Whether you're in the process of rebuilding your credit, or simply planning on establishing it for the first time in your life, there are certain steps you can take to optimize the process. This guide takes you through every step necessary to raise your FICO score as quickly as possible.
How To Build Credit
- Step 1: Open A Line of Credit and/or Take Out a Loan
- Step 2: Properly Manage Your Credit & Loans to Increase Your FICO Score
- Step 2a: Make On-Time Payments
- Step 2b: Keep Credit Utilization Low
- Step 2c: Minimize Deragatory Marks
- Step 3: How Lenght of Credit History Affects Your Score
- Step 4: Other Minor Tips & Tweaks
You can’t establish a credit history without credit. This may seem like a catch-22 to some, since in order to get an offer for credit you need to have credit history. Fortunately, that last bit is not always true – there are ways of opening a line of credit without any prior credit history.
- Become an authorized user on a credit card. If a close relative or significant other has a credit card account, have them add you to it. This will put your name on the map, and will shortly generate a score for you.
- Apply for a student or secured credit card. These credit cards are designed for individuals with no credit history. Often times all you have to do is provide some sort of proof of income or a security deposit, and you can obtain these cards.
- Take out a student loan. Another way of building credit is to take out a student loan to pay for your college/university. Even if you can afford to pay for school, and do not need a loan, it will benefit you to take one out. Simply put away money (as though you were paying for school), and when it's time to pay off the loan, you can do so at once thus avoiding any interest. The net financial result on your account will be the same, but you will have a credit file opened as a result.
It is a good idea to combine two or more of the above suggestions. The greater the diversity of your credit portfolio, which includes credit cards, loans, mortgages, etc., the better impact it will have on your total credit score.
Once you have access to a line of credit – whether through a loan or credit card – the next step in the process is to demonstrate fiscal responsibility. A FICO score is a measure of confidence that the company has in your ability to pay back loans or debt. Following the steps outlined in this section will help your credit history prove that.
One of the biggest factors affecting your credit score will be how often you miss or are late on payments. Most of the steps outlined in this guide will fall back on this crucial measure. If you are late on payments, or miss them completely, your financial institution will report this behavior to the credit bureaus, which may then add derogatory marks on your credit. Opening credit accounts is useless for building credit if you will not pay your bills on time so make sure you are always keeping in line with this step. Even a single missed payment flushes months of credit building down the drain.
Typically, your credit card due date will be the same every month, which should help a consumer keep track of when they need to make a payment.
Credit utilization is the percentage of your total available credit that is being used month-to-month. For example, if you have a total credit limit of $1,000, and carry a balance of $500, your total credit utilization is be 50%.
In order to raise your FICO score, you should ideally keep your credit utilization at 30% or less. This 30% figure is just a good guess, based on the observations of experts in the industry about what FICO may view as ideal. You may alternately see estimates that place this figure at 20%, and others even urge consumers to keep utilization below 10%.
Conversely, if your utilization is too high (60%+) it can begin to lower your credit score.
If you were involved in any negative financial situations in the past, those were more than likely reported to a credit bureau and form part of your credit history. Examples include things like bankruptcies, foreclosures, collections, tax liens, and civil judgements.
Such derogatory marks usually remain on your account for a long time, usually between seven and ten years. The only exception are tax liens, which can remain on your account indefinitely. These will appear on your credit report when you have failed to pay a tax debt. In the case of a federal tax lien, it is possible to have it withdrawn if any or all of the following apply:
- The IRS paperwork wasn’t in order when it was submitted (rather unlikely).
- You are paying off the lien in installments (which depends on the type of repayment plan you have).
- Withdrawing the notice will make it easier for you to pay back the debt.
- Such a withdrawal is in the best interest of both the US government and you. This is the most ambiguous of the reasons given.
If you satisfy any of the above mentioned conditions, you should file a 12277 Form with the IRS. If accepted, the agency will remove the public notice. You can then report the removal to the credit bureau, which will raise your FICO score. You can read more about federal tax liens on the IRS website.
All other derogatory marks on your credit report will remain there for close to a decade, unless you are able to prove they were a mistake or if there are legal developments. If a civil judgement, for example, resulted in a settlement, or was successfully appealed, you may be able to submit proof of this to a financial bureau.
One of the other major contributing factors to credit scores is the duration of time your credit accounts have been open. The longer the better. This is where patience comes into play. There is very little you can do to improve your score from this angle, outside of opening up a credit account as quickly as possible, and waiting for it to mature.
How To Maximize The Age Of Your Credit Account
Become An Authorized User At An Early Age. Earlier in the guide, we mentioned that becoming an authorized user can be a great way to establish credit when you have none to begin with. Another benefit of this method is that you can establish a credit account at an early age – even as young as 16. This will give you a jump start on your “credit age.” Provided that the account is not closed before you reach adulthood, it will benefit your credit score greatly by opening up your own lines of credit once you're old enough.
Do not close credit accounts unless it’s absolutely necessary. Keeping credit accounts open is key to maximizing your credit score. Closing down an account, even voluntarily, can have a strong, negative impact on your FICO score. The older the age of the account, the larger the hit to your score. This is why you should avoid having to have your first credit account be one on which you do not pay an annual or monthly fee. Opting for a "free" account means there will be little to no harm in keeping it open indefinitely, and your FICO score won’t be at risk.
While the considerations we mention above are the main drivers of your credit score, they're not the only things that can affect it. This section briefly outlines other measures one can take to raise their credit score, and tells you how to effectively manage them in order to increase your credit standing.
Minimize Hard Inquiries Into Your Credit Score. Anytime you apply for a new line of credit, or loan, the organization involved will do a credit check on you – these can be either “soft” or “hard” pulls. Soft pulls only verify some basic data. They make sure you are in fact the person you’re claiming you are, etc. A soft pull does not have any effect on your credit. A hard pull, on the other hand, provides the person asking for it with your complete credit history. A single hard pull will slightly lower your credit score for a short amount of time. If, however, you begin applying to many different lenders that do hard pulls, that activity can add up and eventually have a significant effect on your score. We recommend keeping that in mind, in order to not lower your FICO score inadvertently.
Open as many credit accounts as reasonable. The number of different credit accounts you have also can impact your FICO score, this time positively. Having more accounts opened will increase your total available credit, and should minimize your total utilization. That said, however, do not recklessly open accounts that you don’t plan on ever using. If you are inactive on your credit account, your financial institution can potentially close that account, which as we explained above, can then damage your credit score. What's ideal to increasing your credit score is to maintain several credit accounts that you use actively.