Credit is determined by a numerical score between 300-850 that identifies your financial ability to repay borrowed money. Poor credit can limit financial opportunities and make borrowing money more costly. That’s why it is so important to build your credit score. With a better credit score, you can receive a lower loan interest rate, receive a higher loan amount, or find better insurance premiums.
For those starting with no credit history, securing a loan or credit card can be tricky. Here are five steps to help you establish and enhance your credit score:
Start with a Secured Credit Card
If you are building credit from scratch, a secured credit card is often the first step. Secured credit cards are a type of credit card that can help people with limited or poor credit histories establish or rebuild their credit. They work differently from traditional unsecured credit cards, as they require a security deposit to open the account. This deposit acts as collateral for the credit line. The amount of the deposit typically determines your credit limit. For example, if you deposit $500, your credit limit will likely be around $500.
Once approved for a secured credit card, you can use it like any other credit card. You can make purchases, pay bills, and carry a balance from one month to the next.
It’s important to use the card responsibly and make timely payments to build a positive credit history. With responsible use, some secured card issuers may offer you the opportunity to graduate to an unsecured card. This typically involves returning your security deposit, and the issuer may increase your credit limit.
Secured credit cards often come with annual fees and higher interest rates compared to unsecured cards. It’s important to read and understand the terms and conditions of the card, including the interest rates and fees associated with it.
Consider Credit-Builder Loans and Secured Loans
A credit-builder loan is designed specifically for building credit. Applying for a credit-builder loan is easier than traditional loans since the borrower is essentially borrowing their own money. The funds borrowed are held in a savings account or CD by the lender, and the borrower makes regular payments. The loan amount is usually small, ranging from $300-$1,000. After completing the loan term and making all payments on time, the borrower gains access to the funds initially held in the savings account or CD. Credit-builder loans are typically offered by credit unions or community banks, as well as some online platforms.
You may also opt for a secured loan backed by collateral such as funds in your bank account or a CD. The collateral serves as security for the lender in case the borrower defaults on the loan. Although the interest rates associated with these loans may exceed the returns on these accounts, they typically remain more favorable than various other credit-building alternatives.
Find a Co-Signer or Tap into a Friend’s Good Credit
If you have a limited or poor credit history, it can be challenging to qualify for credit on your own. Lenders often use your credit history as a key factor in determining your creditworthiness. If you don’t have a credit history, they may view you as a higher-risk borrower. Co-signing or leveraging a friend’s good credit can help you qualify for credit you might not otherwise be eligible for.
Consider asking a trusted family member or partner to be a co-signer or to add you as an authorized user on their credit card. This action transfers the card’s payment history to your credit report, particularly beneficial if the primary cardholder has a long track record of on-time payments. You don’t need to use the card; simply being an authorized user can expedite your credit-building journey.
When someone co-signs or allows you to share their credit, it can also be an opportunity to learn responsible financial management. You can work together to set a budget, track expenses, and ensure that payments are made on time, which can be valuable for your financial education. When tapping into your friend’s good credit, do it with care, responsibility, and a clear understanding of the associated risks and obligations. It’s also important to maintain open and transparent communication with the friend who is helping you.
Create Healthy Credit Habits
Building a strong credit score takes time and a history of responsible financial behavior. Here are some tips:1
- Always make payments on time, or before your bill is due, paying at least the minimum amount.
- Keep your credit utilization low, ideally below 30% of your credit limit.
- Avoid applying for multiple credit accounts in a short period, as it can temporarily lower your score. Research the best credit cards for your needs before applying and only apply for a new card when needed.
- Maintain open credit card accounts, as closing them can negatively affect your credit utilization and average account age.
- Monitor your credit by checking your credit reports from the three major credit bureaus (Equifax, Experian, and TransUnion). You’re entitled to a free annual report from each bureau through AnnualCreditReport.com.
Building credit is a gradual process that takes time to establish. With patience, discipline, and the right tools, you can establish a strong credit history, opening doors to better financial opportunities in the future.
By following these steps, your credit score can guide you toward a brighter and more prosperous financial path.