What Is “Building Credit”?

Have you heard people talking about how to build credit before? Building credit generally refers to any steps that you take to achieve a higher credit score. You need to know how to build credit when:

  • You’re just starting out and have no credit
  • You need to attain a higher score to qualify for financing at good interest rates
  • You’re rebuilding your credit score after a period of financial distress that damaged it

The process to start building credit in all these situations is largely the same. If you follow the steps that we outline below, you can get the score you want. Even better, you don’t necessarily need to shell out any money to do it.

The Best Ways To Build Credit

Having a strong credit score is the key to unlocking a world of financial stability and securing those sweet, low-interest rates on loans and credit cards. Whether you’re just starting out or looking to improve your credit score, Penny has got you covered with these seven surefire strategies to give your credit a boost and help you achieve financial freedom.

1. Start with a Secured Credit Card

If you’re new to credit or looking to rebuild your credit, a secured credit card is a fantastic place to start. By putting down a security deposit as collateral, you minimize the risk for lenders while demonstrating responsible credit usage.

2. Elevate Your Credit Score with a Credit-Builder Loan

Credit-builder loans are designed to help you improve your credit score. By borrowing a sum of money that’s held in a secured account until you’ve made all your payments, you show lenders that you’re a reliable borrower and give your credit score a nice little bump.

3. Get a Co-Signer

If you’re struggling to get approval for a loan or credit card, a co-signer with good credit can help. By vouching for you and agreeing to cover the debt if you can’t pay, they give lenders the confidence to extend credit your way.

4. Join the Credit Party as an Authorized User

Becoming an authorized user on someone else’s credit card can help you build your own credit history. By leveraging the primary cardholder’s stellar credit habits, you can give your credit score a nice boost.

5. Keep Your Credit Utilization Rate in Check

Your credit utilization rate is the ratio of your credit card balances to your credit limits. Keeping this rate below 30% demonstrates responsible credit use and can help your credit score climb.

6. Mix It Up

Having a diverse credit history that includes both installment loans (such as mortgages or auto loans) and revolving credit (such as credit cards) is attractive to lenders. A flavorful credit mix can help your credit score flourish over time.

7. Be Punctual

Making timely bill payments is crucial to building a strong credit history. Your payment history makes up a whopping 35% of your credit score, so it’s important to pay your bills on time and in full.

Bonus Ways to Earn Credit Without Taking Out Credit

Before you signup for a credit card or loan did you know that these actions also build credit?

Opening a checking account at your local bank

Lenders and creditors like to see that you have an established bank account. This can show them how you manage your money and pay other bills.

Having utilities in your name

It can be possible to have your utilities in your name without a credit history. Which can be a good way to build a credit score. These utilities can include electric, gas, telephone, water or cable.

Establish a residence and employment history

A job and residence history shows lenders your behaviors. It’s easier to determine your likelihood of responsibility with money. You can even ask that your landlord supply the credit agencies with a report of on-time rent payments.

Take Action Today and Achieve Financial Freedom

By following these tips, you’ll be on your way to a robust credit history and a world of improved financial opportunities. Don’t let a poor credit score hold you back any longer – start taking action today to achieve financial freedom.

Finding the Best Way to Build Credit for Your Situation

Situation How to Build Credit Effectively
You’re just starting out and have no credit Get a secured credit card first, then add new cards or small loans
You’ve don’t want to use credit cards Get small personal loans and in-store credit lines that you can afford to repay
You have bad credit following a period of financial hardship Repair your credit first, then get small loans or secured credit cards, based on your needs
You have bad credit and just completed a bankruptcy filing Repair your credit first, focus on paying debts that weren’t discharged (like student loans), then gradually add credit as you can afford it
You have bad credit following a foreclosure Focus on making all payments on the other loans and lines of credit you still have open; if you don’t have any, consider a small personal loan to help with rental transition costs.
You have a “weak” credit score because you stopped using credit for a period of time Review your reports to ensure all past negative items have expired and been removed correctly; then starting building credit as if you’re new to credit

Get professional help to clean up errors in your credit report.

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The 10 Worst Things You Can Do When Building Credit

As you figure out how to build credit in the quickest way possible, there are certain actions that you want to avoid . These actions either damage your score or break the law. Here’s what you need to know…

1:  Use a fake Social Security number to start a new profile

Some credit repair scammers tell you they have an instant quick-fix solution to getting away from bad credit. They tell you all you need to do is use a different Social Security number to start a fresh credit profile. This is very, very illegal. It amounts to Social Security fraud, which is a criminal offense that can even lead to jailtime.

If a credit repair company tells you to do this, run. Then report them to the FTC.

2: Use an Employer Identification Number (EIN) to start a new profile

A variation of the scam listed above is to start a new credit profile as a business. You use an Employer Identification Number (EIN) to start a new profile and apply for credit lines. You’re basically impersonating a business. This is also very, very illegal and can result in criminal prosecution for fraud.

Just to be clear, there is no legal, quick-fix solution to go from a 500 FICO score instantly to 800. It takes work and time to build credit. Don’t break the law trying to get there faster!

3: Miss a payment

As we mentioned above, the single biggest factor used to calculate your credit score is payment history. That makes missed payments incredibly bad when you want to build credit. One missed payment now can set you back significantly. And it’s much worse than having a few missed payments in the past.

The “weight” of negative credit items decreases over time. So, a missed payment last month has a bigger impact than a payment missed seven years ago. (Seven years is when missed payment penalties expire and drop off your report.)

