How To Build Your Credit
Building Blocks
Building a good credit score may seem daunting, especially if you're starting from scratch without any credit history. Fortunately, there are several options available, such as credit builder loans and reporting your utility and rent payments. The best part? You can begin building your credit immediately.
Below we will cover the most effective strategies for building credit, explain how your credit score is calculated, and discuss how long it typically takes to establish good credit.
Proven Steps to Your Success
1. Take Out a Credit Builder Loan
If you can't qualify for traditional loans through banks or credit unions, a credit builder loan might be an ideal option, particularly if you have poor or no credit. This type of loan allows you to build both credit history and savings.
Unlike a traditional installment loan where you receive a lump sum upfront and repay it over time, a credit builder loan requires you to make monthly payments, which are deposited into a certificate of deposit (CD) or a savings account. Once all payments are made, you receive the lump sum (minus interest and fees). These payments are reported to the credit bureaus, helping you establish credit.
For example, Self's Credit Builder Account allows you to build credit and savings simultaneously. It involves paying off a loan held in a CD, with each payment reported to all three credit bureaus. At the end of the term, you receive the savings minus any fees or interest.
2. Sign Up for a Secured Credit Card
A secured credit card is another option for building credit. After approval, you provide a security deposit that acts as your credit limit, and you can use the card to make purchases up to that amount. Remember, the deposit does not cover your balance—you still need to make payments on time, pay more than the minimum, and keep your credit utilization ratio (CUR) low.
Your CUR, which is the ratio of your total revolving debt to your total revolving credit limits, should ideally be below 30%. Keeping it close to 10% can have an even more positive effect on your credit score. Ensure that your lender reports payments to the three major credit bureaus, as this impacts your credit score.
Self's secured Visa® credit card, for example, requires an active Credit Builder Account (CBA) and certain criteria like three on-time payments, an account in good standing, and a minimum savings progress of $100. This card allows you to set your credit limit based on your savings progress and track your spending.
3. Set Up Automatic Payments to Ensure On-Time Payments
Automatic payments, or autopay, can help you make sure payments are always made on time, even if you forget. Since on-time payments make up 35% of your FICO® score, they are crucial for building credit. However, ensure you have enough funds in your account to avoid overdrafts or declined payments.
4. Report Rent and Utility Payments
Reporting rent and utility payments to credit bureaus can help you build credit. Services like Self report these payments, which can affect certain credit scoring models like FICO® 9 and 10, and VantageScore®. Although these models aren't the most widely used, having your rental history reported can still be beneficial, especially when seeking credit from lenders who rely on these models.
Self, for example, reports your rent to all three bureaus when you sign up, and you can also pay a one-time fee to report up to two years of past rental history. Similarly, utility payments can be reported using services like Self, which helps build a positive credit history if payments are made on time.
5. Become an Authorized User
You can improve your credit by becoming an authorized user on someone else's credit account. However, not all credit card companies report authorized users to the bureaus, so check first. If they do, and a trusted individual with good credit habits adds you to their account, their positive payment history and low credit utilization can benefit your credit score.
Keep in mind, though, that if the account has a negative payment history or high CUR, it could harm your credit score instead.
6. Consider a Personal Loan
A personal loan should not be taken out solely to build credit. However, if you need to cover a large expense or consolidate high-interest debt, it could be a viable option. It can help you diversify your credit mix and build a positive payment history, provided you make timely payments. Weigh the pros and cons and compare interest rates before deciding.
7. Review Your Credit Report for Inaccuracies
Improving your credit score could be as simple as correcting errors on your credit report. It's common to find at least one mistake that could be dragging down your score. You're entitled to a free credit report from each bureau annually through AnnualCreditReport.com. You can also request a report directly from the bureaus, although there may be a small fee.
Common errors include:
- Accounts resulting from identity theft
- Closed accounts reported as open
- Duplicate debt listings
- Incorrect payment or delinquency dates
- Accounts with wrong balances or credit limits
If you spot an error, dispute it with each credit bureau in writing. The Consumer Financial Protection Bureau (CFPB) provides guidance on how to file a dispute.
More than 90% of top lenders use FICO® scores to evaluate creditworthiness. Here is how your FICO® score is calculated:
- Payment History (35%): This is the most significant factor, representing how reliably you've paid your accounts over time. A strong history of on-time payments positively impacts your score.
- Amounts Owed (30%): This reflects the amount of debt you currently owe. While the total amount of debt is considered, your credit utilization ratio (CUR)—the percentage of your total available credit that you're using—is more impactful. A high CUR can negatively affect your score.
- Length of Credit History (15%): The duration of your credit history also plays a role in your score. Generally, the longer you've held accounts open, the better for your credit score.
- Credit Mix (10%): This factor considers the variety of credit accounts you have, such as credit cards, mortgages, and auto loans. A diverse mix can show lenders you can responsibly manage different types of credit.
- New Credit (10%): This component looks at the number of new credit accounts you've opened recently. Opening multiple accounts in a short period can indicate higher risk, especially for those with a shorter credit history.
How Long Does It Take To Build Credit?
Building credit from scratch might seem overwhelming, but it could take less time than you think. Typically, if you're starting fresh, it may take around six months after obtaining your first credit product to see initial results.
It's important to note that building credit from scratch may be quicker than rebuilding damaged credit, depending on your financial situation. Factors like past bankruptcies or delinquencies can slow the process. Negative marks, such as late payments, bankruptcies, and collections, can stay on your credit report for up to seven years, while a Chapter 7 bankruptcy may remain for up to 10 years.
Remember, the journey to good credit begins with a single step. Start building or rebuilding your credit today by adopting good credit habits, like those mentioned above. Be prepared for this process to require both time and patience.
Disclaimer: FICO is a registered trademark of Fair Isaac Corporation in the United States and other countries.
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