How to Build Your Credit: Guide for Beginners

Step 1 - Understand Your Current Credit Situation

It is very important to know what is on your credit reports, even if what's there is nothing. When you start to take on credit, like a first credit card, or a first apartment, things begin to appear on your credit report because the lender has "pulled your credit" and looked you up. When they don't see anything, some lenders aren't willing to take a chance.

Having nothing in your credit report is called having a thin credit file. Having a thin file isn't bad, it's just slim on information, as more lenders are willing to take a chance on you, though, your credit report will begin to grow – whether for good or bad is up to you.

Check Your Credit Report

To check your credit report, you can sign up with a service like Experian, which is one of the three major credit bureaus in the U.S., or you can go through the government-sponsored site www.annualcreditreport.com, where you can now request a free copy of your credit report from each of the three main credit bureaus, Experian, TransUnion, and Equifax.

The information you will see listed includes your personally identifiable information, such as your full name, social security number, birthdate, and any addresses you have lived at. Your employment is also listed. You will see any loans or credit cards you have applied for, including ones that were not approved. Payments are listed, both good and bad. Accounts in collections and public records, such as liens and lawsuits, are also listed.

Know Your Credit Score

All the info in your credit report that pertains to loans and credit combines to make up your credit score. The five things that go into this are payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%), and credit mix (10%). These factors are calculated into a three-digit number between 300 and 850. The higher the number, the better off you are in terms of getting favorable credit in the future.

Most lenders base approval on your FICO credit score. Your FICO score is a number that ranges from 300 to 850, and is determined by five different components:

Credit score ranges are defined by FICO, the leading credit scoring model in the U.S., as:

• 300-579 Poor
• 580-669 Fair
• 670-739 Good
• 740-799 Very Good
• 800-850 Exceptional

If you have a thin file due to being new to the credit world, your credit will typically fall within the Fair Credit category; scores don't just start at 300. Credit starts slowly, and the more activity you begin to build, the higher your score will be. Credit typically starts dipping into the Poor Credit category if you're prone to mismanagement or never take the time to build your score.

Step 2 - Establish Credit If You Have None

If you've just started out and are looking to establish a good credit score, there are several ways you can help yourself. Here are three options designed to help you build or rebuild your credit.

• Open a Secured Credit Card. A secure credit card is one where you have to make a deposit to set your credit limit and activate the account. Once you make the initial deposit, you can use the card up to that limit, but you will get bills to pay just like a normal credit card. You will have the option to make payments or to pay the entire balance, thus keeping your credit limit intact. If you don't repay what you owe, the payment will be taken out of your deposit, and your credit limit will decrease.
  
• Become an Authorized User. When you become an authorized user on someone else's credit card, you get the benefits of their good payment history tied to your credit report. You sometimes get a credit card to use as an authorized user, but not always. This gives you revolving credit on your credit report (credit cards are an example of revolving credit). Be sure to attach yourself to someone who is responsible and keeps up with their payments or your credit will be impacted for the worse.
  
• Take Out a Credit-Builder Loan. A credit builder loan is designed to help you improve your credit score with timely loan payments on an installment loan. Along with revolving credit, having installment credit helps give you a solid credit mix. Timely payments improve your payment history and pay off your loan. The catch with a credit builder loan is that you don't get the money until after you repay the loan. This way, a credit builder loan acts like a loan and a savings account.

Remember, these tips only work if you manage your accounts and pay your bills on time, so don't take on more than you can handle all at once.

Step 3 - Build Positive Credit Habits

Positive credit habits are a big part of living a financially healthy lifestyle. This gives you the freedom to seek credit when you need it, and typically allows you to take advantage of savings that are built for shoppers with good credit, like lower interest rates and special savings on vehicles, or lower mortgage rates.

Always Pay Bills on Time

Paying your bills in full by the due date is essential to building a good credit score, since payment history is the biggest factor in your credit score. These timely payments show on your credit report, and the longer you can keep up a good record, the better, too, since length of credit history is the third biggest factor in your score.

Make sure that the bills you pay get reported to the credit bureaus by signing up for a service like Experian Boost, where your recurring monthly payments can help increase your credit score. You can also ask your landlord to report your rent payments.

Keep Credit Utilization Low

A low credit utilization ratio is a very good thing, and lenders like to see yours around 30% or less. This means that at any given time, you're only using around 30% of the credit available to you. In other words, don't max out your credit cards and then only pay the minimum due on the account. This will get your credit score in hot water really quickly.

To keep your credit utilization ratio down, simply ensure that you're only putting on credit what you can afford to pay for in cash. If you won't be able to pay off the full balance when the bill comes, you're probably keeping your credit utilization ratio higher than lenders would like. This could cause problems if you find yourself in need of a loan.

To find your credit utilization ratio, simply add up all your revolving credit, then add up all the amounts you owe. Divide the debt you owe by your available credit, then multiply by 100. Here's an example:

If you have two credit cards, one with a $500 limit, and one with a $300 limit, your total credit is $800. Let's assume you have a balance of $100 on one, and $150 on the other. This gives you a debt of $250. Now divide 250 by 800, and multiply the answer by 100.

• 250/800= 0.3125
• 0.3125*100= 31.25%
• This is slightly over where a lender likes you to be, but isn't too bad. If this were your situation, you should work to make your biggest credit card payment first.

Avoid Opening Too Many Accounts at Once

When you apply for every form of credit that's offered to you, or attempt to take out a personal loan or loans often, this may be a red flag for lenders. It's important to only open the lines of credit that are necessary, and to avoid having your credit score dinged -- and lowered -- by having it pulled by lenders too often. Each time a lender checks your credit, it can cost you around 5 to 15 points. Not what you want to happen if you're trying to build credit.

How To Build Credit as a Minor

As a minor, it's up to your parents or guardian to help you set up the right tools to begin caring for your credit, since legally, you must be 18 to open an account on your own. Things parents can do include helping a minor set up a bank account, with a debit card they must manage, or setting up a savings account that helps them prepare for the future. A minor can also become an authorized user on a parent's credit card or open a joint credit card with a parent, which will begin building credit before age 18. Remember, these things can't be done on you're own until you're 18.

Consider an Auto Loan to Help Build Credit

Did you know there’s another option? If your credit is less than perfect, you can build credit by successfully completing a bad credit auto loan. There are many special finance dealerships out there that have the resources available to help those looking to finance a vehicle with bad credit, no credit, or other credit issues – and we can connect you to one.

At Auto Credit Express, we know how tough it can be to find financing when your credit isn’t great, and we want to take out the stress of searching for the right dealership. Fill out our free and secure auto loan request form, and we’ll get right to work connecting you to a dealer near you!