Getting an early start on building credit is essential, especially if you plan to take out a loan as a young adult. Trying to buy a house with no credit history is a nearly impossible task. Better yet, the difference between an ok and an excellent credit score can save you money - hundreds or thousands of dollars over the life of a loan.
Instead of waiting until you need credit, think about preparing for the future now. Here are five easy ways to build your credit in early adulthood and avoid some common problems later in life.
Start With Just One Credit Card
The simplest way to work on your credit as a young adult is to open a single credit account and use it responsibly. Credit cards influence every aspect of your credit score, making them an important tool for building credit. They’re also more accessible than other types of loans since you don’t have to buy anything specific or go into debt to benefit.
While you might be tempted to apply for several credit cards to establish more accounts right away, this isn’t the best strategy. Opening multiple new accounts at once can actually harm your credit rating. Plus, if you have no credit history, you’re more likely to get rejected for multiple cards.
If you already have several credit cards open, consider keeping only one or two cards in your wallet and in active use at any one time. This will make managing credit much easier and will reduce the risk that you’ll miss a payment or end up in debt because you’ve lost track of your spending.
If you’re not able to get approval for a standard credit card due to a lack of credit history, try searching for a secured credit card. You’ll need to put up a deposit, but you’ll typically still be able to make monthly payments and do all the normal things a credit card user can do to build credit. Just make sure choose a card that isn’t packed with fees and that you card issuer reports your activity to the credit bureaus.
Use Credit Cards Responsibly
Having a credit card is the first step, but the impact of credit cards can go both ways. Use them wisely, and you’ll reap the benefits of great credit later. But if you’re not smart about how you handle your cards, you’ll do more harm than good.
To build on whatever credit you have, it’s crucial to play by the rules at all times. This means sticking to best practices for using and managing credit. To stay on the path to building good credit, you should:
- Pay bills on time, all the time. This may be the most important step of all. Your payment history accounts for about 35% of your FICO credit score, so a trail of late payments will do some serious damage. Make sure to set reminders to make payments, and keep in mind that paying the minimum is still better than not paying at all.
- Pay off balances. The amount of money you owe on credit comes in next with a 30% share of your credit score. Using most or all of the credit available to you is interpreted as an increased risk to lenders, thereby lowering your creditworthiness and your score. Keep balances low or completely pay them off to help your credit now and create good habits for the future.
- Be careful about opening and closing accounts. The rules aren’t always clear-cut, but opening too many accounts at once or closing accounts can negatively impact your credit. The standard advice is to apply for new accounts slowly and methodically and close other accounts only when it’s necessary.
Avoid Cosigning For Others
Cosigning for loans is a tricky case. Cosigning can actually have a positive effect on your credit when all goes to plan and a loan is paid off on time. The real problems lie with the damage done when there are late payments or a default and it’s out of your control.
When cosigning, you’re essentially taking equal responsibility in paying back that loan. If the main borrower can no longer pay, you’ll be on the hook for the balance as will your credit when anything goes wrong. Unless you’re actively monitoring payments for the account you’ve cosigned for, you may not know there’s a problem until it’s too late.
Unless there’s a really compelling reason to do so, avoid cosigning on any type of account or loan.
Use Credit Minimally
Anything you can do to limit the chances you’ll slip into credit card debt will be helpful in improving your credit. Using credit cards more frequently does not do anything to help your credit score.
If you’re not comfortable using credit, consider making just one small purchase a month on your card. As long as you pay your balance each month, you’ll keep your account active and in good standing and develop a credit history without the risk of slipping into debt from relying too heavily on credit cards.
Consider Diversity of Credit
A small but still important part of your credit is to diversify your credit. This accounts for roughly 10% of your credit score, so don’t rule it out completely. Although you don’t want to go out and apply for loans that you don’t need, keep it in mind as it might be something that’s holding you back from taking your credit to the next level.
Of course, other types of loans, including student loans, can have the same positive and negative impacts on your credit. As long as you follow the same good practices as with credit cards, you’ll be in fine shape.