Your financial health is like a puzzle, with different pieces that fit together to create a complete picture.
One of the most important pieces is your credit history and of course, your credit score. (That’s the three-digit number lenders use to determine how likely you are to repay your debts.) FICO scores, the most widely used credit scoring model in the U.S., range from 300 to 850. The average FICO score recently hit an all-time high of 704.
This in-depth guide breaks down everything you need to know about engineering a better credit rating.
Where credit scores come from
Before you can have a credit score, you first need to have a credit report. This is a collection of information about your credit accounts, including who you owe money to, how much you owe, your minimum payments and how long you’ve been using credit.
FICO scores focus on five specific factors to calculate your credit score:
- 35% of your score is based on payment history
- 30% is based on your amounts owed
- 15% is based on the length of your credit history
- 10% is based on inquiries for new credit
- 10% is based on the types of credit you’re using (i.e. loans and credit cards)
Knowing what affects your score can help you adopt the habits that you’ll need to build good credit. But what if you’re one of the 62 million Americans with a thin credit file?
“A thin credit file just means that you don’t have an established credit history,” says personal finance expert and Money Crashers contributor David Bakke.
“Maybe you’re younger and just have never had a need for credit, or possibly in general you’ve never signed up for credit cards or taken out a car loan or a home mortgage,” says Bakke.
With a thin credit file, you may not have enough credit history to generate a credit score. Fortunately, that’s a situation you can remedy. Opening a bank account is a good first step. You can use your account to get a handle on your spending, keep track of bills and start growing your savings. Once you begin using credit, you’ll already be in the habit of keeping your spending in check and paying your bills on time. Both of these positive habits can help your score.
How to build credit from scratch
If you’re starting from square one with building credit, there are a few different routes you can take. Here’s a look at some of the most common ways you can build credit as a beginner:
Secured credit cards
Opening a secured credit card can be a great option to build credit for someone who’s new to credit or has a thin credit file, says Steven Millstein, a certified credit counselor and editor of CreditRepairExpert.
“Unlike other credit cards, a secured credit card requires that you make a cash deposit upfront. This deposit will usually be your credit card limit, which serves as collateral if you fail to make payments,” Millstein says.
The major pro of a secured credit card is that your payment history and spending can help to establish your credit history. That’s because many secured card issuers report your activity to the credit reporting bureaus. With a card limit of only a few hundred dollars, this can keep you from racking up debt.
Credit builder and savings secured loans
Credit builder and savings secured loans offer a slightly different take on building credit.
“These are basically small installment loans where the loan is secured by a certificate of deposit or a savings account,” says Jeff Smith, vice president of marketing for Self, which offers credit builder loans.
“As the person repays the loan, the payments are reported to the credit bureaus so they can impact the credit history. At the end of the term, the CD or savings are unlocked and returned to the account-holder.”
Essentially, you’re repaying a loan to build credit, but you don’t get the proceeds of the loan until it’s paid in full. That’s a reversal from how loans usually work, where you get the money upfront.
There are also other drawbacks to credit builder loans. For example, you may not get immediate funds to make a purchase. On the other hand, this may not matter if your main objective is to build credit.
Become an authorized user
Instead of getting a credit card in your name, you can ask a friend or family member to add you to one of their cards as an authorized user.
“The implication is that their (the main card holders) good credit practices will start to build your credit,” Millstein says.
According to Equifax, being an authorized user allows you to make purchases with the card and have the account’s activity show up on your credit report. Yet, you’re not the one liable for the card’s balance. If the primary card holder practices good credit habits, those habits would be reflected in your credit report and score.
There’s a catch, however. If the primary card holder falls behind on payments or maxes the card out, this can hurt your credit.
Ask someone to co-sign a loan with you
Co-signing on a personal, student or auto loan is another way to build credit. Unlike being an authorized user, however, you share responsibility for the debt with your co-signer.
Asking someone to co-sign can help you qualify for a loan that you may not be able to obtain on your own. Once you’re approved, you can work on repaying the loan and building credit history.
But there is some risk involved. If you default on the loan, both your credit history and that of your co-signer can be damaged. And, this can potentially ruin your relationship, Millstein says.
How long does it take to build credit?
“Building good credit is probably not going to happen overnight and getting a solid credit score as well isn’t going to happen immediately,” Bakke says.
So, just how soon can you expect to see results?
According to Experian, it can take between three and six months of activity to get enough history on your credit report to calculate a credit score. Millstein says it can take about 12 months to grow a fair credit score, which is in the 580 to 669 range for FICO scores. He says working towards a perfect 850 score, on the other hand, can take several years.
Bottom line? You’ll need to be patient and give your good credit habits time to pay off.
Check in with your credit regularly
If you’re hard at work on building credit, don’t forget to track your progress. You can get your credit report three times a year for free through AnnualCreditReport.com. Free credit monitoring services help you track your score month to month.
In the meantime, set up alerts for your bills and schedule automatic payments through your mobile banking app so you never miss a due date. When you make payments on time and keep your balances low, your credit will eventually improve!