Some people have no credit at all, and some people have bad credit. So how do you build a credit score from scratch?
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Understanding how to build credit is particularly important to investors who are looking to use their score to help build their wealth. A good credit score allows them to take advantage of leverage (aka debt such as loans).
To access the most funding options to invest in real estate, chances are you’ll need good credit. There are numerous ways you can boost your credit score, depending on where you are today.
But first, we must understand credit.
How Are Credit Scores Calculated?
The definition of credit is “the ability of a customer to obtain goods or services before payment, based on the trust that payment will be made in the future,” according to the Oxford Dictionary.
There are multiple things affecting your credit score. The length of time accounts have been open, ratio of outstanding debts compared to the credit you’ve been extended, types of credit owned, and number of late or missed payments are all factors that can raise or lower it.
Carrying a high balance on credit cards, opening and closing accounts in a short amount of time, and of course late payments will all ding your credit—as much as 100 points in one go. In addition, the amount of inquires (companies checking your credit to open credit cards, get loans, etc.) can and will ding your credit, even if temporarily.
Be smart about taking on credit, and learn as much as you can about what it is before you engage in accounts reporting to credit agencies.
Here’s a quick rundown of credit scores:
740-799: Very Good
580-669: Fair (Note: It’s common practice to require a 600+ credit score for leasing properties.)
With fair/poor credit, one may experience higher interest rates on loans/mortgages. If renting or leasing, you may be required to pay higher security deposits. A co-signer may even be required in certain instances.
The terminology and ranges associated with these labels do vary by source, but it’s more important to have a general idea of where you fall on the spectrum. You’ll qualify for the best rates if you have a 740 or higher score, with some institutions that even call for a 760.
Types of Credit
There are quite a few types of credit; however, I’m going to focus on the two most common.
One of the most utilized types is revolving credit. Credit cards fit into this category.
With revolving credit, one is expected to pay a minimum each month but is not required to pay the entire amount.
Another common type is installment credit. This refers to such things as automobile loans or mortgages. A certain amount is borrowed, and every month the same amount is paid until the balance is paid in full.
How to Protect Your Credit
To protect yourself and your credit, you should check your credit report annually. More often than you’d think, individuals find out their identity was stolen or some sort of fraudulent activity occurred months or years after the fact.
Don’t give criminals a bigger head start than they already have. Protecting your credit starts with you. Monitor your bank accounts and credit card accounts, and go over your statements to ensure there aren’t any discrepancies.
In instances where you may be vulnerable or in order to be extra cautious, one can go a step further and implement credit freezing, monitoring, or other services to help ensure you don’t become a victim of fraud.
How to Build Credit
Apply for a Credit Card
Dave Ramsey may not support this advice—but to each their own. If you can’t trust yourself to use a credit card appropriately, you may want to disregad this advice.
However, opening up a credit card, using credit, and making timely payments is a great way to build your credit score. The key is paying off your balance monthly and always making payments on time.
If you’ve never had a credit card and/or are building your credit from scratch, you may need a secured credit card. This acts as a prepaid card until you establish somewhat predictable spending patterns with the institution.
Keep Credit Cards Active
As mentioned, the length of time an account has existed is taken into consideration when determining credit scores. However, banks have been known to close inactive cards after a certain length of time.
To prevent a credit dip as a result of a closed account, it’s useful to add a tank of gas here and there on cards you may not use much.
Adjust Your Balances/Records/Limits
It happens to so many people for so many reasons. There may come a point when you are unable to pay off your balance in full.
If this is you, concentrate on paying whichever accounts have outstanding balances down to less than 30 percent of the associated credit limits. This in and of itself will help boost your score.
Do you have a late payment on record? If it’s out of character, it never hurts to ask for this late payment record to be removed. Many institutions will be happy to do this for first-time offenders.
Do you have autopay set up for any of your accounts? If something happens and your payment account is compromised, you will be assigned a new account number. This will interrupt your autopayments.
Pay close attention to your credit card accounts in these instances so that missed autopayments don’t translate into late or missed payments, thereby dinging your credit score. If this happens, again, reach out to your creditors and explain the situation. If you aren’t a repeat offender, they’re likely to help you out.
In some cases, adjusting your credit limit can improve your credit. It can essentially push your revolving credit balance percentage down. This is not recommended for everyone, however. Prior payment history and the status of your outstanding credit will be taken into consideration. Not everyone may be granted a higher limit when they ask.
Student Cards/Credit Building Loans
Some banks even offer services like credit-building loans. Participants are required to make timely payments on these loans, and the institutions report this activity to the credit agencies throughout the process until the loan is paid in full.
Normally, services such as these are offered by local banks. But it never hurts to ask your current institution if you already have an established banking relationship.
Sometimes student credit cards are a good way to go, too. These cards are classified as higher risk due to the inexperience of customers who open said accounts. As such, these cards typically have higher interest rates for those who carry a balance. Be aware of these rates, and try not to charge more than you can afford on these cards.
Authorized Users and Co-Signers
For those who are looking to build or rebuild credit, one option is to be added as an authorized user to someone else’s account. You may consider adding an authorized user to your account for similar reasons.
In either instance, this situation is going to be detrimental to one or both parties if you are not committed to making timely payments. The relationship requires trust. But if both parties are responsible, this is one way to go about boosting your scores.
For best results, before utilizing this tactic, establish the following:
- How often will this card be used and for what purposes?
- Do you both have a history of paying in full and/or on time?
- Can you trust each other to not abuse this card?
In many cases, mortgages, credit cards, rental leases, other loans, etc. may require a co-signer for those who apply and do not meet the optimal credit criteria. A party with good credit co-signs onto the credit agreement with the party that has lower credit.
In doing so, the co-signer is accepting a certain level of responsibility—they are now on the hook for paying creditors should you fail to do so. This is simply another way to lessen the risk on the institution’s side while still allowing for credit building opportunities.
Rent and Utility Payments
Another possible way to build your credit is through rent and utility payments. Certain programs are available whereby a company will collect your rent for a fee, pay it to your landlord, and report your timely rental payments to credit agencies. Some landlords themselves may have such a system in place.
The same situation can be set up for utility payments. But be aware that many utility companies themselves don’t report to the credit bureaus—unless you fail to pay. In those instances, they will report you.
How to Rebuild Credit
People experience all sorts of situations that may bring them to a point where they need to rebuild their credit. While this article is more about ways to increase your credit score or build it from scratch, it’s important to quickly note that there are ways to work with collection companies.
In some instances, you may be able to reach a compromise where you pay them a lesser amount than was owed in order to settle an outstanding debt. But this isn’t always the best option—it’s highly dependent on the individual situation. Obviously the best option is to avoid a debt from being turned over to collections in the first place. This isn’t a forum for legal advice, however, so consult the appropriate financial professionals for the best course of action.
If you find yourself in a position where you’re rebuilding, explore all of the aforementioned options to help get yourself back on the road to success. Avoid further late payments. Avoid being sent to collections. And know that credit issues from years—even decades—ago can continue to haunt you down the road if left unresolved.
This is by no means an all-inclusive look at credit, but for those starting out or trying to build their credit, it’s a great place to start. Understand how credit works, the factors playing into your credit score, and how monitoring your credit report can help you protect your score.
The higher your score, the more of a ding your credit takes should you have an issue with any of the above. Building credit takes time, but it can be done faster if you have the right tools and use the correct strategies.
Do you understand what can hurt your credit score? Do you have a grasp on what can help it? What other questions can I answer for you?
Leave me a comment!