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As with many items in life, with a little attention and care across time, better outcomes tend to appear.  One such example comes in the form of building good credit.  

This financial reputation affects many aspects of your life and feeds through to your bottom line through better financing terms on loans, access to jobs with employers who require credit checks, potential deposit waivers on your utility accounts, or even having more negotiating power for interest rates on new credit cards or loans.

No matter which stage of life you find yourself in, whether you attend college and carry student loans or you want to pay off a mortgage early as a mid-career professional, your choices affect your credit.  By making simple decisions like paying bills on time, living within your means, and maintaining responsible use of your available credit, you can take concrete steps toward building good credit. 

With this grounding, you might still wonder how it works.  For many, credit and credit scoring are shrouded in mystery, causing consternation for seemingly feeling out of their control. This post aims to help you understand the importance of building good credit, the most important factors impacting this effort, and how good credit can place you firmly on the path to financial independence.

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    What You Need to Know About Credit Reports and Credit Scores

    To understand how you can improve your credit score, you will first need to understand your credit report.  Fortunately, the U.S. government has mandated the three major credit bureaus (Experian, TransUnion and Equifax) each provide one free copy of your credit report per year at annualcreditreport.com. You have the option of ordering all three at once or individually as you prefer.

    How Often Should You Check Your Credit Report?

    Reviewing your credit report regularly makes sound financial sense.  It may make sense to space out your free annual credit reports throughout the year to identify any irregular or inaccurate information you find.  A handful of reasons for why you should periodically request your free annual credit reports:

    • First and foremost, the information contained in your reports can directly impact your ability to access credit and how much you will pay for borrowing money.
    • Second, ensuring the accuracy of the information becomes important before you wish to apply for a major loan on a home purchase, a new car, buying insurance, or even applying for a job.
    • Last, but certainly not least, protecting yourself against identity theft. This occurs when someone unlawfully acts as you by stealing your personal information — like your name, your Social Security number, or your credit card number — to commit fraud. Identity thieves can open new lines of credit in your name, rack up considerable debts and then never pay, leaving you on the hook. When these bills don’t get paid, the delinquent accounts show on your credit report, potentially affecting your credit score, and by extension, your ability to apply for credit, insurance, or even get work.

    → Free services like Credit Sesame offer free credit monitoring and even $50,000 in identity theft insurance.  Consider enrolling to monitor your credit at no cost and provide peace of mind.

    Once you download your free credit report produced by any of the agencies (don’t be alarmed if the scores or the information contained vary) you can see the numerous data points maintained on your credit history.  Such items include consumer loans, credit cards, mortgages and more you have now or have had in the past.  

    For each, you will see your important credit factors like your payment history, balances, as well as debt collection agency information if you have dealt with delinquent debts.  Review this information to understand what it means and then verify its accuracy. Should a mistake exist on one of your credit reports, you have the ability to dispute an error.

    Errors can have unintended consequences because your credit report determines so much of your access to financial resources.  Your reports contain pertinent information about where you live, how well and frequently you pay your bills, and whether you have ever been sued or arrested for a crime, or have filed for bankruptcy.  

    man disputing error on credit report

    In exchange for tracking this treasure trove of information about your past and present, credit reporting bureaus sell your history of financial decision-making to lenders, insurers and employers as a means for evaluating your current applications for credit, insurance, and employment, respectively.  

    Given the wide use of this centrally-tracked information, your credit has far reaching implications from landing a job to renting a home, applying for an auto loan, or even getting a cell phone plan.  Correcting any errors you see becomes vital should you have any major needs on your credit. Further, as a result of its importance, Congress passed the federal Fair Credit Reporting Act (FCRA) into law with the intent of promoting the accuracy and privacy of information contained in your credit reports.

    What is a Credit Score?

    The second item you will need to understand regarding your credit history involves your credit score, a numerical representation of your creditworthiness. Higher scores indicate better credit and can make you a prime borrower, whereas lower scores place you in the subprime borrower category.

    Numerous credit scoring models exist and lenders can pick and choose which one they use when evaluating your creditworthiness.  A common system lenders rely on for understanding the risk of lending to a potential borrower is the FICO Score system.  This model scores your financial decisions and weighs items such as how much existing credit you have and how timely you repay your outstanding debts.

    To earn scores in the higher brackets (i.e., more creditworthy) and land the best credit terms, you will need to build a solid credit profile.  This involves making timely payments, restricting how often and how much you rely on credit (low credit utilization), how long your accounts have been open, your mix of credit, among other items.

