Building Credit from Scratch

Your credit report and credit score have a massive influence on your personal finances, affecting financial goals and needs both large (e.g., buying a car or even a house) and small (e.g., applying for an apartment or connecting utilities to your residence).

For young adults and consumers without any credit history, building up credit can be a confusing and complicated process. Many financial institutions require a good credit history to open an account on credit, but it can be difficult to build up that credit history without first opening an account.

Despite these complications, consumers still have several options when building a credit score from scratch. Here’s an overview of how these credit scores work and how you can start your credit history off on the right foot.

What Is a Credit Score?

A credit score is a number that reflects your creditworthiness as calculated by a credit bureau. Credit bureaus evaluate all of your existing credit history—including the five key factors outlined below—and use a proprietary formula to calculate a credit score between 300 and 850.

The average credit score in the U.S. hovers in the high 600s. However, individuals with no credit history may have a much lower score, which can impact their access to credit. This credit score has important implications for consumers, affecting their eligibility to open financial accounts as well as the interest rates they are eligible to receive on loans and credit cards.

If you’re new to building credit, this credit score can provide a useful measure of your success in establishing a good credit history that will help you pursue your financial goals.

How Is Your Credit Score Calculated?

Each of the three main credit bureaus (Experian, Equifax, and TransUnion) calculates credit scores in its own way. However, they all take a similar approach and largely use the same credit information.

These proprietary credit score formulas all divide their main criteria for credit score calculations into five key categories:

  • On-time payment history (35 percent): This includes payments for your credit cards, utilities bills, student loans, and other debt in repayment.
  • Debt utilization ratio (30 percent): Your debt utilization ratio is the amount of credit being used out of your total available credit. In general, borrowers are encouraged to use no more than 30 percent of their available credit card spending limit. Under 10 percent is considered ideal.
  • Length of credit history (15 percent): Although there’s no way to speed up this portion of your credit score, keeping accounts open will help you lengthen your credit history and improve this metric.
  • New credit accounts (10 percent): Although there’s little credit risk in opening new credit accounts, applying for too much credit within 1-2 years can raise a red flag that causes your score to drop.
  • Credit mix (10 percent): To optimize your credit score, seek out a wide range of credit, including credit cards, personal loans, mortgages, and other accounts that are reported to the credit bureaus.

If you notice differences in the credit scores across these various credit reports, this is likely because of the different ways each bureau weighs credit reporting data in its calculations. It is also possible that some credit bureaus will include different information in your credit report, which can affect your score positively or negatively.

7 Tips to Build Credit from Scratch

Ready to get started building up your credit? Here are some ways you can make an impact right away:

1. Open a savings or checking account at your local bank. 

Although the bank account itself won’t build up your credit score, it will help you develop a relationship with a financial institution that might later be willing to issue a credit card or other form of credit.

2. Ask your local bank if they offer a secured credit card.

This secured credit card doesn’t function quite like a regular credit card, but it will be reported as such to credit bureaus and can help you improve your credit score.

3. Become a co-signer on a loan or an authorized user on someone else’s account. 

Co-signing on utilities, student loans, and other debts—with a parent, partner, or someone else you know and trust—can make it easier to get approved for credit and to start building up your credit history.

4. Make on-time payments for all of your bills. 

This is one of the easiest and most effective ways to build and maintain a high credit score.

5. When you open a credit card, keep your balance low and pay it off in full every month. 

Use new credit accounts responsibly, and you’ll gradually prove yourself worthy of additional credit opportunities.

6. Don’t close any credit accounts in your first few years. 

Keeping them open will build up the length of your credit history, improving this important metric.

7. Seek out different types of credit to build out your credit history. 

Just remember not to apply for too many credit opportunities too quickly.

It’s Not Too Late to Start Building Credit

Building credit is an important process, but it is just as important to maintain the right financial habits that will help you preserve your credit score and push it higher over time. Fortunately, the steps required to build good credit are available to anyone—even if you’re just getting started managing your own finances.

Want more tips and tricks to lay a good foundation for your financial future? Download The Millennial’s Guide to Personal Finance today.

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