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Trying to get credit for the first time can feel like you're going in circles. Without a credit history, it's difficult to get credit; but without credit, you can't build a credit history. How do you get out of this loop? Fortunately, there are a couple of solutions.
You can start responsibly building up credit in several ways, including by getting a secured credit card or becoming an authorized user on a family member's credit card. Regardless of what you do to establish credit, your credit score will see the biggest improvement if you make each and every bill payment on time. Keep reading to learn how to establish credit for the first time and build a credit history you can be proud of.
Understand How Credit Works
Your credit report is a record of how you've managed your debts. Do you make payments on time or are you always late? Are your credit cards nearly maxed out? Have you missed a student loan payment? All of this information is available in your credit report.
Banks, credit card companies and other companies you do business with report your payment history to one or more of the three major credit bureaus (Experian, TransUnion and Equifax). That information goes into your credit report. Based on the information in your credit report, a three-digit credit score is generated. There are several different credit scoring models, and each one calculates your score in a slightly different way, but no matter what model is used, the credit score represents how creditworthy you appear to lenders.
When you apply for a credit card, loan or other form of credit, the creditor will check your credit report and pull your credit score. The higher your credit score, the more confident creditors will be that you can pay them back. If you have a poor credit score, however, you may be denied credit or offered credit on more onerous terms, such as a higher interest rate.
Open a Secured Card
Opening a secured credit card is a good way for first-timers to build credit. As the name implies, this type of card is "secured" by a refundable security deposit. If you don't pay your bill, the card issuer can use your security deposit to cover it. The amount of your security deposit typically determines your credit limit. You may be able to get a secured credit card with a deposit as low as $200; some cards let you deposit more money if you want a higher credit limit.
Before applying for a secured credit card, make sure that the card issuer reports your payment history to the three major credit reporting agencies. Otherwise, using that card won't help you build a credit history. Also, clarify any additional fees the card charges as these extra fees can reduce your credit limit. Finally, be sure you know exactly what your credit limit will be so you don't accidentally go over it.
Once you receive your secured credit card, use it to make small purchases every month and be sure to pay the bill on time. This helps establish that you can handle credit wisely. Remember that even one late payment can hurt the credit score that you're trying so hard to establish. To ensure you never miss a payment date, it's a good idea to set up automatic payments for at least the minimum amount due each month.
Become an Authorized User
If you have family members who are responsible credit users with good credit scores, getting added to one of their credit card accounts is a good way to start building credit. Some parents choose to add their teenage or college age children as an authorized user on their credit cards to give them a head start before they can get a card of their own.
To get the most benefit from being an authorized user, see if you can be added to an account that has been open for a long time, that the primary cardholder always pays on time, and that has a low credit utilization ratio (meaning less than 30% of the total available credit on the card is being used).
Once you're an authorized user, you can make purchases on the card, and the account will appear on your credit report. You'll benefit from the good credit history the primary cardholder has already built up with that card. However, it works the other way too: If the primary cardholder is late with a payment, the account could be dropped from your credit file, which will negate any positive effect it was providing.
Being an authorized user is sort of like training wheels for having your own credit card. The primary cardholder is ultimately responsible for all charges on the card. However, you should always strive to pay for your own charges; this will help you develop good credit and budgeting habits (and stay in good standing with the primary user).
Always Make Payments on Time
Once you have a credit card, make sure to pay your bill on time every month. Your payment history is the single most important factor in your credit score, accounting for 35% of your FICO® Score☉ (the credit scoring model most lenders use).
Keeping your credit utilization ratio low is another way to build good credit. This ratio refers to the percentage of your available credit you're using. If your credit card has a limit of $200 and you're carrying a balance of $100, you're using 50% of your available credit. Maintaining a credit utilization ratio below 30% of your credit limit (or better yet, below 10%) will help to boost your credit score. Paying your balance in full each month helps too—and will also prevent you from accruing interest on your purchases.
Do you have any outstanding student loans? Paying those bills on time can help improve your credit score. Student loans are installment credit, while credit cards are revolving credit. Having a mix of both types of credit helps to increase your credit score. Finally, if you pay your own cellphone bills or utility bills, consider signing up for Experian Boost®ø, a free service that adds on-time payments for those services and more to your credit report, potentially helping improve your FICO® Score.
Keep Track of Your Credit Score and Report
When you kick off a fitness regimen, you probably weigh and measure yourself as you go to track your progress. As you begin to build credit, you should check your credit reports and scores periodically to see how your efforts are paying off.
Get a free credit report and review it regularly to make sure it accurately reflects your credit accounts. You can get a free credit report through Experian anytime (it updates every 30 days). And you can get a free credit report from all three major credit bureaus every 12 months through AnnualCreditReport.com.
You'll need to have a credit account for six months before your FICO® Score can be generated, although some credit scoring models will generate a score earlier. After six months, check your credit score to see how it's doing, and continue checking it regularly to see your progress as you build a credit history. You may be new to credit now, staying on top of your credit score will always be a smart idea.