How To Build Credit

If you have any major financial plans for your future, they’ll likely go more smoothly with a good credit score. 

Thinking of buying a home? You can get better rates with a higher credit score. Want to upgrade to a new car? You can find better financing offers if you have a good credit score. Want to rent an apartment in a nice building? Most landlords will check your credit before they let you move in. The list of reasons why you need a good credit score goes on forever. 

Building your credit from scratch can seem like a daunting process. However, it is completely possible to take your credit score from nonexistent to excellent with time. We will discuss the easiest ways to build credit.

Before you start building your credit score, it’s important to understand how it’s created. Your credit score is based on your credit reports, which track many aspects of your financial life. 

Your FICO^® Score will take in a five factors to determine your overall creditworthiness. 

• Payment history. The ability to pay your bills on time can help your credit score. If you have a history of late payments, then you might end up with poor credit. 
• Utilization. The amount of your credit limit that you are currently using will tell creditors how responsibly you manage your finances. 
• Age of accounts. The older your accounts, the better your credit score. 
• Credit mix. Creditors like to see a mix of lines of credit. For example, they want to see both revolving credit and installment loans. 
• Credit inquiries. The number of times you apply for new credit can affect your score. If you are constantly seeking out new loans, that can be a red flag to lenders. 

Now that you know a little bit more about credit scores, let’s talk about how you can build yours today. 

The three major credit bureaus – Experian™, Equifax^® and TransUnion^® – are able to calculate your credit score after 3 – 6 months of consistent activity, such as making monthly payments on existing loans or opening credit accounts. Making payments on time and practicing other good credit habits will help to further improve your score.

While it’s natural to want to raise your credit score quickly, the best way to build credit is a process that takes time and dedication – it’s not something that can be rushed (even articles on how to build credit fast will tell you pretty much the same thing), but it is something that will have a major impact on your life.

Credit cards are a great tool for building credit, but they’re only a part of the larger picture. There are other varieties of credit accounts out there, including personal loans, auto loans, student loans and mortgages. These can either be revolving credit or installment credit.

Revolving Credit

Credit cards are a type of revolving credit. A creditor offers a maximum amount they’re willing to lend (known as the credit limit) and you, the borrower, can use any amount within that limit. As long as you stay within your limit and pay the creditor what you owe each month, you can continue to borrow from this line of credit. 

Installment Credit

With installment credit, a borrower receives a loan for a set amount of money, typically in one lump sum. Over the course of the agreed term (which can be months or years), the borrower makes regular payments to the lender to pay down the initial loan balance and any interest accrued. For this type, think auto loans and mortgages.

Your credit score gives lenders a quick idea of how creditworthy you are. In other words, your score indicates how likely you are to pay them back if they were to lend you money.

While many people talk about their “credit score,” the truth is that you actually have many different credit scores. It all depends on which scoring model your chosen lender chooses to utilize when pulling your credit.

Most lenders will look at your FICO^® Score to determine your creditworthiness. However, the VantageScore^® model, developed by the three major credit bureaus, is gaining in popularity.

Both primary models calculate scores within a range of 300 – 850, though they have slightly different ways of doing so.

According to FICO^®, your credit score is made up of five different factors, each adding up to a certain percentage of your total score:

1. Payment history: Your ability to make on-time payments makes up the largest chunk of your credit score, at 35% or so. (It’s easy to see, then, just how easily a late payment can lower your score.)
2. Utilization: If you frequently use up a majority of your credit limit, that can be a red flag for creditors, which is why this factor makes up 30% of your score.
3. Age of accounts: 15% of your score is determined by how long your credit accounts have been open. The longer you’ve had an account, the better … so don’t close an account unless you have a good reason to do so.
4. Credit mix: Though it only makes up 10% of your score, credit scoring models will also consider the types of accounts you have open. They typically like to see a good mix of both revolving and installment debt such as credit cards, a mortgage or a student loan.
5. Credit inquiries: The final 10% of your score is determined by how often you’re applying for new credit. When you apply for a credit account, a hard inquiry is done on your credit, temporarily lowering your score by a few points. Multiple inquiries within a short span of time can damage your score. However, multiple inquiries for home, auto or student loans within a short period of time are typically treated as a single inquiry, as it indicates that the borrower is simply shopping around for rates. 

According to Experian, a score over 800 is considered exceptional. A score between 740 – 799 is rated very good, 670 – 739 is good, 580 – 669 is fair, and 300 – 579 is very poor.

