Whether you’re in the market for getting a car or applying for a mortgage, you’ll need to build your credit and have a solid credit score to get approved with a low-interest rate. Even if you’re just looking for a new job or apartment, having a thin credit profile — meaning you don’t have enough credit history to generate a credit score — can prevent you from beating out other applicants.
Credit scores are also used when you need to borrow money by more than banks. A bad credit score can cause insurance companies, cell phone providers, and other businesses to charge you higher rates or additional fees. Building a good credit score can be challenging, especially if you’re just starting or your credit history is minimal. Unfortunately, many of our customers will face this issue when they move abroad to pursue new opportunities in another country and need to establish themselves.
However, there are ways you can build a great credit history from scratch. While it can take time, your efforts will showcase to future lenders, landlords, and employers that you’re not a risk. First, it’s important to educate yourself on everything that goes into a credit score.
What is credit?
Credit is borrowed money that you pay back, usually with interest added. If you need to make a large purchase and don’t have enough cash on hand, credit can help you achieve your goal and pay off the purchase over time.
There are two types of credit: installment credit and revolving credit.
Installment credit comes in the form of a loan with a set monthly payment and repayment period. Most loans, including mortgages, auto loans, student loans, and personal loans, are a form of installment credit.
Revolving credit allows you to use a credit line up to a certain limit, pay it off, and use it again. There’s typically a minimum monthly payment, but no set repayment term. Credit cards, home equity lines of credit, and personal lines of credit are forms of revolving credit.
As you use installment or revolving credit regularly and responsibly, you establish a credit history, which is recorded on your credit reports. Your credit score is a numerical representation of that history and gives potential creditors a snapshot of how responsible you are with credit.
The difference between credit scores and credit reports
You typically have one credit report from each of the three national credit bureaus: Experian, Equifax, and TransUnion.
When you take out a loan or use a credit card, the creditor typically reports your account activity to each of the three credit bureaus, who then organize that information on your credit report.
Credit scoring companies, including FICO and VantageScore, use complicated scoring models using the information on your credit reports and give you a credit score based on that information.
Both the FICO and VantageScore credit scores range from 300 to 850. However, the FICO score is used by 90% of the top lenders in the U.S., so it’s generally the one you want to know.
That said, the VantageScore, which is used by many free credit monitoring services, uses the same factors as the FICO score in its calculations. As a result, the two scores are often similar.
As a recap, your credit reports show your actual credit history, while your credit score is a representation of the information found on each report.
What is a good credit score?
When you apply for a loan or a credit card, you’ll often notice that a lender shows a range of interest rates. This means that the rate you get is dependent on your creditworthiness, which includes how good your credit score is.
Depending on where you look, you’ll see different credit score ranges. That’s because different lenders have various interpretations of what they view as good credit.
According to FICO, here’s a good idea of what you can expect the ranges to look like:
- Exceptional: 800 to 850
- Very good: 740 to 799
- Good: 670 to 739
- Fair: 580 to 669
- Poor: 300 to 579
For what it’s worth, the average FICO credit score in the U.S. is 700.
How is a credit score calculated?
Your credit score is calculated based on five factors, with some carrying more weight than others. VantageScore and FICO weigh factors differently, but both of them consider the following.
1. Your payment history
Your payment history makes up 35% of your FICO credit score, making it the most influential factor in your credit history. Essentially, it’s a measure of whether you’ve made your payments on time.
If you always make payments on time, your credit score will reflect that positively. But if you make late payments or allow your accounts to become delinquent, your payment history and credit score will suffer.
2. How much you owe
If you want to borrow money down the road but are already saddled with a lot of debt, lenders may balk at the request.
The same goes if you carry a high balance on one or more of your credit cards. In fact, there’s a ratio — called the credit utilization ratio — that credit scoring models use to determine whether your credit card balance is too high.
Your credit utilization is simply your balance divided by your credit limit. So, if you have a $2,000 balance on a credit card with a $5,000 limit, your credit utilization ratio is 40%.
To improve your credit, it’s best to keep your credit utilization ratio as low as possible, preferably in the single digits. This can be hard at first if you have a low credit limit, but over time it will become easier when you qualify for better credit cards with higher limits.
This factor makes up 30% of your FICO credit score.
3. Length of credit history
This is essentially a measure of how long you’ve been using credit. Since you’re just starting out, it will take time and patience to build this part up. But the good news is that it makes up only 15% of your FICO credit score, so it’s not going to make or break your credit.
