In one of my last articles, we went through all the various reasons why credit matters. However, understanding that you need solid credit is one thing; understanding how to get it is entirely another. This article will go in depth describing what works well to build credit, what can harm your credit, and debunks a couple of known myths around credit scoring.
Things that Matter
Get a Credit Card
If you have no credit or poor credit and want to improve it, getting a credit card is one of the best first steps you can make, provided you use it properly. If you’re unable to obtain a traditional credit card because of your score, you have other options! Here are some non-traditional cards which are easier to open:
Student Credit Card
If you’re a student at a college or university, you may be able to apply for a student credit card. Student credit cards require either a steady income or to have someone cosign with you. Some offer incentives for paying on time or for academic performance.
Retail Credit Card
Depending on the retailer, these forms of credit cards will sometimes offer store discounts or rewards, but usually carry a higher interest rate than traditional cards.
Authorized User on Friend/Family Account
Becoming an authorized user can be a great way to add a lot of good credit, but it also has the potential to harm your credit. If the primary account person misses payment, it’s the same as if you missed a payment. Make sure you’re confident the person you’re asking to join accounts with is going to make their payments and keep their debt to credit ratio low in order to benefit from becoming an authorized user.
Secured Credit Card
A secured credit card means that you pay up front (called a collateral deposit), and that payment becomes the credit line. You put in $500, your credit line is $500. Make sure you read the fine print with these cards, though. Because secured cards are typically only used by those with poor or no credit, some banks will try to take advantage of the situation with high fees or forced add-ons.
Pay Off Balances Each Month
Many people think that keeping a balance on your credit card each month helps improve your credit rating. This is absolutely not true. Keeping too high of a debt to credit ratio can be harmful to your rating. Additionally, many banks will report your balance to reporting agencies before your monthly payment, which increases your debt to credit ratio somewhat artificially.
Pay on Time
Paying your bills on time, over time is the single best thing you can do to improve your credit rating. If you’ve had issues in the past with paying on time, don’t worry! Older mistakes are much less severe than recent ones. Focus on paying this month on time, and move on from past lapses.
Leave Old Accounts Open
Many people think that once an account has been paid off or is done being used, it will somehow help their credit by closing that account. That’s typically untrue! The age of your credit history is a factor in your score. By closing accounts that were positive, you’ve potentially harmed your rating. Keep them open as long as there are no maintenance fees associated with the account.
Maintain A Low Debt to Credit Ratio
Keeping a low debt to credit ratio is second only to paying on time in terms of impact to your credit rating. You can calculate your ratio by adding all of your debts – let’s say $400, and dividing it by all of our credits (excluding mortgages), let’s say $2,000. 400/2000 = .2. Now, multiple that number by 100, so 0.2 X 100 = 20. In this example, the debt to credit ratio is 20%. A ratio of 10% or less is optimal for your rating. If you’re significantly above that, shoot for 30% to start.
Open Only What You Need
I’ve heard people say that the more credit accounts they have, the more it helps their score. This is really untrue. Opening multiple accounts in a short period of time (2 years or more) can have a low negative impact to your score. Make sure you’re only opening accounts you have a need for.
Keep a Diverse Credit Mix
While this is a minor category, having a diverse mix of credit accounts can improve your standing. The three categories of accounts are:
- Credit Cards
- Home Equity Lines of Credit (HELOCs)
- Auto Loans
- Student Loans
- Business Loans
- Home Equity Loans
- Open (not always shown on credit reports since they are to be paid in full monthly)
- Cell Phone Carrier Accounts
- Company Charge Cards
Things that Don’t Matter
One of the bigger myths out there is that opting out of credit card offers will help your credit score. You can call 888-567-8688 (888-5-OPT-OUT), or go to their website to remove your name from reporting agency lists and will prevent unsolicited credit offers for five years. Though this won’t help your credit score in any way, it may prevent you from slipping back into bad debt. Also, if you have old debt past the statute of limitations, this can prevent debt collectors from harassing you about it.
Paying Early or Extra
This is the famous catch-22 of credit ratings. It’s good for your bottom line if you have no debt, but it’s good for your credit score if you have an open account that’s been handled responsibly. If you have extra cash to pay on debts, I’d still recommend you do it, even if it isn’t optimal for your credit.
In order, the best things you can do to improve your credit are:
- Pay on Time
- Keep your debt to credit ratio low – 10% or less
- Have a lengthy, positive history
- Apply for credit only when you need it
- Have a good spread of different types of accounts
If you’re still with us, check out the next article in the series on how to protect your credit.