What are some good ways to build credit?
Your credit rating or credit score is a way for companies to determine how much you are trusted to pay back your bills and debts. In other words, a credit score estimates the likelihood that an individual will default on paying back their credit on a service such as a credit card, loan, or mortgage. A higher score indicates that the individual is thought to be more reliable. A credit score has a value which ranges from 300 (a bad score) to 900 (a good score).
Typically the median score is about 750 with half the population having a better score and the other half having a lower score.
When you apply for a loan or a service which requires long-term payments, such as a mortgage, rent, or car payments then the company you are dealing with will often check your credit score. A better score will improve their chances of doing business with you. Or, for companies which want to business with virtually everyone (such as the electrical company), they may ask people with lower credit scores to make a deposit up front to make sure the company gets paid.
With all of this in mind, how do you build a better credit score? Since the score measures how much you are thought to be trusted with borrowed money and paying bills, the best way to improve your score is to pay your bills on time. You may also want to take out small amounts of credit and pay it back before the due date.
One of the most common approaches to doing this is to get a credit card with a low limit (say $1,000). Then buy common items such as groceries and fuel for your car using the credit card. At the end of the month pay off your credit card before the due date. This shows that you can borrow and pay back money successfully and on time.
While using a credit card and paying your bills on time are probably the best ways to improve your score, there are other factors which will adjust your credit score in small ways.
For example, if you apply for a bunch of loans in a short period of time it looks like you need money in a hurry and this can negatively affect your score. I also found out in my 20s, when I was moving frequently, that having several utility companies checking my credit score prior to hooking up electricity took a few points off my score. Moving around a lot and using different electrical companies made me look less stable.
Having credit options you are not using is beneficial as it shows self discipline and a lack of need for short-term money. For example, if your bank offers you a line of credit and you almost never use it, that shows you can be trusted to have access to (and not abuse) credit which, in turn, benefits your score.
Something I feel worth mentioning is many people worry about their credit score and how each action may affect it – being late on a single bill and applying for one new credit card are two common concerns. Don’t worry about single, specific actions or events. Building a credit score is a marathon, not a sprint. Your credit score will likely bob up and down over time and these little adjustments and shifts in your score aren’t important. What is important is the overall trend.
Your credit score might dip for a few months if you apply for a new line of credit, but then using your new line of credit responsibily will raise your score back above where it was. Missing one bill payment in three years might ding your score, but then keeping up with your bills for the next three years will get you higher than where you were before. Focus on the big picture when it comes to your credit. Pay your bills, use your credit card responsibly, and your score will gradually improve over time.
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