Good credit helps you qualify for loans with lower interest rates and rentals. Learn how to build credit from scratch.
Your credit score is a significant part of your financial health. Without a credit history, you’ll find it hard to get a credit card, loan, or rent an apartment.
A good credit score ensures that you qualify for loans and get the lowest interest rates.
With larger loans, like a mortgage or auto loan, it’s essential for paying less in interest.
While it seems backward that you need a loan or credit card to build credit, there are ways around it.
If you want to improve your credit or build it from scratch, the following covers the best ways to build credit.
Also, learn about the different types of credit and how to maintain a good credit score.
Related article: How much should your car down payment be?
How to build credit from scratch
Your credit score impacts many aspects of life.
Lenders, landlords, and employers run credit checks. So, good credit history is beneficial.
The best ways to build credit are as follows.
Get a secured credit card
If you have no credit history or a low credit score, consider getting a secured credit card.
It works like a traditional credit card but requires a cash security deposit.
Also, most banks and credit unions offer it with a security deposit generally between $250 and $500.
The security deposit protects the lender. If you stop making payments and default, the security deposit covers the amount.
Before applying for a secured credit card, make sure there isn’t an annual fee.
Also, ensure the lender reports the information to Transunion, Equifax, and Experian, the main credit bureaus.
If you get one, use it for your daily spending. Then, pay your bill on time and in full.
After a year of good payment history, check your credit score for improvements.
Then, you can apply for a traditional credit card. If you’re approved, the lender will return the security deposit.
Get a credit-builder or secured loan
The best way to build credit without a credit card is with a credit-builder or secured loan.
Both types have the goal of helping you build credit by reporting payments to the credit bureaus.
A credit-builder loan is where the lender holds the funds as you make payments. Once you pay off the loan, you’ll get the funds.
A secured loan is like a secured credit card, as you’ll give a security deposit.
Then, you make monthly payments towards the security deposit until you pay it off.
Each time you make a payment, the lender will release a part of the deposit back to you.
Credit-builder and secured loans aren’t as common as secured credit cards. But, many credit unions, local banks, and online banks offer them.
Without a credit history, it’s hard to get a loan. If you have a co-signer with good credit, it’s possible.
With a co-signer, you can get an unsecured credit card and other loans. But, the co-signer is also responsible for the entire loan.
If you don’t make payments, the co-signer needs to, or it’ll hurt both of your credit scores.
Aside from getting a co-signer, you can become an authorized user.
But, make sure the lender reports the payment history for authorized users because not all do.
Ask a family member or partner to add you to their credit card as an authorized user.
As an authorized user, you don’t need a credit card. If you choose to use one, make sure you pay for what you spend.
Get credit for alternative data
Alternative data refers to rent, phone bills, and utilities. It’s not generally on your credit report, but it can help your credit profile.
When you don’t have anything or much on your credit report, it means you have a thin file.
Experian Boost, LevelCredit, Perch Credit, and eCredable can help report rent or utility payments.
Alternative data is an excellent way to get credit for your monthly bills.
Student loans
If you need a student loan, it can be a way to build credit.
Many federal student loans skip the credit check. It means you can get approved without a credit history.
Also, it only applies to federal student loans, as private student loans need a credit check.
Make your student loan payments on time and in full. Over time, you’ll build good credit.
What’s a good credit score?
Now that you know how to build credit, what’s a good score? Most credit scores range from 300 to 850.
The following is the range of credit scores and how they’re rated:
- 300 to 579 is poor.
- 580 to 669 is fair.
- 670 to 739 is good.
- 740 to 799 is very good.
- 800 to 850 is excellent.
Aim to be in the very good or excellent credit score category.
How to maintain a good credit score
After you reach a good or excellent credit score, you must work to maintain it.
Continue to pay your bills on time and in full. FICO states that payment history makes up 35 percent of your credit score.
Also, make sure you use less than your available credit.
What you use relative to your available credit is your utilization ratio. Experian recommends 30 percent credit utilization or less.
Another way to maintain your credit score is to keep your old credit accounts open.
The length of your credit history is 15 percent of your score. So, do the least to keep your accounts active.
Payment history, credit utilization, and length of credit history make up 80 percent of your credit score.
So, make your payments on time and keep your balances low.
The other 20 percent is your credit mix and new credit accounts. Both are worth 10 percent.
Aside from the factors that impact your credit score, you must check your credit report once a year.
Every year, you can get a free credit report from Experian, Equifax, and Transunion through Annual Credit Report.
The following covers the steps to request your credit report:
- Online: AnnualCreditReport.com
- Phone: 1-877-322-8228
- Mail: Download the Annual Credit Report Request Form
If you select the mail option, the following is the address to mail your completed form:
Annual Credit Report Request Service
P.O. Box 105281
Atlanta, GA 30348-5281
After you receive your credit reports, review the following information:
- Personal information is correct.
- Public records are accurate.
- Credit accounts (check for fraud).
- Balances and payments are reported correctly.
- Inquiries (hard and soft pulls).
Review your credit reports every year to ensure all the information is correct.
If you find inaccurate data or fraud, contact all three credit bureaus to file a dispute.
How your credit score is calculated
The following is a recap of how credit bureaus calculate your credit score according to FICO:
| Category | Percentage |
|---|---|
| Payment History | 35% |
| Amounts Owed | 30% |
| Length of Credit History | 15% |
| Credit Mix | 10% |
| New Credit | 10% |
Other credit score models
While most credit scores follow the FICO model, you may see different scores.
FICO began in 1989, and another credit score model is the VantageScore, which started in 2006.
The following is a table with the formula for the VantageScore.
| Category | Percentage |
|---|---|
| Payment History | 40% |
| Age & Type of Credit | 21% |
| Credit Utilization | 20% |
| Total Balances | 11% |
| Recent Behavior | 5% |
| Available Credit | 3% |
Keep in mind that the scores are slightly different. But, both are excellent representations of your credit score.
Types of credit
There are many forms of credit accounts, and each type falls under one of three categories.
The three categories are revolving, installment, and service or open credit.
A good mix of the three types of credit is beneficial to your credit score.
The following goes into detail about the three credit types.
Revolving credit
Revolving credit is also known as an open-ended credit line. It allows you to borrow from and repay the credit line up to the limit.
When you borrow from the credit line, you must make payments on or before the due date.
If you pay the entire balance, you don’t pay interest. If there’s a balance after your payment, the lender charges interest on what’s left.
Revolving credit includes a credit card, line of credit, and home equity line of credit (HELOC).
Installment credit
Installment credit is a loan for a fixed amount of money.
You enter an agreement with the lender to make a set number and dollar amount of payments to pay off the loan.
After you pay off the loan, the account is closed.
Installment credit includes an auto loan, personal loan, mortgage, and student loan.
Service or open credit
Service or open credit refers to bills from a person or company that provides a service. It includes rent, utilities, and phone payments.
If you don’t pay as agreed, the companies can send your account to collections, and it’ll hurt your credit.
Conclusion
Start building your credit score with the methods you learned today.
The best part is that you don’t need to go into debt to build credit. Also, you can build credit with or without a credit card.
The sooner you start building credit, the better. With consistency and on-time payments, you can increase your credit score.
Related article:
- Best secured credit cards
- How to get a personal loan
- How to build credit without a credit card
- How a credit card balance transfer works
Featured image courtesy of Pexels.
About David Em
Founder
David Em is the founder of More Money More Choices, which he launched to help you take control of your finances and build your dream life. Before More Money More Choices, David worked in leadership positions in the finance industry.