In addition to considering your oldest credit account, another figure credit scoring models use to calculate your length of credit history is through your average age of accounts. For example, if you open a new credit card account today, your average age of accounts is one month.
Over time, however, that average will grow. Then once you apply for another card or a loan, the average will include the age of both accounts, making it go down.
As a result, it’s best to avoid opening new credit accounts unless necessary. Otherwise, it could drive down your average age of accounts and potentially hurt your credit score.
4. Credit mix
Lenders like to see that you can manage multiple types of credit. For example, having a credit card, an auto loan, and a mortgage is better than having just one of those.
This factor only makes up 10% of your FICO credit score, however, so don’t go out and get multiple loans just for the sake of boosting your credit score. It’s best to work on this one over time as you naturally need different types of loans.
5. New credit
This factor tells lenders how often you’ve applied for credit recently and is based on how many hard inquiries your credit reports have. A hard inquiry occurs when you apply for credit, and a lender checks your score.
That means that checking your own credit score or having a landlord or employer check won’t negatively impact your credit score. The same goes if a lender checks your credit to send you a pre-approval offer. These types of inquiries are called soft inquiries. Hard inquiries stay on your credit report for 24 months, and their impact makes up 10% of your FICO credit score.
5 ways to build an exceptional credit history
Now that you know what goes into your credit score, it’s easier to know what you need to do to take the next step and establish good credit habits. Here are a few things you can do now to achieve that goal.
1. Get access to credit
It’s not easy getting approved for a credit account without a credit history, but it’s not impossible. Here are a few options to consider:
Student credit cards: If you’re a college student, a student credit card is a great way to start building credit. These cards are unsecured, which means you don’t need a security deposit to get approved. Also, some offer rewards every time you use the card.
Secured credit cards: If you’re not a college student or you can’t get approved for a student credit card, a secured credit card is a solid alternative. The main drawback to these credit cards is that they require a security deposit — typically equal to your credit limit — to get approved. Otherwise, they function the same as regular credit cards.
Authorized user status: If you’re looking to build credit quickly or you don’t want a credit card of your own, consider asking a trusted family member to add you as an authorized user one of their credit cards.
As an authorized user, you’ll get a card attached to the account, and the entire account history will be added to your credit report. At the same time, though, you won’t be legally liable to make payments. This is only a good idea if your family member has a perfect payment history on the account and keeps their balance relatively low.
Credit-builder loan: If you want to avoid credit cards altogether, some lenders offer what’s called a credit-builder loan to help you establish a credit history. The difference between this type of loan and, say, a personal or auto loan, is that you don’t get any money when the loan is approved.
Instead, the lender will place the loan funds in a savings account or certificate of deposit. Then once you’re finished making payments with interest, you’ll receive the loan amount.
As a side note, it’s important to keep in mind that rent and utility payments do not typically help you improve your credit. If you stop making them, however, your landlord or utility company could send your account to collections, which will damage your credit score.
2. Make payments on time every time
If you choose to get a credit card or a credit-builder loan, it’s imperative that you make on-time payments every month.
To make things easier, consider setting up automatic payments to come out of your checking account. Then you don’t need to remember to make the payment each month. The only caveat is that you’ll need to make sure there’s always enough cash in your checking account to avoid a returned payment.
And if you have a credit card, make it a goal to pay your balance in full each month by the due date instead of just the minimum payment. That way, you can build credit without ever having to pay interest.
3. Keep credit card balances low
If you decide to get a credit card, use it responsibly but sparingly to start. You’ll typically have a low credit limit — possibly just a few hundred dollars — so you’ll want to keep your credit utilization at a reasonable level.
Over time, however, you can request a credit line increase or get approved for a credit card that offers a higher limit.
4. Get access to your credit score
As you’re working to build your credit, knowing where you stand is crucial. If you have a credit card, the card issuer may offer free access to your FICO credit score. If not, you can get that access from Discover Credit Scorecard.
Alternatively, you can get access to your VantageScore through free sites like Credit Karma and Credit Sesame.
Once you have access, you can track your score over time. These services also typically show you if anything is hurting your score and how to address it.
Also, keep in mind that these credit monitoring services might not have a credit score for you yet. Once you’ve used credit for a few months, though, check back.
5. Be patient
There’s no way to establish an exceptional credit history overnight. Even if you get a few different credit accounts to start building credit, it will take time to develop the right behaviors and prove that you’re consistently a responsible credit user.
As you follow these steps, you’ll start developing a good credit history and setting yourself up for lower interest rates and better chances of getting your dream house, apartment, or job in the future.