How to build credit the right way

How do you get a mortgage, car loan, or apartment lease? By presenting the bank or landlord with good credit history that demonstrates you’ve been financially responsible in the past.

But what if you don’t have any credit history, because you’ve never been approved for credit?

It’s the ultimate catch-22:

• No credit card? No credit history.
• No credit history? No credit card.

If you’re panicking because you don’t know how you’ll get that loan you need without credit history, relax. It can be done.

We’ll walk you through how to good build good credit fast — even if you’re starting from scratch.

A willing parent or significant other who uses credit responsibly can help kick-start your credit score by either co-signing a loan or adding you as an authorized user on a credit card account.

Take Out a Loan with a Co-Signer

The easiest way to build credit for the first time is to open a loan account with a co-signer who already has good credit. A co-signer is simply someone who agrees to be responsible for the loan if you stop paying your bills for any reason.

In most cases, a bank will approve a loan for somebody with no credit history if there is a creditworthy co-signer on the application. In order for this to work, you need somebody who:

• Trusts you enough to put their credit rating on the line for your loan.
• Has good credit themselves.

Be warned: if someone co-signs a loan for you and you don’t make timely payments, your co-signer’s credit will suffer along with your own. If you default on the loan — meaning you stop paying altogether — your co-signer is legally responsible to repay the debt. This situation has ruined plenty of relationships. Proceed carefully.

Another downside to this method is that it requires taking out a loan. That’s fine if you need a loan, anyway — for example, you’re buying a car. But you don’t have to pay interest to build credit.

Become an Authorized User on Someone Else’s Account

With this option, you won’t apply for the card together, but you can ask somebody to add you to their credit card account as an authorized user. Make sure you’re being added to the account as a fully authorized user, as some companies will issue extra cards in different names but only tie the account to one owner.

One way to check this: do they ask for your Social Security number? If not, this trick won’t help you build credit.

After you become an authorized user on a parent’s or somebody else’s credit card, you don’t even have to use the card — as long as they keep paying their bills on time, you will start to build credit. (But it goes both ways, so if they stop paying, this could actually hurt your credit. Again, proceed with caution).

A starter credit card is designed for people new to credit. Unlike many mainstream credit cards, starter credit cards often have:

• Lower credit limits ($300-$500 is a common start).
• An annual fee.
• Higher interest rates.
• Limited or no rewards.

Secured Credit Cards

Some starter credit cards are also secured credit cards. What this means is that you need to have money in a bank account equivalent to your credit line. So, if you want to spend $1,000 on your credit card, you need $1,000 in the bank to cover that.

With secured credit cards, you still make monthly payment — it’s not a debit card, where every purchase is deducted from your balance. Also unlike debit cards, secured credit cards report your payments to the credit bureaus so you can build credit.

Check out our picks for the best secured credit cards if that’s a route you want to take.

Student Credit Cards

If you’re a full-time college student, try starting with a student credit card — see our suggestions for the best credit cards for college students. These cards are designed specifically to approve students and you can upgrade them when you graduate.

Many don’t have the lowest APRs or best rewards out there, but you’ll have a good shot of getting approved and can start building better credit.

Some lenders offer credit-builder loans — small personal loans designed for anyone new to credit. They’ll help you build credit, but come at a cost.

If you take out a small personal loan and repay it in a timely fashion, this will build your credit.

Self is a fairly unique program that allows you to take out a loan and re-pay yourself. The idea behind Self is straightforward: you open a loan, repay yourself, and show the credit bureaus you are responsible with credit. This is likely to increase your credit score, all while keeping the fees and interest costs low.

What About Student Loans?

If you took out student loans for college, you’re in luck. While federal student loans are available to anyone, regardless of credit score, they still help you build credit as you pay them off.

One or two student loans, however, may not be enough to build credit quickly. If you can, you may want to add one or two of these other credit-building techniques to get your credit score higher in a shorter number of years.

Why Do I Need To Build Credit?

If you ever hope to get a home loan or auto loan, you’ll need good credit. Many landlords even require good credit to rent an apartment.

It’s great if you want to stay far away from debt today — but someday you’ll find it’s better to have the credit and not need it than to need it and not have it.

I know a bunch of people who went through most of their 20s without credit. They had no student loans, no credit cards, not even a car loan. They paid in cash and that worked for them. On the one hand, they never had to worry about getting in over their head with debt. But as they got older and started to think about buying a first home (or they just wanted a credit card to take on a business trip), they were years behind others who started building credit in their early 20s — or even younger.

Your credit history may also be used for things like calculating car insurance premiums and employment screening.

I’m not saying this stuff to scare you. Personally, I think it’s crappy that some people get passed over for jobs because they paid a couple of bills late. (And some states are thankfully banning the practice.) But such is the world we live in.

How Long Does it Take To Build Good Credit?

You can build an average or good credit score in just a year or two. But it can take up to seven years to build up an excellent credit score of 750 or higher. (Here’s why.)

It’s possible to build good credit in just a few years, but it requires opening at least a few accounts of each type (loans and credit cards) and being absolutely meticulous about making timely payments. The shorter your credit history, the more a single late payment will set you back.