So, it’s not like you can miss a payment and offset that damage with one positive payment. It will take many positive payment records to offset that one mistake. This is why you want to add credit slowly to ensure you can always keep up with the payments.

It’s important to note that a missed payment is any payment made more than 30 days late. A late payment that you pay within that billing cycle should not get reported to the credit bureaus. They only report missed payments at 30, 60, 90 and 120 days past due. Still, avoid paying late, since that leads to fees and penalties.

4: Max out credit cards

“Credit utilization” is the second biggest credit score factor. It measures how much debt you have versus your total available credit limit. So, if you have two credit lines at $500 each, your total credit limit is $1,000. If you have a $250 balance between the two cards, your utilization ratio is 25%.

Lower credit utilization is always better. Anything below 30% is considered “good” for this factor. However, lower is even better. And the idea that you must keep balances on your credit cards to have a good credit score is a myth. If you’re trying to figure out how to build credit the fastest, paying balances in-full actually provides the best utilization ratio possible.

By contrast, running up balances and maxing out your cards is bad for your credit. If your debt ever gets higher than 50% utilization, seek debt relief immediately.

5: Open too many credit lines at once

Always remember that a credit score is a number that measures your risk as a borrower. So, any actions that make you a high-risk borrower will lower you score. Taking on too many credit lines in a short period of time makes you a high risk because there’s a question of whether you’ll be able to afford the payments.

This is why you really want to only apply for one credit line at a time. Ideally, credit applications should be spaced out by about six months.

6: Close old accounts

“Credit age” is a smaller factor used to calculate your credit score, but it still counts. Basically, a longer time using credit makes you a lower risk because you’ve proven you can manage credit and debt long-term. So, old accounts that you’ve kept in good standing are good for your credit.

But this means that closing old accounts can actually hurt your credit score. Keep those accounts open and in good standing to avoid unintentionally damaging your score.

7: Let an account close due to inactivity

This relates to the previous subject. If you don’t use an account for a long time, the creditor may close it due to inactivity. This would have the same effect as closing the account yourself. It still decreases the “age” of your credit history.

With that in mind, you can’t just keep accounts open and not use them to build good credit. If you have an old account in good standing, find a modest use for the card. Choose something you can pay off in full every month. For instance, use it to cover groceries, gas or a recurring expense like tolls – something that’s in your regular budget that you need to cover anyway. That way, you can use the account and pay it off every month using the cash flow that would have covered that expense.

8: Let an unpaid medical bill go to collections

We specifically focus on medical bills, because if you’re keeping up with the payments on all your other debts, collections shouldn’t be an issue. However, gaps in insurance can often lead to out-of-pocket medical costs that you don’t know you owe. It happens pretty often. People think insurance covers an ER visit or other expense, but their insurance doesn’t all or part of it. The bill goes unpaid and ends up in collections. As a result, it ends up in your credit report.

Any collections account will be bad for your credit, so you want to avoid them overall. However, medical bills can be that thorn in your side that slips through and ruins all your hard work. Make sure to stay on top of medical costs and make sure they’re paid by your insurance. Otherwise, you can set yourself back significantly with this mistake.

9: Incur court fines or court-ordered payments

Collection accounts aren’t the only public record that can negatively affect your credit. Any debt you owe as a result of a court ruling will create a public record that appears in your credit report. This includes criminal or civil court fines, as well as things like unpaid alimony or child support.

This means you can’t ignore your civil obligations to focus solely on paying debts to build credit. In other words, don’t stop paying child support while you build credit! If you can’t afford both, either scale back your credit use or ask the court to adjust your payments.

10: Owe the IRS

Another way to incur debt that will appear on your credit report is to fail to pay your taxes. If you owe back taxes and the IRS places a lien on your property, this shows up in your credit report, too. In fact, an unpaid tax lien is the worst credit penalty you can possibly incur. It’s even worse than bankruptcy or foreclosure!

By law, penalties can only remain on your credit for a set period of time. Most penalties like missed payments and even foreclosure only stick around for seven years. Bankruptcy penalties remain for up to 10 years, although the credit bureaus remove Chapter 13 after seven. By contrast, federal law states that an unpaid tax lien can remain indefinitely. Some bureaus will remove the penalty after 15 years. But that’s still much longer than other negative actions.

So, don’t dodge the IRS because it will be bad for your finances and your credit.

One last note about how to build credit when you have defaulted federal student loans…

If you have federal student loans that slipped into default, they damage your credit just like other defaulted debt. However, repairing that damage is easier with federal loans. There’s a special exception for credit damage caused federal loans in default. If you make six consecutive payments on time on a defaulted federal loan, it becomes current. Even better, the credit damage and negative items caused by the default disappear. It’s basically like you never defaulted in the first place.

This special rule only applies to federal student loans. So, an easy additional way to boost your score if you have federal loans to repay is to focus on making the payments on those loans for six months. The loans become current, the negative items disappear from your report, and you can continue building credit from there.

It’s important to note that bringing your federal loans current using a Federal Direct Consolidation Loan does not have the same positive impact on your credit. Another special rule of bringing defaulted federal student loans current is that you can instantly bring them current through consolidation. But while this removes the defaulted status, it doesn’t remove all the missed payments from your credit report. So, the damage remains. Consider your options carefully and consult a student loan resolution specialist if you have defaulted loans.

Get professional help to clean up errors in your credit report.

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Article last modified on June 27, 2023. Published by Debt.com, LLC