How to build credit

The Credit Card Accountability Responsibility and Disclosure Act (CARD Act) of 2009 restricts anyone under the age of 21 from applying for an unsecured credit card, which means people between the ages of 18-20 have a difficult time building the credit they need to buy a home or car or to simply pay for living expenses.

The good news is that there are ways to build credit if you are one of the 25-50 million “invisible” citizens who are off the grid because you are under the age of 21, you are a recent immigrant to the United States or you have actively chosen to avoid building a credit history until now. It is also possible to build your credit score up if yours is low due to high credit card debt, defaulted loans or a history of late payments that have been sent to collection agencies. If you have bad credit because of inaccuracies on your credit report, a credit repair company can help dispute those inaccuracies and get your credit score raised.

Methodology: I put this guide together so that you can make educated choices about building your credit and your credit history. I consulted with renowned credit expert John Ulzheimer, The National Foundation for Credit Counseling’s Vice President of Public Relations and External Affairs Bruce McClary, and consumer credit expert and author of “The Debt Escape Plan,” Beverly Harzog. In addition, I read dozens of articles on the topic and reviewed federal laws regarding credit cards and credit reporting to find out the most effective ways to build credit from scratch as well as to learn the most effective ways to raise your credit score so you can get better interest rates and get out of debt.

Five fast ways to build credit

  1. Get a secured credit card: A secured credit card is similar to a normal credit card––you use it to buy things, and you incur interest when you don’t pay the full amount. The difference is that you need to put down a cash deposit on your secured credit card. The deposit is generally the same amount as your credit limit, and you’ll get it back in full when you close the account, provided you made your payments on time.

    To get the most out of your secured card, look for one that reports to all three credit bureaus so that your credit history will be documented. Once your credit history has reached a point where you can transition to an unsecured credit card, call your creditor to negotiate new terms.

  2. Become an authorized user: An authorized user can use a credit card account but isn’t the primary cardholder, giving them access to a credit card for purchases with the added bonus of building credit. If you become an authorized user, spend responsibly. You are not legally obligated to pay the bills as an authorized user, but charging more than the primary cardholder can afford to pay will put a dent in their credit and in yours.

    Parents can sign their children up as authorized users at any age, but they should feel that their children are responsible enough not to overspend and risk putting the whole family’s credit into jeopardy.

  3. Get a cosigner: If you’re a college student and/or have limited income, consider asking your parents or another trusted adult to cosign on a credit card for you. This can be a good way to establish good credit without putting down a deposit for a secured card.

    Only take this route if you’re sure you can pay your credit card on time. Whoever cosigns is responsible for making payments if you personally neglect to, and their credit score will take a hit if you are negligent.

  4. Take out a student loan: You need to have a credit history established to get certain types of loans such as auto loans and home loans. However, student loans are a different story. Ulzheimer explains that student loans show up as separate loans for each disbursement. So if you go to school for four years and take out student loans every semester, you will have eight separate loans on your credit report, even though you might only make one payment to one loan agency.

    Ulzheimer maintains that student loans are an effective way to build credit, provided you make payments on time. Delinquent student loans will drop your credit score, and it is much more difficult to rebuild your credit score when you have defaulted loans than when you have massive credit card debt.

  5. Take out a credit-builder loan: Talk to your local community bank or credit union to see if they can offer you a credit-builder loan. These loans are specifically designed to help people build credit. Lenders report your activity to the major credit bureaus, so as long as you make payments on time and in full, they can help build your credit history by demonstrating your responsibility in paying a loan back. Look for a loan with a monthly payment you can easily afford and that has a relatively short repayment period so you aren’t stuck with a loan for years on end.

When should you start building credit?

Parents can make their children authorized users at any age, which means kids can start building a credit history long before they turn 18. Experts advise that you spend time educating your kids them on what credit is, why it matters and how they can make sure they have good credit as adults. When you think they are ready, add your children as authorized users.

If you’re 18 or older and don’t have a credit history yet, today is a great day to start. The sooner you start building your credit history, the better off you’ll be when you’re ready to take out a loan for a major purchase.

How to improve credit with good habits

If you’re focused more on rebuilding rather than building your credit, there are some easy steps you can take to slowly raise your credit score.

  1. Only spend what you can pay: A lot of people fall into a trap of putting more on their credit card than they can pay off, thinking that their good credit history will be able to withstand the debt they incur. The truth is, you need to stick to the good habits you have established that earned you good credit in the first place. Putting too much on your credit card will increase your debt-to-income ratio, making it harder to get loans when you need them. Put yourself on a budget, and build some savings in a separate account for months when you do overspend.

  2. Diversify your debt: Having a credit card is a good place to start building credit, but you shouldn’t stop there. You want more than just credit cards on your credit report to demonstrate your ability to pay back multiple types of debt.

    Auto loans are a good way to demonstrate that you are capable of paying off multiple lines of credit. However, don’t take out an auto loan just to raise your credit score, especially if you have enough cash to pay for it upfront. You’ll end up with interest payments that will likely be more than it’s worth to get your score up a few points. Student loans are another way to raise your credit, but only if you pay them back on time.

  3. Make sure your rent is being reported to the credit bureaus: Most landlords don’t report rent payments to the credit bureaus. If you’re trying to rebuild your credit, use a rent-reporting service to track your timely rental payments and report them to the credit bureaus to help improve your credit score and demonstrate your responsibility.

Bottom line

Whether you're building your credit from scratch or trying to rebuild your bad credit, you have a lot of options. The best way to build a good credit score is to be responsible. Only take out loans and credit cards that you can pay back on time, and start building credit early.

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