Why do you need to build a credit history?
Banks don’t just give loans out to anyone who asks for them. They have a number of factors they can look at to determine if you’re trustworthy enough to extend a line of credit. Credit score is the big one. Your credit score is the figure that indicates your relative trust and responsibility with debt, which is based largely on your history with it. With no history, it’s hard for banks and credit card companies to determine if you’re good about paying back what you borrowed. Building a credit history gives banks a way to gauge whether or not extending credit to you is a safe bet. The longer and better your history with debt, the better your credit score.
But how do you get started? While it’s becoming harder and harder for young people to build a credit history, it’s not impossible. We’ve outlined a step-by-step process of how to start and build your credit history so you can improve your credit score and empower yourself to reap the benefits that it carries.
Start a checking & Savings account
Starting either (or both) won’t necessarily directly help improve your credit score, but they’re essential tools for managing your money and the first step to understanding personal financial responsibility. If used properly, these tools can act as the building blocks for getting started with establishing a positive credit history.
More than that, building a trusted relationship with a bank can put you on the fast track to being approved for credit & loans (without much of a credit history) through the bank that can easily verify your ability to pay it back.
Maintain a decent balance – In order to build trust with your bank, they need to see that you aren’t living paycheck to paycheck. Regardless if there is a minimum balance or not, try to keep a relatively decent amount in your accounts. Not only will this build trust, but it will get you into a good habit of being more financially secure.
Start saving now – Use your savings account to build savings. Start getting yourself into the habit of always putting a little money aside from each paycheck, etc. It’s not only a good habit for your own personal finances (that can help you avoid the need for credit), but the money you save can be used as collateral to apply for a line of credit to get your credit history started. For example: secured credit cards (see below).
Using Credit Cards to build a credit history
One of the easiest ways to build credit is with credit cards. But before you dive right in, you need to first understand how to use them responsibly, particularly if your goal is to improve your credit score. Here are some simple rules:
Start modestly – Start off slowly. Get yourself into the habit of paying your credit card bill monthly before using your card for a wider variety of expenses. Start with things like groceries, gas, and things you usually pay cash for.
Pay the entire balance each month – This is the key to making the most of credit cards. Interest rates can be high, especially for those just starting to build a credit history. Avoid paying interest or using a credit card can become very expensive. This takes both discipline and oversight of your finances. And if you can’t do this, you’re probably better off without a credit card.
Use your card regularly – There’s a common misconception that you must leave a balance on your card (and pay interest) in order to build credit. This simply isn’t true. You do, however, need to continue to use your card regularly in order to build your history. So use the card as regularly as you can, even to pay monthly bills you’d pay cash for anyways, for example. But continue to pay the balance off in full every month to avoid paying interest.
Never exceed your budget – In other words: don’t buy anything you won’t be able to pay for at the end of the month. In fact, at first, only use it if the money is already in your bank accounts. That way you’ll never have to leave a balance and pay interest.
Your first credit card
For better or worse, getting a credit card today isn’t as easy as it used to be. If you’re under 21, you either need a parent’s signature or some sort of financial collateral. Certain restrictions extend to adults, too. Such restrictions make it extremely difficult (especially for young people) to start building a line of credit on their own. But all is not lost. There are a few options:
Secured credit cards – A secured credit card requires a cash deposit which will serve as your “credit” limit. If you can’t pay off the balance from purchases, your deposit is used to pay it off. While it’s not exactly “credit” in the traditional sense, these cards can be useful for starters looking to get into good habits and build a credit history.
Shared accounts – Instead of trying to convince parents to sign off on a credit card for you, it might a better option to have a shared account. That way, they can help you manage your credit card usage and payments. This option shouldn’t be taken lightly, while proper use will help build credit history for both parties, improper use can hurt both.
Subprime credit cards – this type of card should be your last resort because they usually carry outrageously high interest rates and late penalties. If you pay off your balance each month they can be useful tools to build credit until you qualify for a lower interest card, but tread carefully.
Other cards – Gas cards and store specific credit cards can also help build credit and are sometimes easier to come by for new users. However, some cards that require you to pay the balance in full won’t build a credit history. Make sure you’re getting a card with a “revolving account”.