How to Build Credit

Getting your first credit card and starting to build credit can be an intimidating task.  What card should I get?  How much should I spend?  What should I buy with it?  What do I have to do to build good credit?  These are all questions you may be asking yourself.  I know I asked them when I was just starting to build credit. 

For a while, I refused to get myself a credit card.  I felt they were unnecessary and could end up getting me in trouble, so I steered away.  Eventually, I realized that if there is anything I may want to purchase that requires financing (i.e. a car or a house), I was going to need to have good credit so I would actually get approved.  I did my research, signed up for my first card and have been building my credit higher and higher since!

Although credit cards seem scary and dangerous, they're actually really easy to maintain, assuming you follow the guidelines provided by this page.  Let's start with the very basics and answer 3 important questions:

What is credit?

To put it simply, credit is money you borrow from a bank or company to purchase items and services with.  It is a system used to prove you are responsible and trusting enough to be given a loan.  

What is a credit score?

Credit score is a number based on the history of a person's credit files to represent whether they're worthy of credit or not.  This number is based on credit report information usually sourced from credit bureaus.  Most credit is scored on the FICO chart, which ranges from 300-850.  Why they couldn't have made it 0-1000 is beyond me, but I didn't make the rules, I just play the game.    

What is APR?

APR stands for "Annual Percentage Rate".  This one can get pretty in-depth and mathematical, but the basic gist of it is the percentage you owe the credit card yearly for using their services, as well as the interest you may have accumulated by not paying off your card on time.  Try to go for a card with a lower APR if the rest of the features work for you.

Choosing Your First Card

If you have a low credit score or no credit at all, obtaining a credit card might be a bit difficult.  It's a catch-22 where you need credit to get a card, but you need a card first to get credit.  If you're a student, I suggest looking into some student credit cards which give benefits for common student expenses like textbooks, food and even music.  

If you're not a student, your best bet (and probably only bet) is to start off with a secured credit card.  The difference between a secured and unsecured credit card is the secured card asks for an initial deposit.  The start up deposit may differ depending on which card you choose, but it's typically a few hundred dollars or less.  This is to ensure that you have some money available for use to start off with. How much you put down as your initial deposit will determine how much available credit you will be given.  The card I used first limited me to $300.  Card companies change their fees and features, so you'll have to compare secured cards on your own to see which will be best for you.

What to Buy?

Keeping an eye on your available funds when using a credit card can be tricky.  It's easy to accidentally spend more than you're able to pay back, which throws a lot of people down that path of debt.  I've been using a little method to keep myself in check.  I only use my card to buy one specific thing, which is coffee.  I know about how much I spend on coffee every week and know I have my funds figured out so I'm able to always pay for it.  This controls me from being too frivolous with my spending.  You can do this with anything that you pay for often, like groceries or gas.  If you start to use your card for everything, it can add up faster than you expected and is more of a hassle, unless you're really on point with how much you're able to spend.  Don't borrow more than 30-35% of your total available credit before paying it off.  So if your total available credit is $300, spending about $90 and then paying it off is ideal.  This plays into increasing your credit score, which we will get into later.

When to Pay

You will have a monthly payment due at the same time every month.  It probably will depend on the date you signed up for your card.  Find out exactly when this date is and make sure you pay back what you borrowed before this date!  Being on time with your payments is the most important part of building your credit score up.  Missing payments will drop your score faster than anything else you do with the card!  I highly recommend you set a reminder on your phone and/or your computer so you know your payments due date will be coming up soon and it's time to pay it off.

What Determines Your Credit Score?

Some credit card companies give you access to viewing your credit score through them, but if yours doesn't, creditkarma.com provides a free credit score and report.

  • On-time Payments.  The biggest aspect that affects your credit score is on-time payments.  Always pay your bill before it's due.  If you don't, you will collect interest and have to pay even more and your credit score will go down!

  • Oldest Credit Line.  Yes, they determine your credit score by accounting in how long you've had a credit card for.  Although not as important as paying on time, this has a pretty big part in increasing your credit score.  This will obviously be a factor lowering your credit at first, but as the years go by, the more this number will increase.  Never get rid of your very first credit line and always keep it in good standing.   Even if you cancel a card, the activity you've had on it will continue to stay with you.

  • Credit Utilization.  This also has a high impact rating on your credit score and is what we were talking about earlier with spending only 30-35%.  Lenders usually look at how much credit is available, as well as how much is used.  Someone who has "maxed out" their credit cards will have a hard time trying to obtain more credit or financing.  Keeping your average account balance around 30-35%  or lower is a good rule of thumb to use to guarantee you're building your credit higher. 

  • New Accounts.  This doesn't have too much of an impact, but it's still a factor that will determine your credit score.  If you open a lot of different accounts with credit card companies, it won't look too good to lenders.  If you open multiple accounts in a short period of time, that also doesn't look good.  Start off with just one card and build it for about a year just to get the feel for having a credit card, then you can get yourself a card that allows you to borrow much more and obtain the benefits and cash back you see in the advertisements.  I wouldn't suggest going over two or three... and that's pushing it.  

  • Available Credit.  This also doesn't have too much impact on your score, but the more available credit you have, the better it looks to the lender.  You'll just have to keep everything else in check and the companies will raise your available credit more and more.   

WARNING: Many credit cards show a "minimum payment due" to pay off before a certain date. This is tricky and I'll tell you why!  It may seem like this means that you can pay a small amount each month until you pay it off entirely and won't collect interest.  THIS IS NOT TRUE!  Paying the minimum before the due date avoids getting a late fee, but it does not stop the interest!  You have to pay off your credit debt ENTIRELY before that date, or they will charge interest on your account. 

Quick Recap:

Start off with a secured credit card.
Keep spending under 35% of your total available credit.
Spending on a specific item can help budget management.
Pay your card back on time, every time!
Hold on to your first credit card as long as possible.
Keep an eye on your credit score.

And there you have it!  See?  Building credit really isn't as hard as it seems.  Make sure you SHARE on Facebook, Google+ and other social media so your friends and family know how to build their credit, too!

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