    For the remainder of this article, I will dig into some of these factors, starting with your credit mix.  Your diversity of accounts can have a strong impact on your credit score. Because of this, you will want a good combination of credit cards and loans on your credit report. 

    The following sections address some financial tips you can put to use to begin building your credit profile and increasing your credit score today.

    how to build good credit

    Credit Cards

    Credit cards represent one of the easiest and most commonly-used forms of credit.  These financial tools provide access to lines of credit for you to finance common consumer purchases instead of using your own money at the time of purchase.

    In most instances, credit cards represent an unsecured line of credit, meaning they do not have hard assets backing the balance you borrow when you make purchases.  The types of credit cards can vary with cards like co-branded retail store credit cards (e.g., a J. Crew credit card issued in partnership with Comenity Bank), rewards credit cards, cash back credit cards, and more.

    Applying to Different Types of Credit Cards

    For the purposes of credit scores, you will want a diverse mix of retail store and major credit cards. As a good place to start building excellent credit, you can begin by applying for a small specialty retail store card, and then proceed with another major retailer.

    Typically, these retailers offer incentives in the form of bonus points or added cash back for using their branded credit card at their store.  If you have a good control over your spending and know you will need to frequent certain stores, it may make sense to target stores where you can leverage the most benefits.

    After you have obtained some of these retailer credit cards, you can apply directly through your bank for a Visa or MasterCard credit card.  My first credit card came from MasterCard through my bank, CapitalOne. I still use my CapitalOne Quicksilver card to this day and only received approval for the card because I had an established relationship with the bank.

    However, if you have trouble receiving approval for a traditional, unsecured credit card, you may instead consider applying for a secured credit card.  This works by your bank or other credit card company extending you a line of credit based on your deposit balance secured by a savings account. 

    Because this method essentially has you borrow money from yourself, this represents the simplest method to qualify for a credit card. Further, it represents a step in the right direction for building good credit.  You should not have major difficulty finding a credit card company which specializes in offering secured Visa and MasterCard credit cards to aid you in establishing credit.

    However, if you have a desire to monetize your spending with well-suited rewards credit cards, you might consider checking out which cards best fit your spending patterns by using the credit card finder widget at the bottom of the post

    My wife and I put everything imaginable on our rewards credit cards because we earn cash back and rewards points for our spending. For these cards, you want to be mindful of your spending habits, self control, and any applicable fees and interest rates.  Have a look and see if any of them appeal for your unique circumstances.

    Authorized User Accounts

    If a family member (i.e., spouse, parents, siblings) already carry one of these retail or major credit cards, you might consider asking them to add you as an authorized user to their account.  The paperwork for this arrangement rarely requires filing a credit card application.

    However, be warned of an ongoing debate about the effectiveness of becoming an authorized user on someone else’s credit card.  Because the credit card sees you as someone added to the account with limited privileges, you might not receive the full impact as maintaining a card in good standing in your own name.  

    When you have a credit card as an authorized user, you have the ability to make purchases with the card and also to have all usage and payment activity show up on your credit report. The difference with an authorized user and having the account in your own name comes when you do not hold responsibility for making the payments.  

    authorized user account

    This component underpins a significant part of your credit score in scoring models.  Despite having an impeccable payment history on the account which lists you as an authorized user, because you do not hold responsibility, it likely has a lesser impact on your score.

    However, when you attempt to build credit, any little advantage like this could help.  Therefore, do not discount this avenue fully.

    Cosigned Loans

    Having a trusted, creditworthy person cosign a loan can help you receive better terms on an auto loan for a new or used vehicle. These loans pose lesser risk to the lender because the purchased vehicle secures the loan, meaning should you or the cosigner fail to make payments, the lender can simply repossess the car in satisfaction of the loan.

    For cosigned loans, the cosigner vouches for your credit and if you find yourself unable to pay, the lender can then demand payment from the cosigner.  

    As a short-term solution, cosigned loans can get you better terms than a high-credit-risk auto loan (i.e., subprime loan), and after establishing a demonstrable payment history, you will have the opportunity to refinance your auto loan to improve your credit standing further.

    Manage Your Credit the Smart Way

    A diverse mix of accounts underpins a major component of your credit score.  Combined with this, you will also need to make timely payments.  However, much more than simply having diverse credit lines and paying on time comes into play.

