Want to buy a car? Lease an apartment? Get a mortgage for a house one day? You’ve probably heard this before, but in order to take out a loan for any big purchase, you’ll need to have a good credit score attached to your name. We touched on this in our piece on understanding credit, but if you’re still confused, let’s elaborate some more.
Put simply, a credit score is a number between 300 and 900 that’s created based on your spending habits. A high score (anything over about 650) shows banks and lenders that you’re responsible with money and they can therefore trust you with a loan. Thus, the higher the score, the better your credit.
A low score tells banks you might not be the best at managing money, so they may not want to trust you with a loan. This means it might be harder for you to take out a loan or you might get hit with a higher interest rate (the fee the lending company charges you for allowing you to borrow the money) on loans and credit cards.
So, let’s review:
Good credit = Save money, get approved for loans, buy all the things.
Bad credit = Potential for more debt, struggle to get a loan, live in your parents’ basement the rest of your life.*
*We’re totally kidding. But it could happen.
In all seriousness, even if you do have a low credit score (e.g., you opened a credit card and missed a few payments), don’t fret: It isn’t permanent. You can still work to get it higher by developing healthy credit habits. Chances are you’re just starting to build your score—which is great.
“If you don’t have credit history, how’s a bank to know whether you know how to handle credit?” says Dr. Jodi C. Letkiewicz, Assistant Professor, School of Administrative Studies, York University, Ontario, who teaches, researches, and publishes in the areas of consumer finance, financial planning, and financial well-being. “The earlier you start, the sooner you’re building this component of your credit score.”
Achieving a good credit score isn’t as hard as you think. Keep these tips in mind for building up and up.
6 key tips for building your credit score
1. Always pay your bills on time.
“I suggest young adults with their first credit card use it for only one thing—maybe groceries or their cell phone bill—and pay it off every month,” says Dr. Letkiewicz. Late payments or defaults (not paying at all) will have a negative impact on your credit score.
2. Keep your balance low and your available credit high.
That means trying to keep your balance to less than 30 percent of your available credit, if you can (there are no hard-and-fast rules, but this number seems to be the expert-recommended consensus). For example, if your credit card has $1,000 available, keep your balance under $300.
3. Establish a long history.
Avoid closing old credit card accounts (as long as they don’t charge an annual fee) even when you don’t use them anymore. You can just tuck that credit card away in a drawer so you’re not tempted by it. The longer you have accounts open, the more history you’ll have.
4. Avoid frequently opening new credit lines.
This affects the average time your accounts have been open (see point 3 above). Plus, every time you apply for new credit, it negatively affects your score and stays on your report for two years. This only makes up 10 percent of your score, so don’t worry about it too much, but avoid applying for every credit card or loan out there.
5. As time goes on, establish a credit mix.
Lenders like to see you use different types of credit, such as a credit card, student loan, and a home mortgage—it shows that you’re a responsible borrower. This can be difficult to do when you’re first starting out, so keep it in mind for the future; for now, just aim for responsible credit use.
6. Follow up before and after a missed payment.
If you’re finding it difficult to make your payment or you missed a payment, immediately contact the lender and discuss it with them. They may be willing to work with you to come up with a repayment plan, and this can limit the damage to your score. “As long as this doesn’t become a regular habit, it won’t affect your credit score,” says Dr. Letkiewicz. “If you get into trouble and find you can’t pay your credit card bill (or any bill), don’t bury your head in the sand and hope it goes away! Call your creditor and let them know. You might be surprised to find out they’re willing to work with you until you get on your feet.”
Students share their tips on building credit
“I use my credit card for all my purchases rather than paying by debit. I make sure to make all of my payments on time and to pay at least the minimum monthly payment. This way, I avoid fees from exceeding my monthly debit transactions permitted.”
—Giovanni P., fourth-year undergraduate, McGill University, Quebec
“If you can, cosign with a parent and allow them to monitor your spending for at least a year.”
—Tyler P., third-year graduate student, University of Guelph, Ontario
“I got a checking and savings account along with a credit card from my bank. Use the credit card to build credit, but be wary of getting into debt. They increased my spending limit to $1,600, and I’m in the hole for almost the entire amount.”
—Alejandra M., first-year undergraduate, Metropolitan State University, Minnesota
“Pay monthly payments on a credit card. Don’t spend more than you have in actual cash.”
—Jenna F., fifth-year undergraduate, University of Manitoba
“I have my credit card payment automatically taken from my debit account. I also have a feature that text-alerts me when I spend a certain amount of my choosing so that I don’t overspend.”
—Justin V., second-year undergraduate, Trinity Western University, British Columbia
“Don’t max out your credit card limit and always pay your bills on time.”
—Mamaka K., second-year undergraduate, St. Clair College, Ontario
“You could take out a small loan of a few hundred dollars just to build credit and pay that off in just a few short months to minimize paying interest. Having various forms of credit and experience paying those off positively impacts your credit score over time.”
—Jonathan C., fifth-year undergraduate, Park University, Missouri
“No credit essentially is bad credit. Credit is something you want to develop from a young-ish age (like late teens or early- to mid-twenties). Don’t wait too long until you’re trying to make huge purchases, like a house.”
—Elliece R., third-year undergraduate, University of Regina, Saskatchewan
Jodi Letkiewicz, PhD, Assistant Professor, School of Administrative Studies, York University, Ontario.
Askew, A., Goering, M., Rysdahl, I., Smith, C. et al. (2013). Financial literacy and perceptions of post-college life of undergraduates. St. Olaf College. Retrieved from https://wp.stolaf.edu/sociology/files/2013/06/Fianancial-Literacy-and-Perceptions-of-Post-College-Life-of-Undergraduates.pdf
Detweiler, G. (2016, December 8). Just how bad is my credit score? Credit.com. Retrieved from https://www.credit.com/credit-scores/what-is-a-bad-credit-score/
Dornhelm, E. (n.d.). US average FICO score hits 700: A milestone for consumers. FICO Blog. Retrieved from http://www.fico.com/en/blogs/risk-compliance/us-average-fico-score-hits-700-a-milestone-for-consumers/
Federal Trade Commission. (2013, September). Credit scores. Retrieved from https://www.consumer.ftc.gov/articles/0152-credit-scores
Federal Trade Commission. (2013, March). Free credit reports. Retrieved from https://www.consumer.ftc.gov/articles/0155-free-credit-reports
Federal Trade Commission. (2012, August). Setting out on your own. Retrieved from https://www.consumer.ftc.gov/articles/0331-setting-out-your-own
Harvard College Griffin Financial Aid Office. (n.d.). Set yourself up for financial success. Retrieved from https://college.harvard.edu/financial-aid/financial-literacy/credit
Raghaven, D. (2014, July 7). How student loans affect your credit score. US News & World Report. Retrieved from https://creditcards.usnews.com/how-student-loans-affect-your-credit-score
Singletary, M. (2017, July 11). Average FICO score crosses a milestone, but let’s not get cocky. Washington Post. Retrieved from https://www.washingtonpost.com/business/get-there/average-fico-score-crosses-a-milestone-but-lets-not-get-cocky/2017/07/11/ac288f6a-6650-11e7-8eb5-cbccc2e7bfbf_story.html?utm_term=.1ae7f5948440
USA.gov. (2017, May 11). Credit reports and scores. Retrieved from https://www.usa.gov/credit-reports
US Department of Education. (n.d.). Interest rates and fees. Federal Student Aid. Retrieved from https://studentaid.ed.gov/sa/types/loans/interest-rates