Build Credit the Right Way

Create Credit Without Going Into Debt

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Most people don’t think about their credit scores until either they’re applying for a loan or they have a credit problem – like being declined for a credit card or not getting an apartment.

That’s a mistake. Your credit reputation affects much more than just borrowing money… and it can have a huge impact on your path to financial security and freedom.

Building good credit puts you in a stronger financial position from the first time you borrow money – and yes, credit cards count as borrowing money – to the day you start using debt to your advantage. Caring for your credit score can lead to better financial habits, which will help you build your future fortune.

And that all starts long before you’re in a situation where you need to think about your credit.

Good Credit Can Save You Thousands of Dollars

There are lots of reasons to establish good credit, but the most important is saving money. With a positive credit history and a high credit score, you can save thousands of dollars every time you borrow money. That’s because higher credit scores get you lower interest rates on all kinds of debt.

Lower interest rates mean smaller, easier to manage loan payments… plus less of your money goes to the lender (whether that’s a mortgage provider or credit card issuer). That means you get to keep more of your own money.

But that’s just one benefit of a good credit score.

Your credit score affects other areas of your life as well including:

  • Getting a job
  • Renting an apartment
  • Getting life insurance
  • How much you pay for auto insurance
  • Whether or not you have to pay utility company deposits

What Goes Into Your Credit Score

When people talk about credit scores, they’re usually talking about FICO, the most commonly used credit scoring system in the US. The three major credit reporting bureaus – Equifax, Experian, and TransUnion (can you please link to the home page for each credit bureau please)– each put their own spin on your FICO score by mixing it with information they gather from your lenders to create a credit report. (I would go into a rant about credit bureaus but that really doesn’t belong here.)

Credit scores range from 300 to 850, and higher means better. Basically, scores higher than 700 are considered good, scores above 750 very good, and scores over 800 excellent.

Your score has 5 main components:

  1. Payment history (whether you pay your bills on time and in full)
  2. Credit utilization (how much you’ve borrowed compared to your available credit, the total amount you could borrow)
  3. Length of credit history (how long you’ve been borrowing)
  4. Credit mix (the different types of debt you have, like credit cards and student loans)
  5. New credit (how much new credit you’ve applied for recently based on new inquiries)

The first two – history and utilization – have the biggest impact on your score. So do your best to pay your bills on time all the time and keep your utilization under 30%.

You can learn more about credit score components in my book Debt 101.

Credit-Builder Helpers

It seems like you can’t win: You can’t establish credit without borrowing money, and you can’t borrow money without established credit.

Luckily, you have some options when it comes to building credit, no matter how old you are.

  • become an authorized user on someone else’s card, as long as they have good credit and the card issuer reports on all authorized users to the credit bureaus
  • get a student credit card
  • get a secured credit card, which works like a regular credit card with a prepaid cash safety net
  • get a loan with a cosigner (another person who guarantees that payments will be made) 

Opening and maintaining a bank account won’t directly impact your credit score, but it will help you build up a financial history – along with banking relationship.

You can also use alternative credit options. This new(ish) trend lets you establish credit without borrowing money and without using traditional banking. Instead, they use bills you’re already paying to help you build a credit history. Those bills include things like utilities, cell phones, rent, monthly childcare expenses, and insurance premium payments.

In order for these alternatives to help you build good credit, you have to make on-time payments every month by check and not with cash. Using a check provides a clear record of your payment history that lenders can use to verify your on-time payments. Copies of paid bills can also serve as evidence that you’re a good credit risk. You can have these alternatives added into your credit score through services like UltraFICO and Experian Boost.

Avoid Building DEBT While Building Credit

You don’t have to build up debt in order to establish credit. In fact, going into debt because you’re trying to build credit can end up having a negative effect on your finances.

A lot of people get in financial trouble by mistakenly thinking these steps will help improve their credit:

  • Buying things they can’t afford just to use their credit cards
  • Making minimum payments on credit cards in order to have a monthly payment
  • Opening multiple credit cards at once to increase available credit
  • Maxing out credit cards in order to get higher limits

You probably noticed that all of those have something in common: credit cards. Using credit cards without having the ability to pay them off immediately can get you into serious, long-lasted financial trouble. If using credit cards is part of your plan to build credit, make sure to borrow mindfully and stay within your regular budget.

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