How to Build Your Credit History as a Young Adult
Why you need a credit history
“We’re going to pull your credit.”
Depending on your situation, those six words can either give you a “no big deal” feeling or send shivers down your spine. When someone—a bank, a credit card company, a cell phone or utility service, a landlord or even a prospective employer—talks about accessing your credit history, that means they will learn all about your financial situation.
So, what exactly is in your credit history? According to MyFico, here is the information it will show:
- Your total debt: the amount you owe on any loans, credit cards or other bills.
- Your payment history: your track record for paying your bills, either on time, late (not good) or missed (even worse).
- Your credit history: the length of time you have had credit extended to you, whether or not you have used any or all of it.
- Any new credit: recent loans or other types of credits granted to you.
- Your credit mix: revolving credit (unsecured credit cards), installment credit (installment loans) and service credit (utility or cellphone, for example).
- Personally Identifiable Information (PII): your name, address, social security number, date of birth and employment information.
- Credit inquiries: a list of lenders who have requested a copy of your credit report (known as a “hard pull” or “hard inquiries”).
- Public record information from state and county courts: overdue debt that has been sent to collections or any bankruptcies.
The first five categories are what your credit score (more about this later) is based on. If the number is good, then chances are you’ll get that vehicle loan, an approved rental application or the job you wanted. If your credit score isn’t so great, you could be rejected because you are a bad risk.
But what if your credit history is non-existent? Maybe you always paid cash for what you needed because you wanted to stay out of debt. But now you’re learning that a debt-free/cash-only life means that, as far as the credit bureaus are concerned, you are invisible. And that can keep you from being able to get a loan, be approved for an apartment lease, or maybe even be hired by a company, says the Consumer Financial Protection Bureau.
When your credit history is inadequate for scoring, then there is no way for the lender or employer to judge how financially stable you are. And that is a big red flag that can stop you in your tracks and leave you asking, “Now what do I do?”
If this is the situation you’re in, it’s time to build your credit history.
NOTE: Not sure if you have a credit history on file? Go to www.annualcreditreport.com to request a free copy of your credit report from one or all of the three major credit bureaus: Equifax, Experian, and TransUnion. If you have one available, download it and review all the information carefully to catch any errors or inaccurate information. If you see a problem, the credit bureau site will tell you how to report it. There’s more information on this on the FTC (Federal Trade Commission) page.
How to build a credit history
Creating your credit history from scratch takes time but it can be done. And considering how important and necessary having a credit history is, the sooner you start, the better off you’ll be.
Here are some methods financial experts recommend.
Apply for a secured credit card. You deposit a relatively small amount of money (say $500) in advance that serves as the credit limit for that card. Then you make regular payments the same way you would with an unsecured card. Once you’ve established a track method of making payments, you’ll get your deposit back and, depending on the card company, maybe even qualify for an unsecured card.
Apply for a secured loan. A secured loan is a loan that uses some type of collateral (for instance, a car or motorcycle) as a condition of borrowing, explains Investopedia. But remember: if you default on the loan, the lender can seize the collateral.
Become an authorized user on another person’s credit card. This allows you to charge on that person’s card, thereby showing that you have credit in your name, and also benefit from their good credit history. However, you want to make sure that the person whose card you’re on is financially responsible and makes the payments on time; otherwise, it will count against you since you’re both on the card.
Use your rent and utility payments to build your credit. Some landlords report payments to Experian RentBureau. If that’s not an option, Bankrate.com recommends signing up for a rent payment service that works in partnership with RentBureau and have your rental payment history reported. (Another company that offers a similar service is Esusu.) Or sign up for Experian Boost—a free service that allows your payments to be added to your Experian credit file.
Apply for a credit builder loan. This is a small, short-term (typically six months to two years) loan that is deposited into a savings account. You make fixed payments that are reported to the credit bureaus helping to establish your credit history. Once you’ve paid off the loan, the lender gives you the total balance, including any interest that you paid.
Consider participating in a lending circle. This is a group of friends or family members who contribute a specific amount of money each month into a pool. Each month, one member receives that money. When the lending circle is facilitated by a nonprofit such as Mission Asset Fund, the payments are reported to the credit bureaus.
Once you have a solid credit history, then apply for a credit card and use it to create a track record of charges and payments. The easiest method is to set up automatic credit card payments for recurring bills (utility payments, cell bills, etc.). Just be sure to pay the balance on the card in full each month so you don’t incur finance charges.
Also, before you apply for any credit cards or a loan, or any other activity that can result in a hard pull, download a copy of your credit report to make sure the information is correct. Currently, all three credit bureaus are offering free weekly online credit reports.
If you also want your FICO credit score, you can get it for free at FICO® Free Plan—no credit card required. (Your lender or insurer may use a different FICO Score than the version you receive from myFICO, or another type of credit score altogether.)
How your credit score is calculated
Your credit score can spell the difference between getting a loan and being rejected, or getting a great interest rate for financing compared to one that is higher than you would like.
As explained earlier, lenders base your credit score on five main areas. But each area carries its own weight in terms of calculating the overall score. According to MyFICO, your payment counts for the most—35%. Next on the list is the total amount you owe (30%), followed by the length of your credit history (15%). New credit and your overall credit mix are each worth 10%.
Once you’re starting to build your credit history, focus on keeping up to date with your payments—either paying them off in full each month and/or making your payments on time—and keeping your total debt (how much you owe to everyone: bank, credit card companies, other types of lenders) as low as possible.
When you do that, your credit score can range from Good (670-739) to Very Good (740-799) and maybe even Exceptional (800+). If you have late or missed payments, too much debt or other negative information, your score can drop to Fair (580-669) or even Poor (below 580). If you keep that in mind and focus on building your credit, your credit history will work in your favor, not against you!