    A major metric many credit scoring models use looks at how much credit you use as a percentage of the total credit available to you.  This number, commonly referred to as the credit utilization ratio, shows many elements of your creditworthiness.  

    1. How much credit lenders extend to you
    2. How much you rely on it for your finances  

    Those who manage it well and do not run up significant balances demonstrate better credit tendencies in the eyes’ of creditors.  Many credit experts recommend keeping your credit utilization ratio under 30% on an ongoing basis, with even lower scores being optimal.  

    • Credit Utilization Ratio Example

    For example, if you have $10,000 in available credit, you will want to draw less than $3,000 on your accounts.  This would result in a 30% credit utilization score for credit scoring purposes.

    • Use The Credit You Have

    The second element for managing your credit utilization comes with actually using your available credit.  Also, you want to do this is a demonstrable way, meaning you do not immediately pay off your credit cards as you incur a balance.  This results in no balance showing to credit bureaus, therefore they assume you have not used your credit.

    To counteract this but also avoid making interest payments, elect to submit your payments closer to your due date.  This will ensure that any balance activity gets reported to the credit bureaus. 

    Further, even if you pay off your balance and do not regularly draw on the account (and don’t pay a costly annual fee), you should leave the credit card account open to maintain your available credit.  To avoid having your account closed, you may need to make small, regular purchases or the credit card company may opt to discontinue your account.

    buying a latte on a credit card

    How Do I Build and Keep a Good Credit Score?

    After having reviewed the various determinants of credit scores, one last item to stress with respect to building and keeping a good credit score: no secret formula exists but some guidelines can help get you there faster. Specifically, consider the following actions and repeat them regularly:

    • Pay your loans on time, every time. Consider setting automatic payments on your credit cards, loans, or other expenses.  A solid payment history represents a major determining factor for your credit score. At a minimum, consider setting up reminders so you do not forget to set payments to execute.
    • Don’t get close to your credit limit. Credit scoring models rely on assessing your overall credit utilization ratio as a means for measuring your prudent use of available credit.  This means if you hold 3 credit cards, each with $10,000 limits and you have $9,000 on one card, you are still only using 30% of your overall credit ($9,000 / $30,000 = 30%).  Avoid “maxing out” your credit limits as this signals credit risk to the credit bureaus. Further, do not fall victim to the belief you must carry a balance each month to build a good credit score.  Allow the balance to remain on the account during the pay period but make the decision to pay off the balance each month because this helps you to achieve the best scores.
    • A long credit history will help your score. Credit does not get built overnight.  Rather, demonstrating good credit habits over long periods of time builds credit best.  By showing a lengthy credit report with loans repaid steadily over time and on time, you will prove yourself as a good credit recipient.
    • Only apply for credit that you need.  Be judicious with the credit you apply for because credit scoring formulas assess the frequency with which you apply for lines of credit.  These inquiries signal a need for credit and can act as red flags if you accumulate too many in too short of a time. In some instances, rapidly applying for numerous lines of credit can appear to lenders that your economic circumstances have changed negatively. 
    • Fact-check your credit reports. Having a vigilant approach to fact-checking your credit reports will go a long way toward preventing identity theft and potential negative repercussions to your credit.  If you spot suspected errors when reviewing your credit reports, do not waste time and dispute them at once. Especially for older lines of credit you have not used in years, you will want to make sure those accounts have no transaction activity.  Services like Credit Karma and Credit Sesame will provide notifications of unusual activity on your credit reports and cost nothing to you.

    One Final Tip

    If you are new to building your credit, consider applying for specially-designed products meant to help you to establish and build credit. Several financial institutions have developed a multitude of products and services catering to these individuals.  For those who have more seasoned experience with handling credit cards and feel comfortable with their credit, consider applying for rewards credit cards using the tool below.

    Which Rewards Credit Is Best for You?

    About the Site Author and Blog

    In 2018, I was winding down a stint in investor relations and found myself newly equipped with a CPA, added insight on how investors behave in markets, and a load of free time.  My job routinely required extended work hours, complex assignments, and tight deadlines.  Seeking to maintain my momentum, I wanted to chase something ambitious.

    I chose to start this financial independence blog as my next step, recognizing both the challenge and opportunity.  I launched the site with encouragement from my wife as a means to lay out our financial independence journey and connect with and help others who share the same goal.

    Disclaimer

    I have not been compensated by any of the companies listed in this post at the time of this writing.  Any recommendations made by me are my own.  Should you choose to act on them, please see the disclaimer on my About Young and the Invested page.

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