Good credit is an important part of life and for those young adults who need student loans for college, their first car, or a new home, the lack of a credit history can be a problem. There are quick ways to build good credit and establish a positive credit history. Responsible financial habits, when established early, can ease the transition to adulthood and financial independence.
Here are the best ways to build a good credit score fast.
Why You Need To Build Credit
As a young adult or recent college graduate you may be wondering why it is important to build credit in your early 20’s. If you needed financial aid and student loans to get through college then you likely had your parents co-sign your debt, meaning the financial institution who issued your funds was willing to overlook your lack of credit history. However, as the real world looms and your parents are no longer offering you a financial cushion, getting credit can prove to be more challenging.
Due to the lack of financial education in the United States, many millennials who are just starting out in the world may not realize how crucial a good credit score history is to financial security and independence. Here are just a few ways your credit score is used and why you need to build your credit fast.
- Credit Card Companies– Credit card issuers use your credit history to approve or decline applications. Once you are approved, a credit score can determine how high or low your interest rates are. Similarly, if you need more credit to purchase higher-priced items, you may need a credit limit increase.
- Home Loans and Mortgages– These are likely the largest purchases you’ll ever make. The interest you pay on your mortgage will amount to hundreds of thousands of dollars, depending on where you live. Because of the amount of a home loan, a higher interest rate due to a low credit score or bad history can cost home buyers tens, if not hundreds, or even thousands more in interest payments.
- Auto Loans– When buying a new or used car, most adults often finance their purchase. The final amount you pay for this depreciating asset should be as low as possible to help you divert extra cash to other activities that actually create wealth, such as investing. Your credit score and history may either earn you a no-interest loan or overburden you with higher monthly rates.
- Getting A Job– Many employers check your credit score to determine your financial habits. The idea is that a financially responsible individual who manages his/her own finances well is likely to be a better employee.
- Car Insurance Coverage– No one likes paying insurance premiums, yet auto insurance is mandatory in the United States. Furthermore, statisticians have found a positive relationship between people with high credit scores and safe driving. For this reason, the best car insurance companies in most U.S. states check your credit score to determine your insurance rates, offering a discount to drivers with strong credit.
- Business Loans– Buying a business tends to be the surest way to financial independence in the United States. However, as a first-time business buyer most purchases require the cooperation of the Small Business Administration (SBA). SBA loans often require a sizable as well as a strong credit history to get approved. Having no or bad credit can be the difference between the ability to buy a business and being forced to pass up an incredible financial opportunity.
Now that you know why you should care about building up credit, let’s discuss how to actually do it!
It Starts With Your Job
In order to build credit and establish a history, an individual must have a stable income and for most people that means getting and keeping a job. Whether the job is part or full time, an employment history is the first step to building credit.
It is important to remain employed at the same job for at least a year unless, in the case of students, the job is temporary or seasonal. Jumping from job to job causes your income to be unstable, making it difficult to get credit.
Open Bank Accounts
High school and college students can establish checking and savings accounts at local banks or credit unions. While having bank accounts will not improve your credit score, it will establish you as a customer and may make it easier to obtain credit through your financial institution.
It is also important to maintain the accounts in good standing since overdrafts can have a negative impact on your relationships with the bank. With a savings account and a decent income most people over age eighteen can obtain a secured credit card or loan.
Apply for Secured Credit Cards
Debit cards, which are issued with checking accounts, do not report to credit bureaus and will not build your credit history. A secured credit card has a credit limit equal to the amount in a savings account that is used to ensure the principal of the loan will be paid if the account holder defaults on the payments.
These credit card companies make regular reports to credit agencies and can improve your credit score and establish a payment history. The money in the savings account that secures the card cannot be withdrawn unless the card is paid off and cancelled.
Like other credit cards, secured cards have monthly payments that must be made on time to build a good credit history. The best strategy may be to use the card only for essential monthly expenses and to pay it in full each month.
Interest rates on secured cards can be high and by paying the card off each month, cardholders avoid paying interest while their timely payments improve their credit score and build a good credit history.
Consider Secured Loans
The first loan many young adults obtain is a car loan which is a type of secured loan. The loan is secured by the value of the car and if the debtor does not make the payments when they are due, the lender repossesses the vehicle.
As a rule, banks and credit unions offer lower interest rates on car loans than finance companies. Plus, being a customer of the bank you get the loan from increases your chances of being approved.
Paying off a car loan is a great way to build a credit history fast, but it is important to keep monthly payments affordable. Include the cost of full coverage car insurance when deciding how much you can spend on a new or used car. Lenders require full coverage as a condition of the loan.
Getting Unsecured Credit Cards
Once you have established a good payment history for about one year you can apply for unsecured credit cards. If you already have a relationship with a bank, you are more likely to be approved for unsecured credit through their credit department.
The credit limit on unsecured cards is based on your credit score, payment history, income, and outstanding debt. Just as with secured cards, it is important to pay these cards in full each month to show responsible spending habits.
Shop around before applying for a credit card. Different cards may have different interest rates and some have rewards programs that offer cash back on everyday purchases. You should also consider the fees that apply to the cards since some have annual fees while others may charge high transaction fees, especially for cash advances.
Choose a card that fits your spending and lifestyle habits. It may be better to apply for a card with a higher interest rate and a good rewards program if you intend to pay off the full balance every month.
Automate Your Payments
If you forget to pay your bills on time it can hurt your credit history. Automating payments insures that all your bills get paid when they are due. There are two options for making automatic payments. You can either:
- authorize your bank to release the funds from your checking account on receipt of an electronic bill, or
- you can charge the payments to a credit card and pay off the credit card bill each month.
Using a credit card will improve your credit score and help build your credit history as you pay your regular monthly expenses.
Do Not Apply for Multiple Loans or Credit Cards
If you apply for several credit lines at once, it will have a negative impact on your credit score and can hurt your credit history. It is better to apply for one line of credit and allow some time between credit applications.
Each time a lending institution pulls your credit report, it lowers your credit score unless you are comparison shopping for a single loan (e.g. auto loan) and apply through all the lenders within a 30 day period. This would be considered a single inquiry for your credit report.
Instead of applying for new credit cards, request an increase of the credit limit on the cards you already use. Nearly one third of your credit score is based on the ratio of your available credit to your actual debt. If you have a high credit limit with a low debt balance, it raises your credit score.
Even if you do not plan to use the additional credit, it is smart to apply for the increase since it will improve your score and credit history.
It usually takes between one and three years of good payment habits to establish a credit history. A good credit score can help young adults who are seeking full time employment and housing for the first time since employers and landlords often pull credit reports when considering applicants. If you build your credit history fast and early, you will have a good head start on your financial future.