When you’re ready to open a credit card or take out a loan, the credit card company or lender will check your credit report and credit score to learn about how you’ve managed credit in the past.
If you have a long history of effectively managing credit and making payments on time, you’re likely to have a good credit score and will be more likely to be awarded the credit card or loan with favorable terms and rates. If you’ve never used credit or have negative information on your credit report, like missed payments, you may be less likely to secure a loan or credit card. If you do get the loan or credit card, you may get less favorable rates.
Building credit takes time, so it’s important to begin building your credit before you really need it.
How to Build Credit with a Credit Card
Credit cards are a very useful type of credit tool, and when used wisely, they can help you build your credit. However, it’s important to manage credit card use, because credit cards can also be a route to debt if you misuse them. Here are four ways you can build credit with a credit card:
- Open your first credit card account. If you have already established some credit history, look for a card with a low spending limit, which may be easier to qualify for if your credit history is limited. Make small charges that you can easily pay off right away, and pay the balance in full every month. This will help build a profile on your credit report of responsible credit use and reliable payment.
- Get a secured credit card. If you have little credit history or negative history, it may be difficult to get a regular credit card. A secured credit card may be an option. Secured credit cards are usually tied to a savings account, and the limit on the card is typically the amount in the account or a percentage of it.Just as with a regular credit card, you build credit with a secured card by making responsible charges, keeping your balance low or at zero, and paying on time every month. Not all lenders report secured credit cards to the credit reporting companies, but the lender may be willing to convert the account to a traditional credit card after a certain period of time. You should ask these questions prior to deciding whether to open any account.
- Open a joint account or become an authorized user. If you’re having trouble getting your own credit card, another option for building credit is to become an authorized user on someone else’s account, or to open a joint account with someone who has a good credit history. Parents may choose to help a younger person with little credit history by adding him or her to the parents’ existing credit card accounts as an authorized user, or by opening a new card jointly. For joint accounts, you are responsible for repaying charges on the card, and so is the other account holder. If you don’t repay money borrowed on a joint account, the joint cardholder will have to, or you’ll both feel the credit impact of late or missed payments.
- Request a credit limit increase. After you have paid down your debt and decreased your utilization rate, or if your credit is already in good standing, you may consider asking for a credit limit increase from your credit card provider. Your credit utilization ratio is a comparison between the total amount of credit available to you versus the total amount you’re using, and it’s an important factor in your credit score.A credit utilization ratio of 30 percent or less is often considered good by lenders and others; the lower the ratio the better it is for your credit score. For example, if you have $1,000 of available credit, and only owe $200, your credit utilization ratio is 20 percent. Increasing your available credit can lower your credit utilization ratio and positively impact your credit score, as long as you’re careful not to charge up to your new limit. The lower your utilization rate is, the better your credit score will be.On the other hand, asking for a credit limit increase when you have high balances may not be the best approach, since it may be difficult to get a provider to agree to an increase and it could increase your risk for adding more debt if your spending is not managed properly. This in turn, would negatively impact your credit.
How to Build Credit without a Credit Card
Credit cards aren’t the only option for building credit. Remember, your credit report is a snapshot of how well you manage what you owe. Whenever you use credit wisely, that information can be included in your credit report. Here are five ways to build credit without a credit card:
- Pay student loans diligently. If you’ve got a college degree, you probably have at least some student loan debt. Student loans are reported to the credit bureaus, so making your student loan payment on time every month can help build your credit.
- Take out an auto installment loan. Auto loans are among the easiest types of loans to obtain, although the interest rate and terms can vary greatly depending on who underwrites the loan for you. If you are planning to buy a vehicle, shop around for the best possible deal, secure the loan and make the agreed-upon payments on time every month. If you have trouble finding a loan on your own, you may need a co-signer to share responsibility for the payments. Other types of installment loans will also help you with building credit history, such as mortgages and personal loans.
- Obtain a secured loan. Banks and credit unions understand it’s not always easy to build credit when you’re starting out with little credit history or negative marks on your credit report. Some offer credit-builder loans, or passbook/CD loans — low-risk loans designed specifically to help you build credit. They work much the same way a secured credit card works; for a credit-builder loan, you deposit a certain amount into an interest-bearing bank account and then borrow against that amount. The deposit is your collateral, and you’ll pay interest at a higher rate than your deposit earns it.For passbook or CD loans, some banks allow you to use an existing bank account or certificate of deposit as collateral for the loan. Before you take the loan, confirm with the lender that your on-time payments will appear on your credit report.
- Non-profit lending circles. Organizations such as the Mission Asset Fund (MAF) and its non-profit partners have been gaining popularity and have expended across the nation by providing low-income borrowers a way to get financing while building credit. Organizations such as these can provide affordable loans and report positive payment history to the credit bureaus.
- Ask for credit where credit is due. Just because you’ve never had a loan or credit card doesn’t mean you don’t know about paying bills. If you reliably pay your rent and utilities on time, you’ve demonstrated good money management habits and you can ask for credit for that good track record.Rental payments and utility bills don’t typically appear on a credit report — unless you fail to pay and the leasing company or service provider sends the delinquent amount to a collection agency or files suit against you to recover the past due amount. However, recently some companies have been taking steps to change that.