Becoming financially independent is exciting, but learning how to do so can be challenging. Building good credit is a must: It will help you qualify for loans, auto insurance, mortgage, rental applications, cell phone plans, credit cards and can even impact job prospects. Building a solid credit history early is going to give you a jump start down the road. According to FICO, 15% of your credit score is based on the length of your credit history. So the earlier you begin building your credit, the better off you’ll be.
Good credit can open up financial possibilities that are otherwise hard to achieve, so it makes sense to start building good credit as soon as possible. College can be a great time to work on building a credit score from scratch as long as you go about it the right way. The sooner you start building your credit, the more time you have to work towards building a great credit score. Here are five ways you can begin to build your credit.
First off let’s look into what goes into your credit score.
It may be tough to earn a high credit score without understanding how you're being graded. The FICO score, the most commonly used credit scoring model, uses a weighted model. That means that some components are more important than others. The breakdown of a FICO score is:
- 35 percent payment history
- 30 percent amounts owed
- 15 percent length of credit history
- 10 percent types of credit used
- 10 percent new credit
In short, this means that paying debts on time is the most important thing you can do to keep your credit score up. Creditors report on-time payments and payments that are more than 30 days late. Next is to keep your balances low compared with your credit limits. (i.e., you don’t want to carry a balance of more than 30 percent of a credit card’s limit, and lower is better.)
Also know that a long credit history showing how you’ve managed credit over time positively affects your score. Having a mix of accounts, such as student loans and credit cards, helps lenders see how you handle different types of credit. It’s important to know when you apply for a new line of credit, it will temporarily ding your credit score. It's best to avoid applying for credit unless you need or can afford it.
Building Credit With Student Loans
One way to start building credit history without a credit card is with a federal student loan. While private student loans may require an established credit history, federal student loans don’t require a credit check, and you can get these loans based on financial need without any credit history.
That means you can borrow the money you need to pay for school and build your credit by paying back those loans responsibly and on time. You can start making the minimum payments on your student loans even before you graduate to begin building your credit history.
If you end up getting multiple student loans, once you graduate, you may want to consolidate your student loans to get a better interest rate. By rolling several student loans into a single loan, you’ll reduce the number of loans with outstanding balances. Remember, though, even one late payment can ding your credit score, so make those payments a priority.
Become an authorized user on a family member’s credit cardIf you don’t want to or can’t open your own credit card account, consider asking your parents to add you as an authorized user on their cards. Being an authorized user means you can use someone else’s credit card in your name. You can make purchases and use the card as if it were your own, but paying the charges legally remains the primary cardholder’s — your parent, for example — responsibility. When you become an authorized user, the primary cardholder with the credit card will be reported as if it were your own, and this can boost your score.
This is a passive way to build credit history while never having to actually apply for credit yourself. Not all card issuers report authorized user accounts to the credit bureaus, though, so check first. Then, proceed with caution. If the balance gets too high or a payment is late, it may impact your credit as well as the primary cardholder's credit – regardless of who's to blame. Becoming an authorized user has long been a popular choice for students aiming to build good credit.
Get the right credit card for you
Once you’re able to open a credit card in your name, it’s a good idea to do so if you know you can pay off the card balance responsibly and not use the card as a way to spend money you don’t have. First, decide which credit card is best for you.
Student Credit Card
Using a student credit card wisely is a great way to quickly build your credit. Having a revolving line of credit, such as a credit card, adds to your account mix and gives you more fuel to feed your rising credit score.
The keys are to choose the right student credit card for your needs and to make all your payments on time. Know all the details of your credit card, including late fees, balance transfer fees and APR, and stay on top of your billing statements. Find some of the best student credit cards to help you establish a good credit history here.
Be aware that simply being a college student may not be enough to qualify you for a student card. You’ll generally need to show proof of income, and if you have no credit history at all, you may find it hard to get approved. In that case, consider a secured credit card.
These cards require you to put down a cash deposit as collateral. The deposit acts as security in case you fail to pay your bill, which reduces the risk of approving you for a card. A secured credit card requires a deposit, such as $500, that is the user’s credit limit. If a credit card payment isn’t made, the card issuer pulls money from the deposit. Your monthly activity on the secured card is shared with the credit bureaus, so if you’re making regular payments this could help your credit.
Apply for a credit card at your Bank
Besides a student card or a secured credit card, another option is applying for a credit card with a bank where you already have a checking or savings account. If you have a good history of not letting your balances go below the account minimums or getting overdraft fees, you will be more likely to get approved for a credit card.
