rates of your line of credit. This includes:
- Higher interest rates for consumers with lower FICO scores.
- Better rewards cards offered only to those with high credit scores.
- Higher credit limits for those with a solid borrowing history.
- Additional concessions on mortgages and auto loans for those with low credit scores.
How Do You Access Your Credit Score?
When credit bureaus and scoring agencies have so much power over your financial future, it’s important to know exactly what they’re reporting about you.
There are three simple ways to check your credit score:
- On a recent financial statement – Some banks and other institutions now include your credit score on your statements or in your online banking portal.
- Directly through a credit bureau or scoring agency – You can purchase your credit score through Equifax, TransUnion or Experian, or from FICO, which is the most common source of credit scores for top lenders.
- From a scoring service – Some companies monitor and provide updated credit scores, either for free or a monthly subscription cost.
You can also request a free credit report every 12 months from each of the three major credit bureaus. These don’t explicitly state your credit score, just the comprehensive details that go into calculating it.
How to Build Your Credit
When you’re young, it’s natural to be uninterested in the financial obligations of adulthood. But there might come a time when you want a loan or credit card. You’ll need to know how to build credit — fast, if possible.
And if you already have a credit card, check out our blog post on how to build credit with a credit card for more tips.
Better Late Than Never: How to Start Building Credit
Without any loan or credit card debt to your name, your credit is deemed unscorable by FICO. But six months after you secure your first loan or line of credit, you’ll have a corresponding score.
Here are some helpful ways to build credit in those initial unscorable days, while starting slow and working your way up:
- Become an authorized user and practice financial responsibility – If someone is willing to add you as an authorized user on one of their accounts, it will help build your credit and your understanding of financial responsibility. If the primary user makes prompt payments, you’ll benefit. And if you make small, manageable purchases and pay them off (or in this case, pay the primary user back), you’ll be set up for success during your next credit-building phase.
- Graduate to your own secured credit card, then a traditional card – Secured credit cards are great ways to build credit when you don’t have it because the requirements for approval are relatively minimal. Secured cards require an upfront deposit equal to your card’s credit limit to mitigate the lender’s risk. From there, you can upgrade to a traditional card.
- Try a credit-builder loan – Created for the express purpose of establishing credit where none exists, this functions as a reverse loan. Instead of receiving money upfront that you then pay off, you make regular payments towards the total amount. Once you’ve paid in full, you receive the total sum and sometimes the interest, too.
How Long Does It Take to Build Credit?
Unfortunately, there’s no quick-fix scheme available to build or boost your credit. From the first time you borrow any amount of money, it takes six months just to develop any FICO credit score at all.
Building good credit can take quite a bit longer. By the same token, earning yourself a bad credit score can happen quite quickly.
- Payment history is the most heavily weighted aspect of a FICO credit score. It takes time to not just pay off your debts, but build a pattern of prompt payments that earns you the FICO score you want.
- Without a long history of debt management, every payment matters. When you have a well-established credit score, one late fee or an unusually high utilization ratio won’t have a huge impact. But when you’re just starting out, even one missed payment can drop your credit score.
What’s the Best Way to Build Credit?
This isn’t usually the answer people want to hear, but the best way to build credit is slowly but surely. In fact, attempting a get-credit-quick scheme will have the opposite effect, as opening multiple lines of credit all at once will lower your score.
The most efficient credit-building strategy is to follow these best practices and watch your credit score grow over time:
- Treat your credit card like a debit card – By this, we mean only charge purchases to your credit card that you can afford to pay out of your debit account (generally, your checking account). This prevents new credit card users from falling into the age-old trap of credit: spending money you don’t have just because you can.
- Set up automatic payments to avoid missed or late payments – When paying off your credit cards is still a foreign concept, it helps if you don’t have to think about it. And if you’re only making purchases with money you have in the bank, you won’t have to worry about overdrawing your checking account.
- Limit your spending to maintain a low credit usage ratio – When your credit limit is low, it’s even more important to regulate your monthly spending to keep a low credit utilization ratio. This means only using about 30% or less of your available credit. A ratio under 10% is even better, according to many lenders.
- Pay off your credit card twice a month – If you’re relying on your credit card for many of your regular expenses, try to pay it off more frequently. By lowering your balance halfway through the month, you’ll avoid a high credit utilization ratio.
- Get non-traditional payments put on your credit report – If you don’t have a car loan, mortgage or student loan to pay off, you can build your credit through other recurring payments, including:
- Rent – If you sign up for a rent-reporting online service, they’ll add your history of regular payments to your credit report. Some credit score agencies incorporate these into your score.
- Utilities – Experian Boost similarly rewards you for the payments you’ve already been making by adding your cell phone and utility bills to your credit report.
- Keep lines of credit open – Unless you have a reason to close an account, it only serves to boost your credit score. That’s because the length of your credit history impacts your score. If you close your oldest account, you’re lowering the average age of your accounts. Plus, having fewer accounts usually leads to a higher credit usage ratio because you can’t spread your purchases across various credit cards.
Build Your Credit With Tally
The best way to build credit is through consistency. But it’s not always easy to fulfill your various payment responsibilities across different accounts and cards.
Tally manages all your cards in one convenient location and makes a single, automated monthly payment on your behalf, so you don’t have to worry about late fees and blows to your credit score. Stay on top of your credit with the ultimate debt management system.