Building good credit is one of the most important things you can do for your financial future.
Credit information is used by everyone from landlords to employers to insurance companies, so it’s key to build a score that will allow you a little breathing room.
Where to start: Check your credit.
First thing’s first, check your credit report. A credit report won’t include your three-digit score, but does include a detailed account of your credit history. Take advantage of free annual reports online to ensure the information is error-free (yes, errors do happen, so pay close attention!).
“You always want to check your credit once or twice a year, because that way you can make sure that there’s nothing that has shown up on the report that you didn’t know about,” says Ben Cohen, Senior Vice President of Mortgage Lending at Guaranteed Rate. “Sometimes somebody calls me for their home, and they have a $50 medical collection from two years ago that they didn’t know about, and it’s ruining their credit.”
Brendon Sklar, Assistant Vice President at Fifth Third Bank in Wilmette, recommends checking reports from all three credit bureaus, since not all institutions report information to all three.
Next, look up your score.
Once you’ve dissected your credit report, you should look up your credit score to know where you stand. FICO credit scores range from 300 to 850. While Credit.com suggests the average U.S. credit score is 674, the ideal score to be approved for many loans and mortgages is around 740.
To build and maintain excellent credit, follow these guidelines:
1. Set up automatic payment for all bills.
Payment history is the largest contributing factor to your credit score, according to MyFico. One of the quickest ways to knock your score is missing due dates on bills.
“I see people all the time that they make all the money in the world and they’re totally qualified to buy a home, but they’re so busy, they’re on the run, and their credit is ruined and they can’t buy a home (because they didn’t make payments on time),” Cohen says.
Avoid any accidental slip-ups by setting up automatic payments for all bills and credit cards.
2. Pay down your debt.
Hands down, reducing the debt you owe is the easiest way to build your credit score, since debt represents 30 percent of your score. The first step in doing this is figuring out how you spend your money, says Morgan Stanley wealth advisor Kathy Roeser.
“Put together a spending plan,” Roeser says. “If you look at that at least once a year and figure out what are the core living expenses and then your discretionary expenses, that will help you have a big-picture plan about how to deal with a budget. Then you need to go through and find out where you can cut those discretionary expenses and start paying down whatever debt you might have.”
There are many online budget trackers to help you do this at home, but it can be beneficial to meet with a credit counselor or financial advisor. Go over where your debt is coming from, where the highest interest rates are, and come up with a viable payment plan.
3. Open a major credit card in your own name.
If someone else in your family manages the finances, open a card with your name on it, and set up automatic payments for one of the bills. This is an easy way to charge something each month and pay it off worry-free.
“The rule of thumb is they want you to have three major credit cards and have the highest credit limit with the lowest balance,” Cohen says.
Caution: Don’t go opening too many cards at once.
“New accounts will lower your average account age, which will have a larger effect on your score if you don’t have a lot of other credit information,” according to MyFico. “Also, rapid account buildup can look risky if you are a new credit user.”
Once you have your card(s), it’s important to actually use them.
“You want to have activity reported every month,” Cohen adds. “People go and open up a credit card, but there’s no activity for a credit bureau to determine if you’re worthy. You have to have a history of paying it.”
4. Use no more than 30 percent of your available credit.
You have to use credit to build it, but you don’t want to use too much each month. Your best bet? Use less than 30 percent of your available credit each month—but it’s even better if you can stay under 10 percent.
Tip: To avoid going overboard, call your credit card company to see if you can increase your limit (see below), or make two payments each month. Paying off your credit card bill in smaller chunks throughout the billing cycle helps lower the number before the statement closing date, when your spending is reported to credit bureaus. It also helps to spread out your spending on your different cards, rather than making all big purchases on one card.
5. Increase your card limits.
Call your credit card company and ask to increase your limit. “The more credit you have is beneficial to offset spending habits,” Sklar says.
If you’ve never asked to increase your limit, or have had an increase in salary, you can raise your limit—sometimes, substantially. To do this, simply call your credit card company and ask.
Caution: Only do this once in a while, since multiple requests raise a red flag to credit bureaus.
6. Open a retail or gas card if you don’t already have one.
Ten percent of your credit score is determined by “types of credit used,” so it can help to have a few different sources of credit. Opening a retail or gas credit card (one that has good perks, reports to all three credit bureaus and that you can pay off on a regular basis) can be a good way to diversify your credit.
Caution: Be careful not to open too many of these cards at once, especially around the holidays, when special deals are offered at every turn. Each time you apply for a new card, the lender pulls your credit report, and multiple hits on your report in a small time frame can lower your score.
It takes years of financially responsible behavior to build and maintain good credit—these steps, along with conservative spending habits, will help point you in the right direction.