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Earning a positive credit reputation requires time, action and dedication. If you're just starting out, you'll need to have an open and active account for three to six months before a credit score can be calculated. With the right strategy, however, you can develop a credit history that will result in a credit score faster than you may think.
Once you establish a credit history, you'll be on your way to building credit scores you can be proud of—and that lenders will value. Here's what you can do to build your credit file.
How a Credit Score Is Calculated
A credit score is a number that uses the information that appears on your credit report to estimate how likely you are to repay a loan on time. Lenders refer to this score to help them determine their level of risk in lending you money. That's because credit scores are based on the idea that past actions are predictive of future behavior. Specifically, a credit score is designed to predict your likelihood of falling at least 90 days behind on a bill within the next two years.
Though there are many credit scoring models, most lenders use the FICO® Score☉ or VantageScore®. Both range from 300 to 850, with higher numbers generally indicating a lower risk to lenders. Each credit scoring model uses a proprietary algorithm. Some more heavily weigh certain data, but the same general rules apply: You will earn a higher score if you make all your debt payments on time, keep revolving balances well below your credit limit, and have a variety of account types.
You have no control over which scoring model a lender will use, but you do have control over your own financial habits to ensure the information that ends up on your credit report helps your scores.
First, understand what does not go into a credit score. Employment status and income will not play a factor, though you will list them on a loan application. Also absent from your scores: Your age, race, gender, where you live and other personal identifying information.
So, what are credit scores calculating? Your credit reports tabulate how well you have been managing your financial obligations. To develop a credit score you'll need to open and use credit accounts, such as loans and credit cards. Your activity with them—how long you've had the account, number of on-time payments and other factors—is used to calculate your scores.
For a loan, credit scoring models will factor in the age of the loan, the amount, whether you made any late payments and the balance left on the loan. For a credit card, what matters is your monthly payment pattern, how much of your available credit you're using, length of time you've had it and your total number of credit lines.
Expect your credit scores to be negatively impacted if your credit reports show late or missed payments, foreclosures, collection accounts or charge-offs. If you use too much of your available revolving credit—30% or more for most scoring models—your credit score could take a hit. Also, each time you apply for credit, a hard inquiry will be noted on your report. Too many hard inquiries in a short period of time can shave points from your score.
Reasons Why You May Not Have a Credit Score
Avoiding debt may seem natural to those just starting out, but it starves your credit reports of vital data. Using credit and incurring debt—even very small amounts you quickly pay off—makes you less of a mystery to lenders. If you never take on debt, a lender will have no idea what kind of borrower you may be, which makes you inherently risky.
Without supplying sufficient information to your credit report for a long enough period of time, you will have what's called a thin credit file, and may not have a credit score. Maybe you're a young adult and haven't entered the world of credit yet. If you're an immigrant to the U.S., any debts from your country of origin won't be listed on your credit reports from the three major U.S. credit bureaus (Experian, TransUnion and Equifax). These situations can leave you with a thin credit file until you begin building more credit.
If you have recently opened credit accounts on your credit reports, you won't have a credit score until you have used them for a while. The two primary scoring models, FICO and VantageScore, consider your accounts slightly differently. A FICO® Score will develop after you have at least one account open and recorded on your file for six months. A VantageScore, though, will generate much faster. As long as your credit report shows at least one account, it can begin to factor in to your VantageScore.
With either scoring model, you'll have to keep accounts active if you want them to reflect positively on your credit. Inactive accounts are at risk of being closed. Closing an account can cause your score to drop if it increases your credit utilization rate or shortens your credit age. Even if paid-off loans and credit cards still appear on your report, there won't be sufficient activity for the scoring model to create an accurate score if you haven't made a charge or a payment in 24 months.
How to Start Building Your Credit
You can start to build credit by adding accounts to your credit reports now. If you're just beginning, you have options:
- Secured credit card: To get a secured card, you need to put down a cash deposit with the credit card issuer, which is generally equal to the card's credit limit. That money is held in a separate account, and the funds guarantee the credit line so there is virtually no risk for the lender. If you run up a debt that you don't pay, the lender simply keeps the deposit. But if you pay all your bills on time, you'll likely receive your deposit back. When deciding on a secured credit card, make sure to choose one that reports payments to the three credit bureaus
- Low limit unsecured credit card: These can also be an option, since the issuer won't lose much if you default. Low limit unsecured credit cards tend not to require a high credit score, and won't require upfront cash like a secured card. They do usually charge high interest rates, however, so shop around when you're looking for one of these cards.
- Become an authorized user: Another possibility is to become an authorized user on a close friend's or relative's credit card account. Most issuers will send the account history to all cardholders' credit reports. When it appears on yours, it will jumpstart your credit history. An authorized user doesn't even have to use the card to reap the rewards, as long as the primary cardholder uses it and makes payments on time.
- Credit-builder loan: Applying for and repaying a loan will also help improve your scores, since it adds variety to the mix. Credit-builder loans, usually offered by credit unions, can be a great addition. Like a secured credit card, you deposit a sum of cash into a separate account and receive a loan that matches the deposit. You then repay the loan in installments (plus interest) over a fixed term. When you've paid it off, you get your deposit back.
- Cell phone and utility bills: If you have utility accounts or a cellphone in your name, you can add them to your credit report with Experian Boost™† . It's a free program, and once those accounts are listed on your credit reports, your timely bill payments will add points to your credit scores.
After you have at least one type of credit account on your credit reports, consider applying for another in your name to add variety.
Just be sure to treat credit cards the right way. Pay the debt in full by the due date every month. If you do charge something expensive, be conscious of your credit utilization ratio—the amount of credit you're using relative to your available credit. Owing less than 30 percent of your available credit is considered good, but it's better not to carry a balance from month to month at all.
The sooner you start to add information to your credit reports, the faster your scores will develop. In as little as a few months, a three-digit score will be generated. It may be low in the beginning, but by continuing to prove that you're financially responsible with a several types of debt, your scores will steadily rise.