How to Build Credit in 10 Easy Steps?

Now a days it’s extremely important to establish good credit. Forget about getting reasonable interest rates when you’re about to buy a home or a car. Before you can buy a house or a car, you’d need some cash flow through a job or your own business. At present you need good credit to even land a decent job or secure loans to start your business. After that you’ll need your excellent credit to rent an apartment, seal a cool deal on your cell phone and get decent rates on auto as well as health insurance (if your employer does not provide one or if you are self employed).

A small mistake on your part while using your credit card can be difficult to erase. As a result your credit rating can be damaged for years. And you’d end up paying high interest on your loans as well as every other purchase that uses credit score as a metric for pricing.

I am a young guy in my early twenties who is learning the intricacies of an increasingly complex adult world. So if you’re just starting out like me, congrats! You have a great opportunity ahead of you to build an excellent credit history by doing the right things from the start. Here’s what I’ve learnt about the dos and don’ts for building a solid credit history.

1. Order your credit report and check it diligently

Your credit score comprises of a 3 digit number that lenders use to measure your credit worthiness. These scores are created from the contents of your credit report. Three major bureaus namely TransUnion, Equifax and Experian prepare credit reports.

Ever wonder who takes a look at these credit reports? Your lenders, landlords, employers, insurers, utility companies, cell phone service providers and any other merchant who uses credit to gauge an applicant’s ability to pay. They will check your credit via a hard or soft pull. So a check of your credit report will give a firsthand glimpse of what lenders are saying about you.

I usually check my credit report twice a year. You can purchase an Equifax 3 in 1 Credit Report which contains a line by line comparison of your credit history with Equifax, TransUnion and Experian. When you so so save some dollars by using an Equifax Promo Code. Since the Federal Law entitles all U.S. citizens one free annual credit report from Experian, Equifax and Transunion, I get my second annual credit report from annualcreditreport.com.

2. Understand your credit score

To understand what factors contribute to your credit score, simply answer these two basic questions:

a. Do you pay your bills on time?

b. What percentage of your available credit do you actually use?

If your answer to the first question is yes then you’re well set on your way to stellar credit. For those of you who have a hard time keeping track of your bills, set up a simple online reminder system (I use Google Calendar) or set up automatic payments to make sure that your bill payments get in on time. The credit system is designed in a very tricky way. If you miss a single payment and get the “late payer” tag, your credit score could be damaged for a long time. Just so that you know, it takes seven years for the effects of any action that destroyed your credit score to be completely erased from your credit history.

To keep your credit score at the highest possible level, it’s best to keep your credit use to a conservative limit of 10% of your total credit. Worst come worst, you can go up to 30% of your total credit limit. But maxing out your credit limit is a big no no if you want an excellent credit score.

3. Boost your credit by opening bank accounts

When I was a teenager my father had helped me open a bank account. I continued with that account till I became an adult. Henceforth I opened a checking account at my school. Then I got introduced to online banking. There has been no stopping since then. I regularly check out bank bonuses and open accounts at various banks to maximize on banking deals.

The good news is that if you have bank accounts to your name, lenders see that as a sign of stability.

4. No need to carry a balance on your credit card

To have a good credit score don’t go with the myth that you need to carry a balance on your card every month. By experience I have found that paying your bill in full each month is the best way to build solid credit.

5. Borrow good credit

Please note that being added as an authorized user to a credit card will not help you build a credit history. For me the fastest way to a good credit score was piggybacking on my father’s excellent credit history. By being a joint account holder on his credit card account and having him cosign my student loans, I actually built my credit score by borrowing his good credit record. Since he had an excellent credit score, I was able to qualify for student loans at decent interest rates which I would not have otherwise gotten.

I have made it a point to pay my monthly payments on my student loan on time. So far have not missed one. This act shows off on my credit report as a “responsible borrower” which aids in boosting my credit score.

