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Are you looking for quick and easy ways to build credit? Before you get started, you should understand how a credit score works and the things you can do to watch it. Whether you’ve never had a credit card before, or you have a long history of credit use, these tips are for you.
What is a credit score?
A credit score is a number that represents your creditworthiness. A lender can look at this number and get a pretty good idea of the likelihood that you’ll repay a loan on time. The lower the score, the more risk the lender assumes. A better score is based on responsible credit use and tells a lender that they may be able to take a chance on lending you money.
A credit score is based on five main factors:
● On-time payments. A consistent, strong payment history is a big plus.
● Credit utilization. The amount of credit used compared to your total credit limits.
● Credit history. As your credit ages, your credit score can improve in turn.
● Credit mix. Having a good blend of revolving credit (such as credit cards) and installment credit (like a student loan) can make the number better.
● Hard Inquiries. Each time a credit report is pulled, it can cause your score to dip.
Credit scores range from 300 to 850. Hitting the high end puts you in place to access affordable credit when you want it.
What are the different types of credit?
Having a good credit mix will help your score, but what does this mean exactly?Consider the following different types of credit accounts to reach a more desirable mix.
1. Revolving credit
Credit cards and bank lines of credit are the two most common examples of revolving credit. You’ll have a set credit limit that you can borrow against over and over. You won’t have to pay the whole thing off at once, either, just as long as you meet the minimum monthly payments.
2. Installment credit
Student loans, car loans, and mortgages are examples of installment credit. You have a set amount to borrow, and you agree to pay back a certain amount each month fora set period of time. You usually can’t borrow any more money until the balance of the loan is paid in full.
3. Charge cards
Similar in appearance to a credit card, these are most common in business. Employees may get charge cards to put expenses on, and employers must repay the full amount charged every month. There is no allowance for carrying balances over from month to month.
4. Service credit
Every time you get a service or product before you pay for it, you are using service credit. Rent, utility bills, and cell phone service all fall under this category. Failure to pay may cause your bill to end up in collections, where it can damage your credit score and cause financial headaches for years to come.
How credit scores work
Every action you take in relation to the above credit categories will be reported each month to the credit bureaus. They then use that data to create a credit score. The most common credit score is FICO, created by Experian, and it’s widely recognized as a way for lenders to see if you handle your finances well.
Why is a good credit score important?
A higher score makes borrowing cheaper and easier. It also grants you access to larger loans and credit cards, which can allow you to finance a car, home, or other large purchases. Having a low score doesn't mean you can't borrow. You'll pay more for the privilege, however, and your loan limits will be much smaller than someone with a better credit score.
How to build your credit score
Building credit is a catch-22. Those who need to build credit may not have it, and you can't build a score without it. Where do you start? Try these options, depending on your current access to credit.
How to build credit with a credit card
Even if you have a low credit score, you are more likely to be approved for one of these cards. They are designed for those who have never used credit, or for those with a poor track record.
● Secured credit cards. A secured card requires that you put down a cash deposit first, and you can then use the card up to the limit of your deposit. They work just like a regular credit card and because you are pre-funding your purchases, there is less risk to the lender.
● Store credit cards. You probably get asked to apply for these each time you shop at a major retailer. While these cards generally have higher interest rates and lower credit limits, they can help build your credit if used responsibly.
● Student credit cards. Banks that offer student credit cards understand the needs—and risks—of a young borrower. These cards may have attractive perks for college kids, but don’t expect these to have a high limit.
Once you have a card, building credit may be as easy as asking for a higher credit card limit. The amount of your total credit you are using directly affects your credit utilization, and the number you should aim to be below is 30%. Though most accounts won’t let you ask for a limit raise for at least six months after you open an account, if approved, having a higher limit can help you use a lower amount of your total credit, especially if keeping the same spending patterns. When doing so, your credit utilization number goes down – which can help your score go up.