Even if yours is already considered good, work to improve your credit score even more. This will help you qualify for lower interest rates, increase your credit limit on existing cards, or even open a luxury rewards credit card.

Many personal finance sites and apps, including Rocket Homes^SM, offer users free access to their VantageScore^® – simply sign up for an account to see yours.

Don’t worry if you feel overwhelmed by all the unfamiliar terms and concepts associated with building and maintaining good credit. That’s what we’re here for!

Before we dig into how to build your credit score, let’s go over some of the expressions you may come across along the way.

• Annual Percentage Rate: This number tells you the percentage of interest you’ll pay on your balances. Note that your APR is annual, meaning that’s what you’ll be charged on a yearly basis. To find out what you’ll be charged in interest each month, divide your APR by 12. If your account accrues interest daily, you can divide the APR by 365 to get your daily rate.
• Credit card: A credit card is a type of revolving loan used to make purchases as needed, up to a specified limit. Most credit card issuers offer a grace period, typically 25 – 30 days, during which you can pay off the money you borrow without being charged interest. For many people, using a credit card is one of the preferred ways to establish and build credit.
• Credit limit: Also called a credit line, a credit limit is how much money a creditor is willing to lend you at one time. Once you hit your credit limit, you’ll need to pay down some of the debt you owe before you can continue using that account.
• Credit report: This is a detailed report of your entire credit history, including how often you make on-time payments and whether you’ve had any delinquencies. This information is tracked and provided by the three major credit bureaus and is used to calculate your credit score.
• Credit score: This number reflects the information in your credit report. There are a few different types of credit scoring models, but the one that is used most widely by lenders is the FICO^® Score, created by Fair Isaac Corporation. These scores often range from 300 – 850.
• Utilization: Your credit utilization rate is the amount you currently owe divided by your total credit limit. So, if you have one credit card with a limit of $6,000 and you currently owe $3,000, you’re at a utilization rate of 50%. It’s generally recommended that you keep your utilization below 30% to maintain a high credit score.

There is not a single way to build credit that stands out above the rest. Instead, it’s important to try a variety of strategies to build a solid credit history.

Here are a few ways to get started. 

Secured Credit Cards

Secured credit cards allow you to open a credit card by making a cash deposit. Your credit limit will be directly tied to your cash deposit. If you manage your secured card responsibly, it can be a good place to start building your credit score. 

With a secured card, you put down a refundable security deposit, which serves as your credit limit. Deposits can range from $200 – $2,000, depending on the credit card company’s requirements.

You’ll borrow from the original amount you deposited – the deposit serves as collateral if you end up being unable to pay.

After you’ve spent a while making on-time payments and keeping your utilization low, you’ll hopefully have built a good enough credit score to upgrade to an unsecured card. Your credit card company may even offer to convert you to an unsecured account automatically, possibly with a higher credit limit.

Unsecured Credit Cards

Unsecured credit cards are “traditional” credit cards – they don’t require a deposit to qualify for approval. People who are approved range from those who have some form of credit history all the way to those with excellent credit scores.

If you have no credit history or credit score, it’s likely going to be tough to get approved for an unsecured card right out of the gate.

Even if you don’t start out with an unsecured credit card, it should ultimately be your goal to attain one. Unsecured cards, in addition to not requiring a deposit, tend to come with more benefits and higher credit limits.

Although it will be difficult to obtain a traditional credit card without a credit score, it can be a good way to prove your creditworthiness. Obtaining an unsecured credit card might not be your first step towards building your credit score. However, it can be an important step down the line.  

Student Credit Cards

If you’re still in college and are looking to build your credit, student credit cards are a great way to help you start building credit.

Student cards allow young adults with little to no credit history to begin building credit. These types of cards generally require you to have some sort of income (such as a part-time job) to be eligible for approval.

They also tend to come with pretty low credit limits, which can make them good if you’re looking for a lower-risk way to get used to the responsibility of having credit.

Become An Authorized User

If you have trouble opening your own credit card, then you could become an authorized user on someone else’s credit card account. A good person to ask might be your significant other or closer family member with an excellent credit score.

As an authorized user, you’ll receive your own credit card to use with access to the account’s line of credit. Although you aren’t responsible for making payments, the actions of the primary account holder will be reflected on your credit report. For example, if they make on-time payments, then your credit report will see a positive improvement. However, if they miss multiple payments, then you can expect a drop in your score. 

Credit Builder Loans

Credit builder loans allow you to build credit without touching a credit card. However, you’ll need to have enough room in your budget to make small monthly payments. 

