CREDIT BUILDING

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Building Credit
Building credit is a long-term investment and there's no single thing you can do to make that happen immediately. Credit history will gradually build as you continually increase the number of on-time payments. Even improving credit takes time, where the fastest change of bringing all accounts current, can take 30—60 days to reflect on your credit report. The best way to build and improve credit is to do so steadily, by paying all your bills on time every month, managing your credit utilization ratio and ensuring you use a mix of credit types wisely.

Types of Credit

Consumer credit (the kind of credit you use, as opposed to what corporations might) is generally available in four types:

  • Revolving credit: This type of credit is open-ended; when you borrow, you'll agree to repay a certain amount each month, but you won't be expected to repay all the money by a definite end date. Instead, you'll be able to carry a balance and borrow more — up to a preset limit — each month. The longer the principle of the debt remains unpaid, the more interest you'll pay on it. Credit cards are the most common form of revolving credit.

  • Charge cards: They look and work much like credit cards, but with charge cards you have to pay the balance in full each month.

  • Service credit: Anyone who provides you with a service and bills you in arrears (after you've received the goods or services) is extending service credit to you. This type of credit includes your utility companies, landlord (if you rent an apartment), mobile phone provider, etc. Each month, you pay an agreed-upon amount. While this kind of credit doesn't typically appear on credit reports, if you fail to pay your bills on time, these creditors could report the late payments to the credit bureaus or send the account to a collections agency that reports late payments, causing the negative information to appear on your credit report and harm your credit score.

  • Installment credit: This is the kind of credit most people typically think of as loans. If you have a mortgage or a car loan, it's installment credit. It's probably the most commonly used and easiest form of credit to understand. You borrow a specific amount from a lender, and agree to repay it with interest in installments of a specified amount over the life of the loan — usually ranging from months to years.

Understanding Your Credit Report

Your credit report is a record of your credit history over time. There are three major credit reporting agencies, or credit bureaus: Experian, Equifax, and Transunion. Each provides its own credit report. (You can check your 3-bureau credit report.)

Your credit report will generally contain the following types of information:

  • Personal information: This will include your "vitals," such as your name (and any aliases or common misspellings that may have been reported by a creditor), social security number and any variations that may have been reported, birth date, current and previous addresses, and current and previous employers. It does not include information about marital status, bank account balances, income, education level, race, religious preferences, medical history, personal lifestyle, political preferences, friends, criminal records or any other information unrelated to credit.

  • Trade account information: Here you'll find a list of your open credit accounts, including the creditor's name, your account number, the amount you owe, your available credit limit or original loan amount, and whether you've paid on time and are current on payments. You'll also find data on closed accounts, including the payment history on those accounts and whether or not they were closed in good standing. Negative information on credit reports can include missed or late payments and charge-offs. Learn more about the types of negative information that can appear on your credit report.

  • Public Record Information: Credit reports also contain information from the courts, including bankruptcy filings. Public records can negatively impact your credit.

  • Credit inquiries: Your report will show hard inquiries based on actions you have taken, such as applying for credit or financing or as a result of a collection. Soft inquiries, on the other hand, are a result of actions taken by others, like companies making promotional offers of credit or your lender conducting periodic reviews of your existing credit accounts. Soft inquiries also occur when you check your own credit report or when you use credit monitoring services from companies like Experian. These inquiries do not impact your credit score.

If you're looking for ways to improve your credit, taking care of negative information can help. Contact the reporting agencies if you find any inaccurate information on your credit report, pay down high balances, and bring all accounts current if you've fallen behind on any payments.

You can also learn more about understanding your Experian credit report.

How Credit Scores Work

No campaign to build credit would be complete without giving some attention to your credit score. Before deciding to loan you money, potential creditors will probably consider your credit score.

A credit score is a number, generally between 300 and 850, that lenders use to predict how likely you are to repay money you've borrowed. The score is based on information in your current credit report, called credit score factors. It's intended to be an objective, reliable way for lenders to assess a borrower's potential creditworthiness.

Because there are multiple credit reporting agencies and many different credit scoring models (the equations for calculating credit scores), you have far more than one credit score. Credit scores are not included in a credit report and when separately requested, are calculated at the time of request. Generally, however, FICO and VantageScore are the most commonly used types of credit scores in lending decisions.

Information on your credit report that can influence your credit scores includes:

  • Payment history

  • Credit utilization ratio

  • Types of credit used

  • How long you've been using credit

  • Total balances on all debts you owe

  • Public records like bankruptcies​

Financial Behaviors and Credit Mistakes to Avoid

Some financial behaviors can undermine your efforts to build your credit, so it's important to know what to avoid. Here are four common mistakes:

  • Not understanding how much you can afford. In general, a 43% debt-to-income ratio should be taken into consideration when taking on additional debt. The debt-to-income ratio is all of your monthly debt obligations divided by your gross monthly income. The CFPB states that evidence from mortgage loan studies suggests that consumers with higher ratios are more likely to have difficulty making monthly payments.

  • Not having a budget. A personal budget is a necessity for all aspects of money management. Knowing how much you're spending and saving every month can help you make better decisions about how to use credit and how to manage debt.

  • Failing to shop around for installment loans. Choosing an installment loan, such as an auto or mortgage loan, should be like any other buying decision. You should comparison shop for the best possible deal. Comparison shopping can help you find the lowest available interest rates, fees and service charges. Lenders recognize this shopping behavior and credit scoring systems take this into consideration, as well, for inquiries made in a short period of time.

  • Failing to protect yourself from fraud. Credit card companies already take measures to reduce fraud, and federal law protects consumers from some effects of credit fraud. However, it's important for you to take steps to protect yourself as well. Review your credit statements every month and monitor your credit report. Take care of cards by carrying only the ones you need in your wallet. Shred statements and receipts that have your account number on them, as well as any credit offers you receive in the mail.

  • Applying for multiple credit cards in a short amount of time. Suddenly taking on a lot of potential new revolving debt is a strong sign of risk and could indicate that you may use more credit than you can actually repay. This could negatively impact your balance-to-limit ratio and increase the number of hard inquiries impacting your credit.

Credit can be a powerful tool to help you achieve your financial goals. It's important to understand how it works, how to build your credit and how to ensure your credit history always works for you.

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