Most consumers with credit scores in the top 10th percentile (800 or better) have at least 10 years of credit history. That’s because the average age of your credit accounts is one scoring factor. The longer your accounts have been open and in good standing, the more creditworthy you appear to be.

So even if you don’t need credit today, if you want to get the best rate on a mortgage in 10 years, you should start to build credit now.

How Can I Build Credit Fast?

You can build credit quickly by starting with one account, then gradually adding new credit cards or other accounts every six months.

Again, it will take about two years to build a “decent” credit score. But if you add new accounts — and pay them all on time — your score could be quite good in the same amount of time.

The first step to building credit is to open an account that reports your payment history to the credit bureaus.

There are three credit bureaus: Equifax, Experian, and TransUnion. The bureaus maintain databases of everybody’s credit history and package this information as reports and scores to sell to banks, landlords, employers, etc.

For the most part, they collect similar information, although each may track this information differently, and there may be discrepancies on your credit history with each. This is why it’s important to check all three of your credit reports at least once a year. You’re legally entitled to a free credit report from each bureau annually, but those reports unfortunately don’t include your score.

» MORE: Here’s how to also get your credit score for free

Examples of accounts that report to credit bureaus include:

• Major credit cards (Amex, Discover, Mastercard, Visa).
• Installment loan accounts (mortgage, auto, or student).

Examples of accounts that do not report to credit bureaus include:

• Debit cards (regular checking and prepaid).
• Utility and phone bills (electric, water, cable, cellphones).
• Rent payments, unless you or your landlord subscribe to a rent-reporting service.

So even if you have a checking account, an apartment, and a cellphone, you may not have a credit history.

Why Does Having More Credit Help My Credit Score?

Since managing multiple accounts responsibly is more difficult than managing just one or two, the credit scoring system rewards consumers who regularly pay multiple accounts.

Credit scores are funny. I know it seems counterintuitive that someone with more credit cards is less of a risk than someone with just one. But it’s true — to a point.

A good credit score is earned by managing credit well. Until you do that, the credit bureaus don’t have any way to say what kind of credit risk you will be. It’s a lot like safe driving. Insurance companies often give discounts to drivers who haven’t had a ticket or accident in a couple of years. But when you first start driving, you can’t get that discount because there’s no data to indicate whether you’re a safe driver. So showing you can manage a few different credit accounts is a good thing.

The second reason this will help is for what’s called your debt utilization ratio. This is the percentage of the credit limits on all of your credit cards that you’ve currently borrowed against. For example, if you have two credit cards with $500 limits, you have a total credit limit of $1,000. If you have a $600 balance between the two cards, your utilization ratio is 60% — you’ve used 60% of your total credit limit.

With utilization ratios, lower is better, and a high ratio will decrease your credit score.

Here are a few ways to improve this number:

1. Only use a small percentage of your credit line.
2. Pay your card balances down before the closing of the statement cycle. (This will reduce the month-end balance that is used to calculate this number).
3. Increase your available credit.

If you get a new credit card with a $1,000 limit, now your total available credit is $2,000 and your utilization ratio becomes 30% instead of 60, which is better for your credit score.

Do I Have To Go Into Debt To Build Credit?

No! And if you can help it, don’t go into debt just to build credit.

It’s a common myth that in order to build credit you need to carry a balance on a credit card. That’s not true. The credit bureaus reward you for using a credit card and paying it off, whether you pay it in full each month or not.

And borrowing too much — especially in the beginning — will likely hurt your credit score, not help it.

Unfortunately, there is some truth to the fact that credit bureaus reward consumers who have both credit card (revolving) accounts and loans with fixed monthly payments. But if you don’t need a loan, you don’t have to take one out and pay interest just to build credit.

Can I Build Credit by Paying My Rent on Time?

In some cases, yes.

There are several companies — Rental Kharma, Rent Reporters, and RentTrack, for example — that will report your rent payments to one or more of the credit bureaus.

Unless your landlord or property manager already works with these companies, you’ll need to pay a monthly fee (Rental Kharma charges tenants $8.95 a month). Your landlord will also need to validate your rental payments for the system to work.

Also know that most utility bills do not count towards your credit — unless you fail to pay them.

What Do I Do Once I Get My First Credit Card?

So you’ve got a credit card. Congrats! Now the only things you should do are: use the card occasionally and pay the bill on time every month.

Ensuring consistent timely payments is the most important part of building credit. Missing your payment just once can set you back a year or two. But as long as you use the credit card and make regular payments, you’ll start to build credit.

From a financial standpoint, only charge to the card small amounts that you can pay in full at the end of every month. Treating your new credit line like “free money” and then only paying the minimum balance is asking for a big headache when you realize you owe hundreds or thousands at a high interest rate. I know because I made that mistake. Don’t do it!

It’s the catch-22 of personal finance: you need good credit to get a credit card, but you can’t build credit unless you’ve got… oh right, a credit card. But there are ways for someone just starting out to build credit. Become an authorized user, apply for a starter credit card, or take out a credit-builder loan.

Regardless of the route you take to good credit, remember that the most important thing is making timely payments, whether on a secured card or a credit-builder loan.