Table of Contents
- Credit scores are largely dependent on a positive payment history.
- Credit mishaps, like missed payments, will remain on your credit report for seven years.
- To build good credit, pay bills on time, minimize hard inquiries, maintain a solid mix of credit types, and keep your utilization ratio low.
- If you don’t qualify for standard lines of credit, consider a secured credit card or small loan to build credit.
Credit scores are the main driver in whether you qualify for a mortgage loan, car loan, or student loan, plus the rate and terms you qualify for.
Understanding Credit Score Calculation
Five Factors determine your credit score:
- Payment history (35%)
- Amounts owed (30%)
- Length of credit history (15%)
- New credit (10%)
- Credit mix (10%)
Payment History (35%)
Creditors and lenders want to be paid back on time, which is why your payment history comprises the largest portion of your score. If you’ve been late on, or entirely missed, any bill, like a credit card, installment loan, or cable bill, your payment history will suffer.
Amounts Owed (30%)
The amount owed, also referred to as credit utilization, is the amount of your total credit line you’ve used up. For example, if you had $10,000 of available credit and used $5,000 of it, you’d have a 50% credit utilization ratio.
It’s important to keep your credit utilization below 30% to keep your score in check. This signals to creditors and lenders that you’re managing your credit effectively.
Length Of Credit History (15%)
The longer your credit history, the more data there is about you. This provides lenders more information about how long you’ve been able to manage credit effectively.
Think about it: If you were to lend someone $10,000, you’d likely want to see decades of on-time payments as opposed to 2 weeks of on-time payments.
New Credit (10%)
New credit refers to the credit accounts you’ve recently opened. If you open too many accounts in a short period of time, it may signal to lenders that you’re relying on credit to get by.
Plus, when you apply for a new line of credit, the institution will typically run a hard credit check. This temporarily decreases your score, even with one inquiry. Incurring multiple hard inquiries will warrant a more significant drop in your score.
Credit Mix (10%)
Lenders want to know that you can manage different types of credit. Now, this doesn’t mean you should go open a new credit card and apply for a mortgage just because. It means you shouldn’t fear having multiple lines of credit — just make sure it’s a diverse bunch.
It’s important to understand that building a solid credit score is a gradual process. Each of the five factors plays a unique role in determining your credit health. Attention to these areas, especially payment history and credit utilization, is essential for establishing and maintaining good credit. Consistent, responsible financial behavior over time is key to seeing an improvement in your score.
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Starting From Scratch
If you’re new to credit, you might find that your score doesn’t increase as quickly as you hope. With payment history being the largest portion of your score, time plays a major factor.
Because of this, lenders may be hesitant to approve you. In their eyes, you don’t have a history of managing credit effectively, and depending on the type of loan you’re looking to borrow, this may be a dealbreaker.
Generally speaking, it takes around three to six months of credit activity before a score can be generated. There are several things you can do, however, to build a positive credit history during that time.
Strategies To Build Good Credit
To get your credit score at its peak, you’ll need to pay all bills on time, manage your usage, maintain a diverse credit mix, and limit hard inquiries.
Pay Bills On Time
This one is self-explanatory — pay all bills on time. If you struggle with this, put your bills on autopay, so you’re never late on a payment.
Manage Your Usage
Keeping your credit utilization ratio below 30% is an indicator of proper credit management. This means that at any given time, your balance should not exceed 30% of your total available credit. If you’ve exceeded that limit, pay your bills more frequently to keep your balance low.
Maintain A Diverse Credit Mix
Having one line of credit forever isn’t a bad thing, per se, but on-time payments on multiple credit products like student loans, car loans, and mortgages is better. This demonstrates to lenders that you’re able to manage several types of credit at once, which is an indicator of financial responsibility.
Limit Hard Inquiries
Each hard inquiry you incur causes a temporary drop in your score. If you incur several hard inquiries in a short timeframe, you may notice a more significant drop. As much as you can, try to avoid incurring hard inquiries.
Building good credit isn’t just about avoiding negative marks, but actively fostering positive financial habits. On-time payments, credit mix, and managing credit utilization are all proactive steps in this process. Remember, your credit score reflects your overall credit management strategy, so diversifying and responsibly handling different types of credit can significantly boost your score.
