Before you apply for a mortgage, establish and learn how to build credit. Just follow these easy steps.
You can’t establish credit or get a credit score until you use a credit card or take out a loan—but it’s almost impossible to get a credit card or a loan without already having credit. Welcome to the dilemma of how to build credit.
Interested in getting a mortgage loan? You need to crawl before you run, so you’ll have to prove you’re responsible enough to handle a small amount of credit first. You start life with no credit at all, so first, you’ll need to establish credit, and then you can start to build it. And if you’ve already established credit, but need to improve your credit score, we’ve got you covered in this guide.
What does it mean to build credit?
Before lenders give you credit or loan you money, they need some proof that you’re financially responsible. Building credit is the process of creating a documented history of how you’ve handled credit.
1. Build a support system — enlist the help of family.
Ask to be added to a parent’s credit card as an authorized user. (Being linked to someone with bad credit doesn’t help, so be choosy.) If your family member agrees, you’ll get a credit card with your name on it that you can use, but you won’t be the primary cardholder.
Note that for an additional authorized user to build credit works only if the credit card issuer reports authorized users to the credit bureaus. If it doesn’t, you won’t be building and establishing credit, so find out first.
2. Get a secured credit card.
A secured credit card is like training wheels for a bike. You’re not meant to use either forever, and a secured card gives you credit practice. You put down a cash deposit, and the deposit amount typically becomes your credit limit.
You are the primary cardholder with a secured credit card, which helps you establish credit better than being an authorized user on someone else’s account. If you always pay your bills for your secured card, when you’re ready to apply for an unsecured credit card, you’ll get your deposit back.
Ask the credit card issuer if they report to the credit bureaus. That is the point, after all, of getting one. Also, plan to keep your secured card for at least six months before you apply for an unsecured card. And keep this tip in mind from accredited financial counselor Roslyn Lash, also known as the Ol’Skool Money Mentor: “To have a better score, do not charge more than 30 percent of the credit limit.”
3. Take out a credit-builder loan.
This is a loan designed specifically to boost your credit history, which is handy for people wondering how to build credit. You take out a loan of, say $1,000, from your financial institution (if it offers this program—you may need to shop around). Instead of getting the $1,000 right away, the money goes into a savings account for you (one you can’t access). You make the payments first, including interest, and then you get the funds.
Think of a credit-builder loan as a forced savings account. Only with a credit-builder loan, you will have established a credit history. Make sure you make your scheduled payments on time. If you skip payments or are late, you’ll establish the wrong kind of credit. And negative credit is even harder to fix than no credit.
4. Pay your credit card bills back, and on time.
The most important factor lenders use to determine your creditworthiness is payment history. That is, do you pay your bills, and do you do so on time? “Constantly paying your bills late can ruin your credit, so make it a priority to be on time each month,” says Jamie Wharton with Earnest.com, a low-cost lender.
Wharton suggests setting up auto pay for recurring bills to help ensure you don’t miss a payment. “But just because your bills are on auto-pay doesn’t mean your accounts should be on auto-pilot,” she says. “Keep an eye on your bank accounts to make sure you have enough money to avoid costly overdraft fees.”
5. Check your credit report and score.
After all your hard work, you’ll want to know if it’s paying off. You do that by getting a copy of your credit report from all three credit bureaus: Experian, Equifax, and TransUnion. Go to AnnualCreditReport.com and request a free copy. (You can get one free copy per year from each bureau.) Read your report to make sure the information is accurate. If not, contact the bureau to correct it.
If your credit report is your school transcript, your credit score is your overall GPA. Most lenders use FICO to find out people’s credit scores, which requires at least six months of credit history produce a score. Another credit-reporting system lenders use is VantageScore, which can determine credit history in only one month. Unlike your school GPA though, you can keep working to get your credit score up throughout your entire life. So keep on making good credit moves, and it’ll keep on growing.
Hitting the reset button sounds tempting — especially when faced with a less than stellar credit score; but starting over with a blank slate will only set you back further.
Now that a forewarning is out of the way, on to the good stuff: Actionable tips to raise your credit score swiftly and without financial risk. You can expect most of these tips to affect your credit score in about 30 to 60 days, the typical time that’s considered speedy.
Request a copy of your credit report and look for errors.
Write a negotiation letter to your credit bureau.
If a negotiation letter doesn’t work, contact the company reporting a late payment to ask if it will campaign for the removal. If a payment was incorrectly reported (see No. 1), or if you simply forgot a bill when you’re usually 100% on the ball, you may be able to get the late payment removed.
Stop using your credit cards
You can lower your credit utilization rate in two conventional ways: Lower your spending and increase your credit. Your credit score is largely determined by the amount of debt (credit card and loan balances) compared with your credit limits. Spending around one-third of your credit limit is the recommended credit line, but crossing that debt-to-credit threshold won’t help your score. Alternatively, you can request an increase in your credit or open a new card as a way of increasing your credit-to-spending ratio, but this is a risky move if your spending doesn’t slow down. Be wary of raising limits if it wouldn’t be financially feasible to pay back any and all spending.
Don’t apply for multiple forms of credit in a short time
Each time you request a new form of credit, including car and home loans, etc, you’ll likely face a credit inquiry. Too many inquiries within a short time and the credit bureaus may ding your credit. Keep this in mind as you request credit increases or open up new accounts. Both actions may result in one too many credit pulls and consequently, a decrease in your credit score.
Settle late payments — then automate your payment schedule.
Timely bill pay is gut-wrenching when you’re financially strapped, but proactively settling bills will make future payments easier. Credit bureaus count a late payment starting from the first day of your last late payment, so the sooner you can square the bill, the better. This is particularly true if you can pay off past-due debts before they reach the 30-day, 60-day, or 90-day thresholds. It’s scary to confront the financial challenge, but it’s doable. Once you’ve settled any late payments, make future payments even simpler by automating. Automation avoids accidental missed payments and takes the mental clutter of scheduling multiple payments off your mind.