Step 1: Understand what your FICO Score means
The first step in building your credit is having a good understanding of what goes into your FICO Score (frequently referred to as a credit score). FICO Scores are broken into five different factors with varying importance, which are the most commonly used ways to measure credit. A credit score is determined by the following factors:
- Payment History (35%) This is the most important factor in determining a credit score for those who have been using credit for a while. Keeping your payments on time is incredibly important because late payments can hurt your score, as well as cost you in extra fees and penalty interest rates.
- Amounts Owed/Credit Utilization (30%) Limiting the amounts owed on all different types of accounts is crucial to building a strong credit score. This is done by keeping your debt balances low in relation to your credit limit. Additionally, having a larger number of accounts with amounts owed can increase your risk, so its essential to be aware of your balances for good credit health. A good rule of thumb is to keep your credit utilization below 30% on all of your balances.
- Length of Credit History (15%) This is not as simple as it sounds. Credit history takes into account the following aspects:
-The age of a consumer’s oldest credit account
-The age of a consumer’s newest credit account
-The average of ALL the consumer’s credit accounts
-How long different accounts (mortgages, credit cards, loans, etc) have been active.
-How long it’s been since different types of credit account have been used.
Keep in mind that recent activity on accounts have more impact on your FICO score than older activity. Also, the longer history of good credit a person has, the better their score will be.
- Types of credit in use (10%) Having a diverse mix of different accounts will help give a small boost to your credit score. This can include your various credit cards, retail accounts, installment loans, finance company accounts and mortgage loans.
- New credit (10%) Opening several new accounts in a short period of time can cause greater risk, as well as costly credit application penalties. So if you’re just starting your credit history, be weary of quickly opening multiple accounts.
Step 2: Learn the rules of credit
Building credit comes with a set of guidelines that you must follow in order to successfully prove that you’re creditworthy. Here are some tips:
-Make all of your payments on time, on ALL accounts.
-Keep your debt low, don’t let your debt balance exceed 30% of your credit limit.
-Keep accounts open and active as long as possible and use your card regularly. When an account is closed, utilization will go up and payment history may go down.
-Avoid opening too many accounts at once. This lowers your account age and causes credit application penalties.
-Check each of your credit reports annually for errors.
Everyone is entitled to one free credit report a year from each of the three major credit bureaus: Experian, Equifax, and TransUnion. To access your score, go to:
www.annualcreditreport.com. In addition to this, scores can also be purchased for a small fee from any one of these bureaus. Several credit card issuers and lenders also offer free options for you to access your credit score, so these are worth exploring as well.
Step 3: Start smart and be patient!
Its important to know that building your score into 700-800s won’t happen in a day. When you decide to first start building credit, you’ll probably want to begin with a secured credit card that is backed by a cash deposit which is usually equal to your credit limit. Use this card to build enough credit to get an unsecured card, which will have better benefits. You can also get a cosigner on an unsecured card, or try to become an authorized user on another person’s card to start building your credit history immediately without the legal obligation to pay for your charges.