But there is a caveat here. If you default, not only will you suffer but your co-signer’s credit report will also show your delinquencies as well, thus affecting his credit.

If you want to be added as a joint account holder on someone’s credit card, make sure to check that the person whom you are planning to piggyback upon has good credit. Else you will become responsible for any debt on the joint card account. Plus it’s difficult to get your name removed. It gets worse if your joint card holder is an irresponsible person. Any late payments or other problems on his part could make it harder for you to get future credit. In such cases it’s best to establish your credit history without the help of a joint card holder or co-signer.

6. Apply for credit early, start at college

Several experts might have different opinions on this one. But I can vouch that getting a credit card (from Citibank) when I started college helped boost my credit score. It’s easy to get a credit card while you are at college since lenders know that if you cannot pay your balance your parents will help. Once you land a job the story is different. However I was careful when I signed up for my first credit card as a freshman. I made sure that the card did not have any annual fee, had a grace period for payments and low interest rates. Since I always pay my balance in full every month, interest rates really did not matter for me. But even then I wanted to be on the lower end just in case if I ever needed to borrow.

For the first couple of years at college I had only this one credit card. Though bankers and card companies set up booths (where they hand out freebies for signing up for a card) at our college at the start of every semester, I chose not to apply for any. Having too many cards could affect my credit score since I was just starting out.

7. Get secured credit if you can’t have a regular one

One of my friend’s application for regular credit card got denied. But he was keen on building his credit history while he was at college. So he went to one of the nearest local banks and signed up for a secured credit card. He had to deposit $500 and his credit limit was upto $500 i.e. his deposit. Since he got his secured credit card from Wells Fargo, a respected and trusted banker, he was in safe hands. He did not have to pay any fees – application or annual for his new secured card. The best part was that he converted his secured credit card to a regular one after 18 months of on time payments.

If you are thinking of applying for secured credit, please choose your card issuer carefully. Else you might get swamped with outrageous fees and high interest rates. Also make sure that your card issure reports to the credit bureaus, else you won’t build any credit history.

8. Store cards can come in handy

If you don’t have enough money to make a deposit and apply for a secured credit card, then it might make sense to get a store credit card. Several department stores like Sears, Macy, HomeDepot and likes offer varied lines of credit. The cool thing is that it’s easier to get approved for these cards. Choose store credit cards that use Visa or Mastercard as their issuers. That will help add some meat to your credit history. Usually credit card from stores that typically use finance companies rather than major banks to handle their credit card transactions don’t add much weight to your credit history. A couple of these type of these type of cards is enough to get your credit history started.

9. Installment loans help

I have observed that installment loans help boost credit scores. To test the concept, I took out a small loan from my local (university) bank and paid it off within 3 months. Since it had a 6 month interest free period, I did not have to pay any interest. But this loan showed up on my credit history. Since I paid it off much before the last installment was due my score got a boost. My lenders got the message that I am a responsible borrower.

So if you’ve been paying off your credit balances in full every month, keep an eye for interest free loans (limited time frames only). If you get one, borrow responsibly, pay it off sooner than needed and observe the boost in your credit score. Always make sure that the loans are of small amounts and the time frame of paying it off is short. Else you will be shelling out your hard earned cash in bank interests.

10. Rotate and regularly use your revolving credit accounts

It pays to remember that for your credit scores to be generated you need to have had credit for at least six months with at least one of your accounts updated in the past six months. To do so, I never use cash. I use my credit cards to pay for everything I consume. I rotate my cards and use them in turns to avoid inactivity on any one for a long time. If you get a credit card and never use it, your account may be cancelled.

Well that’s it. Hope these tips will help you build an excellent credit history. Before you leave, please note that if you’re planning to order a credit report from Equifax, use an equifax promotion code. It helped me save 5 bucks.

If you have any more tips for building credit, please leave a comment. I really appreciate it!

Image Credit: Damon Duncan via Flickr