Whether you are starting from scratch or starting over trying to recover from a bad credit score there are ways to build or rebuild your credit. First let’s look at how credit is scored in the first place. There are five things taken into account; payment history, amount owed, length of history, new credit, and types of credit used. See chart below for percentages.
As you can see payment history and amount owed play the most important roles.
So how do I establish a good payment history? Most popular option is the secured credit card, you put down a deposit and they give you a credit line against your deposit which acts as collateral. This is good for building or rebuilding credit, usually within six months of good payments they will either raise your limit or offer you an unsecured card or possibly both. Second great option is to see if your rent is being, or can be reported, to the credit bureaus. Many landlords report your payment history to the credit bureaus, if they do not, there are services you can use to pay your rent that will do it for you. Though they do charge a fee if your landlord is not signed up with the service, however they usually range around $25 for a registration fee and $7-9 a month, which is well worth it to watch your score climb. If you’re already paying rent it’s a pretty easy way to build your score. A third option is a credit builder loan where you get a loan, but you don’t walk away with the cash that day, instead the lender puts the money in an interest-bearing savings account for you and once repaid with interest you collect the money. This establishes a good payment history with the lender and the credit bureaus. However, you need to check with the lender to make sure they report to all three bureaus. If they only report to one you will end up with a higher score with one bureau. Also bear in mind these loans tend to charge application fees or loan origination fees in addition to interest. Sometimes these fees can be added into the loan payment, other times they want it upfront. However, the interest is generally less than traditional loans and unsecured credit cards. So how long does it take to establish a good payment history with the bureaus? According to Experian, about 6 months.
So now that you have established some credit you need to keep it on the good credit track. The amounts owed compared to how much credit you have is the second most important factor in your score. It’s best to not charge more than you can afford to pay back. This seems like common sense, but in America we are very good at living beyond our means, in 2019 the average American household is carrying $6800 in revolving credit card balances and paying over $1100 a year in interest. Yikes! Sticking to a budget you know you can afford is a sensible way to stay on track. Paying off your card every month or if you must carry balances try to keep them to a minimum. It’s ideal to have a 30% or less utilization rate, consumers with 800 credit scores tend to use only 7% of their available credit. Your utilization rate is the amount of credit you use up to your limit. If you have $10,000 worth of credit over 3 cards, then you would want to keep their cumulative balances at $3000 or less, preferably less, 7% would be a mere $700!
Next, length of history of your accounts are taken into consideration, simply put, how long your credit accounts have been open. Keep the accounts open and paid on time for at least a year before you close any account and ideally only if they carry an annual fee. I know it sounds crazy to keep open accounts you are not really using but it’s the best for your score in the long run. Also bear in mind, some companies will close your account due to inactivity if not used once in awhile so try to buy something every 6 months or so and pay it off right away.
After length of history comes new credit. When you apply for credit of any kind the company will reach out to the bureaus for your full credit history this is called a hard inquiry. In general, hard inquiries are not a bad thing, unless you are just starting out or you are doing a lot of them in a short period of time. (When you are ready to buy a house this is why your real estate agent will tell you to not apply for any new credit and to carefully shop lenders as each lender will run a hard inquiry and you don’t want your credit score falling right before you apply for a loan. They really aren’t just saying it to be mean!) In these instances, it’s kinda bad because hard inquiries drop your score 5-10 points for about 30 days. 5-10 points when you have a good established score is no big whoop, 5-10 points when you are struggling to raise or maintain your score it is a big whoop. In addition, it’s best practice to not apply for a lot of cards at all but especially within 30 days of each other and especially when you are starting out. The bureaus keep tabs on how many times you apply and when you’re beginning to build credit it looks risky to lenders.
Lastly taken into account are the types of credit you apply for, aka your credit mix. It’s good to have a diverse mix because it shows to lenders and creditors you are good at managing and balancing your money. There are two types of credit loans, installment and revolving. Installment is your different types of loans with fixed payments and a definite end date such as student loans, auto loans, and mortgages, and revolving is your different types of credit cards which do not have specific end dates or set balances. If you are building or rebuilding credit and can’t get a traditional loan to diversify your portfolio, the credit builder loan we talked about earlier is a good option. However, it’s important to notate that title loans and payday loans do not appear on your credit report and therefore have no bearing on your score. Even though credit mix is only %10 of your score it is very helpful to garnering a better score faster. You may still reach the coveted “800 Club” but it will take much longer to do so without a diverse portfolio. When it comes to your credit score every little bit counts! Especially when you are trying to build or rebuild your credit.
Now that you know what compromises your score, how to cultivate it, and how to maintain it you can be on your way to building or rebuilding your credit so you can be closer to your dreams of home ownership. And when you are ready, I’ll be here for you.