Options For Building Credit
You have a few options when it comes to building credit:
- Standard credit cards
- Secured credit cards
- Become an authorized user
- Find a cosigner
- Credit builder loans
Standard Credit Cards
Standard credit cards offer you a line of credit based on your creditworthiness. If you have a poor credit history or no credit history, you may not qualify. However, if you do, making consistent on-time payments will improve your credit score.
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Become An Authorized User
If you know someone with good credit, ask to be an authorized user on their account. As an authorized user, you’d have access to their credit line, which comes with their positive payment history. This payment history will reflect on your credit report, which in turn increases your score.
| Pros of Becoming an Authorized User | Cons of Becoming an Authorized User |
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Find A Cosigner
If you’re unable to qualify for a line of credit on your own, or if the rate you’re given is undesirable, add a cosigner. A cosigner is an individual with good credit that agrees to take responsibility for the debt if you fail to make payments.
A cosigner serves as another layer of protection for lenders, ensuring payments get made one way or another. This can help you qualify for a line of credit and begin building credit.
| Pros of Finding a Cosigner | Cons of Finding a Cosigner |
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Credit Builder Loans
A credit builder loan is a small installment loan designed for people with little or no credit history. Unlike other loan types, you won’t receive the funds after approval. Instead, the lender will hold the funds in a separate account, and you’ll make payments on your principal each month.
Once you’ve paid off the full loan, you’ll receive the funds. Throughout the process, your lender will report each payment to the three major credit bureaus.
| Pros of Credit Builder Loans | Cons of Credit Builder Loans |
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When exploring options to build credit, it’s good to choose strategies that align with your financial situation and goals. Whether it’s using a standard credit card, becoming an authorized user, or utilizing credit builder loans, each option has its pros and cons. Tailoring your approach to fit your unique circumstances will make the process of building credit more manageable and effective.
Mistakes To Avoid
When trying to build your credit, make sure to avoid:
- Late payments: Late payments remain on your credit report for seven years, making them challenging to remove. Put bills on autopay if you’re afraid of missing a payment.
- Overcharging: Exceeding your credit limit can result in high fees, a drop in your credit score, and potential closure of the line of credit. It’s best to keep your balance below 30% of your overall credit limit.
- Closing accounts: Closing credit accounts can shorten your credit history. Even if you don’t use the line of credit, keep the account open.
- Indiscriminate credit applications: If you need to open a new line of credit, do so with intention. Submitting applications willy-nilly could lead to excessive hard inquiries.
The Takeaway
Building credit doesn’t happen overnight. You’ll need to commit to making wise financial decisions for at least three to six months before you see a significant shift in your score. Remain patient and disciplined, and you will see results.
Frequently Asked Questions (FAQs)
How Quickly Can You Build Credit?
It typically takes three to six months to generate your first credit score. However, getting your score into the “excellent” range takes longer.
What Is A Good Credit Score?
A score of 670 or higher is considered good. That said, it’s best to aim for a score in the “very good” or “exceptional” range:
300-579: Poor
580-669: Fair
670-739: Good
740-799: Very Good
800-850: Exceptional
How Do You Fix Bad Credit?
With some credit mistakes, time is of the essence. For example, only time will remove missed or late payments. For other mistakes, you may want to consider other options.
How Long Does It Take To Recover From Bad Credit?
Negative payment information, like late payments, will remain on your credit report for seven years. Chapter 7 bankruptcy will remain for up to 10 years.
Find out more
- Maximize Your Credit Score – Aim for the top with our guide to achieving a high credit score.
- Proactive Credit Monitoring – Learn how consistent monitoring can protect and improve your credit score.
- Demystifying Credit Repair – Discover the truth and benefits of credit repair services.
- Navigating the Credit Score Scale – Understand the significance of credit score ranges and their impact.
- Budgeting for Credit Repair – Plan your finances with our guide to credit repair costs.
- Clean Up Your Credit Report – Steps to ensure your credit report is up-to-date and error-free.
- Understanding Credit Inquiries – Grasp the differences and impacts of various credit inquiries.
- Choosing a Credit Repair Agency – Key factors to consider when selecting a credit repair service.