Here’s how credit builder loans work: You borrow a relatively small amount of money (usually $300 – $1,000) which the lender puts into an account. You make regular payments to the lender. Once you’ve paid off the loan, you’re given access to the account with the lump sum that you originally borrowed. Of course, you’ll need to pay interest over the course of the loan. Some lenders may refund a portion of it. Be sure to learn all the terms and conditions before taking out the loan.

As you make regular, on-time payments, the lender will report your payment history to the major credit bureaus.

Many credit unions and banks offer credit builder loans. Take advantage of the best offer you can find. 

Student Loans

Often, the first encounter many of today’s young adults have with credit is taking out loans for school. While we don’t advocate taking out student loans you don’t need for the purpose of establishing credit, if you had to take out loans to pay for your education, you can use that to your advantage by using them to build your credit.

Remember that payment history makes up the largest chunk of your credit score, so do your best to avoid making late payments. If you’re having trouble staying on top of your loans, you may want to look into debt consolidation or see if you qualify for any loan modification options, such as an income-based repayment plan.

Rent Payments

While there are some landlords and services that will report your rent payment history to the major credit bureaus, it may not be the most efficient way for you to establish a credit score – though it has become more common in recent years. Your landlord can report your payment history, or you can enlist a rent reporting service to do it.

However, once it’s on your credit report, your on-time payments may not be reflected in your credit score. That’s because not every credit scoring model factors in rent payment history.

Within the FICO^® scoring model, there are several different versions. FICO^® Score 8, the most widely used version, doesn’t factor in rent. The most newly released version, FICO^® Score 9, does factor rent history into your score, but creditors have been slow to adapt it.

VantageScore^® also allows rent to factor into your score. As these newer scoring models become more popular, more people who are new to credit will be able to establish credit through less traditional routes.

It can take a while to build up to an excellent score, especially when it comes to the “length of credit history” aspect. That means even though you may have established your credit history, building strong financial habits is what will increase or maintain your credit score. To get started out on the right foot, here are some responsible credit-building tips and strategies you may want to keep in mind.

Report Your Current Bills

If you already make on-time payments for your regular bills, then finding a way to report those can be a good option. For example, your rent, utility, and cell phone bills could provide an outstanding record of on-time payments. 

Check into services like Rental Kharma and RentTrack to see if it is worth it to put these bills on your credit report. It could help to accelerate your progress toward an excellent credit score. 

Make On-Time Payments

If you already have some debts, such as student loans, then make sure to stay on top of your bills. It should be a priority to make on-time payments in full every single month. If possible, you should work toward eliminating your debts. As you pay the down, your credit score could reflect a marked improvement. 

Monitor Your Credit

As you build your credit, it’s important to monitor it along the way. If you catch any problems on your credit report, you’ll have a better chance of fixing them if you address them right away. 

It won’t hurt your credit score to check your reports on a regular basis. In fact, it could lead to a higher score if you’re able to catch a mistake early. 

Rocket Homes^SM provides a free look at your credit score, plus access to your TransUnion credit report. Take advantage of this free tool. 

Keep Your Utilization Low

It can be tempting to whip out your credit card for every purchase you make. However, it’s best to strategize your purchases so you keep your utilization rate as low as you can.

When you’re first starting out, you’ll likely have a relatively low credit limit. This means you have to be even more careful about what you put on the card, as even smaller purchases can push your utilization rate past the recommended 30%. To avoid this, you might consider using your card for only small, regular purchases such as the monthly payment for your favorite video streaming service.

Keep in mind, though, that not using the card at all won’t do anything for you. It may even lead to the card being cancelled, which can negatively impact your score if you’ve had the account open for a significant amount of time.

As you build your credit, your credit card company may offer you a higher credit limit. This can also help you keep your utilization low, as long as you keep your usage the same.

As you start to build credit, don’t be discouraged if your score doesn’t respond overnight. It will take some time to build a credit history and a good credit score. 

In fact, you should not expect to see results for several months. The three major credit bureaus -- Experian, Equifax, and TransUnion -- all calculate your credit score after collecting 3 to 6 months’ worth of credit activity. 

Of course, you’ll want to see an immediate improvement to your credit score. But is important to stay the course even if you aren’t seeing dramatic results. 

Although building credit takes some time, it’s better to start sooner rather than later. If you are starting from scratch, then it’s important to take action as soon as possible. Many of your long term financial goals, like buying a home, are tied to a great credit score. With that, you shouldn’t put off starting the process.

Check out RocketHQ Learning Center to find out more about improving your credit score today.