Standard credit card
If you can qualify, a regular credit card is great because it will have a higher credit limit than any of the cards above, and can offer better rewards programs. It's important to do some research first. Look for a card that has a low interest rate, no annual fees, good credit limits and clear billing policies. Check out some of the best ones here. Remember that when you receive a credit card that’s all yours – one with no co-signers – the responsibility for handling the card wisely and repaying your debts falls squarely on your shoulders.
After getting any of the above credit cards, start using it with baby steps. Here are some guidelines to follow on your credit card.
Pay Off Your Balance Every Month
Just because you have a credit card doesn’t mean you should live outside your means. You should only be charging everyday purchases you’d be making anyway, such as groceries, gas, or anything else you were already planning on buying. According to CNN Money in 2013, the average college graduate left school with $3,000 in credit card debt. Pay your balance off every month to avoid debt accruing, paying interest, and hurting your credit.
Use Your Card
Don’t let a new card sit in your wallet. To build credit, you have to use your card. Simply having a credit card won’t build your credit alone. You need to have a payment history, so make a small purchase every now and then and immediately pay if off. Again, only use your credit card within your means and never spend on something you can't afford to pay back right away.
Make Your Payments on Time
This is important, since 35% of your credit score is based on payment history. This is also why it's important to never spend more than you can afford to pay back. You want to ensure you can pay off your full balance on time. Consider setting up automatic payments to avoid a late payment. Set up an alarm on your phone or write it on your calendar.
Keep Your Accounts Open
It’s recommended that you keep your oldest credit card open to show a long length of account duration, which benefits your credit. Closing an account may shorten your credit history and reduce your available credit, both of which can lower your score.
Don’t Let Your Balances Grow
Regardless of the type of card you have, keep your balance at something you can pay off every month to avoid paying interest and accruing debt. Thirty percent of your credit score is based on the amount owed, so those big balances are only going to hurt you in the end.
Do not apply for several credit cards at one time.
Now that you have credit in your own name, don’t apply for several credit cards at one time. This can lower your credit score since new credit inquiries make up 10% of your score. People with short credit histories who rack up lots of new accounts in a short period of time might be seen as riskier borrowers than those with long histories and fewer accounts.As a student and new credit holder, it's likely you won't need more than one line of credit anyway. In order to keep everything manageable, stick to just one card for a while.
Avoid putting huge expenses on the credit card unless it’s an emergency
Keeping your debt levels low will ensure that if there is an emergency, you’ll still have plenty of your credit line accessible. So, if your tire blows out, you can purchase a replacement without exceeding your credit limit. Ideally, you should never spend more than you have using a credit card unless it's an absolute emergency. In those cases, it's a good idea to also have an emergency fund so you don't have to use a line of credit.
Get credit for your rent payments and other bills
Establishing a payment history is important in building good credit. Paying your rent on time isn’t always reflected on your credit, but you might be able to change that. While rent payments typically aren’t reported to credit bureaus, there are several companies that can help you make them count. Businesses like PayLease, Rent Track and Rental Kharma for example, help you add previous and current rent payments to your credit report to build your payment history.
As long as you have a good history of on-time rent payments, those payments can help boost your credit score. Even if you’re still in college and paying rent (in your own name, not your parents’), you may be able to add your on-time payments to your credit report to boost your score.
Use a credit-builder loan
With a credit building loan, the money you borrow is held in an account at the financial institution for the length of the loan. You build credit by making consistent, timely payments which are reported to the three credit bureaus. When you’ve repaid the entire loan, the balance of the account is released to you. These loans are usually offered by small financial institutions like a credit union or a local bank, or online through companies like Self Lender. Before you go this route, make sure you’ll be able to keep up with the payments regularly until the loan is fully repaid.
Finally, as you’re building your credit score, take time to manage it. Some places, like myFICO.com or Career Karma, have free services that allow you to keep a constant check on your credit score. You should check your credit report every few months to keep an eye on what you’re doing right and wrong.
When reviewing your reports, check for errors. Besides identity theft, it’s also a good idea to monitor for mistakes. There could have been a glitch in a company’s system that reported your payment as late when it really wasn’t, for example. If you find errors, report them to the creditor that provided the information and the credit bureau. You can follow the Consumer Financial Protection Bureau's guide on filing disputes if you need extra help.
While building credit, you'll start to understand how you manage money and where you encounter obstacles. Building your credit while you’re still in college can help you prepare for the realities of life after graduation. Establishing good credit habits now will go a long way toward saving money when you're financially independent. By understanding how credit works, using credit cards, getting rent reported to the bureaus and showing financial discipline, you can ace money management when you make it to the real world. Want more professional development tips? Check out the Meratas blog!
Topics: Personal Finance