How to Build Credit the Smart Way

Being on top of your accounts and making smart decisions is key when it comes to improving your credit. Building your credit in a smart way can help you achieve your goals — better credit means a less worrisome financial future. Paying off any high credit card balances you have, checking your credit reports for errors and keeping an eye on your credit utilization rate are all key aspects of building and maintaining good credit. If you keep your debt low, your ratio of debt to your total credit limit will also stay low. Most importantly, you’ll want to focus a lot of energy on paying your bills on time every month. Here are some of the smartest ways to build credit.

How to Build Good Credit

First of all, if you don’t have credit, just know that any account you open will need to stay open for six months in order for you to have a credit score (the credit reporting agencies need six months to monitor and report your activity, too). Building history takes a while when you start from nothing, but the cards and loans we’ll discuss can help you jumpstart the process.

1. Apply for a credit card

Many credit cards for building credit, including secured cards, work well for establishing a solid score. Just choose a routine monthly expense, charge it on your credit card and pay the account in full each month. Payment history makes up 35% of your credit score, so making a series of on-time payments can really help your score.

A secured card is a good option for consumers with no or very little credit. After a year or so of on-time payments, you’ll build enough credit to qualify for an unsecured credit card. (You can go here to learn more about the best secured credit cards on the market.)

2. Apply for a credit builder loan

Believe it or not, there are loans out there designed specifically for people looking to build or rebuild their credit. (If you’re not sure where your credit stands, you can view your free credit report snapshot on Credit.com. Your credit scores are updated every 30 days, so you can check your progress as you work to build them up.)

An option for building credit the smart way is through a credit builder loan from a credit union. A credit builder loan is an installment loan with terms ranging from 6 to 18 months. Since credit builder loans are reported to one or more of the three national credit reporting agencies, on-time payments for the loan will build up your credit.

It’s a good idea to choose a credit builder loan that reports to the three credit reporting agencies — Equifax, Experian and TransUnion. That way, you’ll see proof of your on-time payments in credit reports from each of these companies.

With a credit builder loan, a lender places the money being borrowed into a savings account on your behalf and you pay off the loan through a series of monthly payments. You get access to the money in the savings account when the loan is paid in full.

So with a credit builder loan, you build credit and you build up some (albeit very, very small) savings, too. Loan amounts for credit builder loans may be small, around $500, so you won’t need to struggle to make monthly loan payments.

Just be sure to make those payments on time each month. If you don’t, late or defaulted payments will show up on your credit report. Then you’ll end up hurting the credit you’ve been working so hard to build.

3. Become an authorized user

If you’re good at paying on time each month, consider becoming an authorized user on someone else’s unsecured credit card.

You’ll have much more room for spending compared to a secured card, and you’ll have access to this person’s good credit history. If the credit card issuer reports your activity as an authorized user to the credit reporting agencies, you’re golden. If not, all your efforts to pay on time (or have someone else pay your bills since you aren’t legally required to pay the balance as an authorized user) and “borrow” someone’s credit history are moot.

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How Long Does it Take to Build Credit?

Building good credit in a safe way takes time. Having said that, if you play all your credit cards right, you could establish a solid baseline card after 6 to 12 months of on-time payments. That’s pretty fast, all things considered, and your work doesn’t even have to stop there.

Here are some other steps you can take to build good credit in the long-term:

  1. Watch your credit utilization: It’s generally recommended that people keep their credit utilization rate below 10%, or at most at 30%, of their total credit limit(s).
  2. Add a mix of credit accounts over time. Credit scoring models reward you for being able to responsibly manage all types of credit. So, if you’ve mastered the credit card (a revolving line of credit), for example, your score could benefit from an installment loan, like an auto loan. That’s not to say you should go out and buy a car simply in the hopes of bolstering your credit. At the end of the day, you only want to take on financing you need and can actually afford. However, adding a mix of credit accounts organically over time can improve your credit standing.
  3. Limit credit inquiries. There’s another reason you don’t want to go out and apply for too much credit at once — all those financing applications will generate hard inquiries on your credit report, which can ding your scores and be viewed as a sign of risk when amassed. So be careful to limit and space out loan applications as you work to build your scores.
  4. Monitor your credit regularly. That’s how you’ll know how you’re doing and what you can work on to improve your scores. It’ll also help you keep an eye out for errors on your credit reports, which are more common than you think. (You can go here to learn how to dispute errors on your credit report.) Remember, you can pull your full credit reports for free each year at AnnualCreditReport.com.

There’s a lot to keep track of but with some strong focus and planning, you can stay on top of your finances and greatly improve your credit. After a year of paying your bills on time, potentially adding a new form of credit and removing any errors from your credit report, your credit could look vastly different. Know that obtaining a secured credit card or credit builder loan can also greatly increase your potential to build credit in a smart and relatively quick manner. Keeping your credit up is reassuring because you know that when the time comes to buy a house or car or take out a new loan, you’ll be an excellent candidate.

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