Building your credit can seem like a daunting task when you are first getting started, but follow these easy steps and you’ll be on your way to a higher credit score in no time.
In order to get started on your credit building journey, first you should understand how your credit score is calculated. Your FICO score is calculated according to a formula produced by the Fair Isaac Corporation. There are 5 main components which are reported to the credit reporting agencies by your banks and other lenders.
With that in mind we have taken each of these 5 components, summarized them, and provided you with an easy tip to help maximize that component of your credit score.
1) Payment History (35%)
The largest component of your credit score depends simply on whether you have paid past amounts due on time.
TIP #1: Pay your bills on time. All of your bills. In addition to credit cards and other loans, unpaid rent, utility, and hospital bills can eventually make their way into your credit history and leave a big mark.
2) Amounts Owed (30%)
The next largest component takes into account what portion of your available credit you typically use, otherwise known as your utilization ratio. This ratio is reported both on each individual credit account as well as the overall utilization across all your credit accounts.
TIP #2: Keep your credit card balance on each card below 30% of the credit line. If you tend to spend more than 30% of your credit line, you may want to pay off your balance before the end of your billing cycle or ask for a credit line increase. Note: even if you pay your balance off in full every month, your bank typically reports the balance due on your statement.
3) Length of Credit History (15%)
This component takes into account the age of your oldest account, as well as an average age of all your accounts. In general, a longer credit history will increase your FICO score.
TIP #3: Don’t close your oldest credit card account. Even if you don’t use it, an old credit card account can help you establish a long credit history (in addition to lowering your utilization ratio as described above).
4) Types of Credit in Use (10%)
Your FICO score also considers the mix of credit accounts you own, including credit cards, personal loans, mortgages, installment loans, etc. However, it’s not necessary to open one of each and this component won’t be an important part of your score as long as your credit history has enough additional information on which to base a score.
TIP #4: Get a credit card (and use it responsibly). If you don’t already have one, open a credit card account. It’s the easiest way to generate some credit history. If you do already have a credit card account, don’t worry about applying for other types of credit accounts as the incremental benefit is likely to be minimal.
5) New Credit (10%)
This is one of the most confusing components because applying for a new credit card or loan may temporarily ding your credit – yet you need credit accounts to build history, and in some cases having more credit lines can improve your utilization ratio. In general, this component is trying to catch high-risk borrowers that are potentially over-extending themselves, not the one off credit card or auto loan you are thinking of taking out.
TIP #5: Don’t apply for multiple accounts in a short time – especially if you have a short credit history. Opening one new account is unlikely to have a meaningful impact, but if you have a short credit history and try to open multiple accounts in succession, that could indicate higher risk to future lenders and hurt your score.
One last tip: Check your credit score frequently to make sure there are no errors and that your score is moving in the right direction. Credit Karma and Wallet Hub offer free credit reports and are both great resources. Many credit card issuers now offer free reports as well. If you see an error, contact your bank or the lender to correct it. With these tips in hand, you can now be on your way to better credit. Good luck!