What’s the best way to build credit and improve your credit score?
A lot of people think that just using credit cards and paying them off every month is all that is required to build good credit.
While having on-time payments is a great place to start for building good credit fast, it’s just one factor for calculating your credit score. There are several other factors we’ll discuss below so you can make the most out of building and keeping a high credit score.
Below, we’re going to review what is exactly required to increase your credit score fast, so let’s get into it.
1) Limit Your Credit Applications; Choose Wisely!
Every time you apply for new credit you get a small ding on your credit score, whether or not you get approved. This is because of a hard inquiry, so apply for new credit accounts wisely.
While hard inquiries might drop your credit score a few points, soft inquiries will not.
What’s the difference between a hard and soft inquiry? It’s pretty simple to explain, consider the following:
- A “Hard Inquiry” is registered to your credit report when a financial institution pulls your report because you are applying for new credit. It can stay on your credit for up to 180 days.
- A “Soft Inquiry” occurs when a request for your credit report is part of a background check or when you simply just want your own copy of your credit report.
So by knowing that hard inquiries are bad for your credit score, it’s wise to limit how many credit applications you fill out in a given time. It’s also important that you don’t apply for different types of loans at the same time, such as a car loan and mortgage. Just stick to one type of loan at a time.
For example, if you are in the market for a new home and applying for various mortgage loans to shop around the best rate, this is actually OK. When banks view your credit report it will be obvious to them you are trying to secure the best mortgage for your new home purchase. But, if they see you are also applying for a car loan or a lot of credit cards, this will not look favorably on you.
2) Build A Strong Credit Age And Payment History
The basic building blocks of creating a high and stable credit score are showing a history of reliable on-time payments to your creditors. The more time you can demonstrate a stellar credit history, the better it looks to lenders and the credit bureaus.
Generally, two or more years of recent on-time payments will look the best.
Also, try not to close out good-standing credit accounts that show a long payment history. This can temporarily drop your credit score.
3) Maintain a Low Credit Card or Revolving Line Of Credit Utilization Ratio
Try not to exceed 30% of your total available credit line amount on your credit cards or other revolving lines of credit.
For example, if the credit line is 1,000 dollars, don’t ever use more than 300 dollars of it.
If you go above 30%, your credit score could go lower.
Be especially careful with large balance transfers, which can really max out a credit line fast.
To help keep under the 30% utilization rule, I pay off my credit card balances every month in full.
If you have a special line of credit with a high balance, you might not be able to pay it off in full every month, which is understandable. Just set a goal to get it paid off as soon as possible.
The bottom line: The lenders hate it when you pay off your credit card balance every month; I do it anyways. I’ve seen credit scores increase much faster as a result because it keeps the utilization ratio at almost 0%. Never make just the minimum monthly payments if you can help it, it will cost you a lot in interest payments. SO PAY OFF THE BALANCE IN FULL EVERY MONTH!
4) Consider Auto-Pay On All Of Your Credit Accounts
Setting up auto-pay will force you to make on-time and consistent payments to all of your credit accounts. Just make sure you maintain a sufficient cash balance in your checking account to cover the estimated amount of monthly payments that will go out. It’s also not a bad idea to set up overdraft protection on your checking account, just in case!
Minimum Payments Warning
The auto-pay amount set up for your credit card and revolving line of credit accounts will most likely just cover the minimum payment that is due. So remember to make the extra payments manually to pay down the remaining principal balance when needed.
REMEMBER! You want to keep that credit utilization below 30%.
5) Dispute All Erroneous Negative Items On Your File
If you have any errors on your credit report, it will bring your score down and make it hard to qualify for any new loans or credit accounts.
So get into the habit of disputing credit report errors the moment you see or suspect they might be on your credit report. To learn about checking errors on your credit report, check out my article about: How To Check and Dispute Errors On Your Credit Report.
Late payments are the most common type of errors that are reported and can really bring your score down; scaring creditors away from approving you on any new future credit.
If you’re currently having issues with late payments, I highly recommend you review my guide on Credit Report Late Payment Removal.
6) Improve Your Credit Score Fast By A Opening Credit Card
Let’s discuss three popular credit card options that most banks offer to their customers. Below, we breakdown which options are good for building up a credit history vs. not good.
Prepaid Credit Cards
(no advantage for rebuilding credit)
Prepaid credit cards work more like gift cards or debit cards. They have high fees and are usually offered by big companies like WalMart, GreenDot, and NetSpend. They don’t provide any advantages for rebuilding credit. The big reason for this is that they don’t report any payment history to your credit report, so it’s best to skip this as an option.
Secured Credit Cards
Can be a great start but to qualify you’ll be required to deposit money into a checking account. This secures the credit with cash, and then you’re issued an actual credit card that can be used for purchases.
Then all you have to do is make the payments on time every month and start building up a new payment history that reports directly to your credit report.
Typically, you can start with just 100 dollars (or more). After about 12 months the bank that issued you the secured credit card might even convert it to an unsecured account and refund the deposit to you.
The downside of this option is a secured credit card signals bad or no credit; So I recommend this only if you can’t qualify for an unsecured credit card first!
Unsecured Credit Cards
Out of all the credit card options, unsecured accounts are the most common and is the type of credit card account most people will want to get.
It will build up your payment history without requiring any kind of upfront deposit money.
If you have bad credit or a newly established credit history, you will most likely have to pay a higher interest rate and some type of annual fee.
If the interest rate is high, it will not matter if you follow the good habit of paying off the balance in full every month. Then, as your credit score improves, you can apply for better credit card offers later on.
7) Revolving Lines Of Credit (LOC’s) Will Help Raise Your Credit Score
Below, we discuss the different types of Lines Of Credit accounts that can help you raise your credit score. These work much like a credit card account and will help build your credit history as you make on-time monthly payments.
Regular Revolving Line Of Credit
A line of credit operates the same as a credit card because you can draw from it, then pay it back, then take a draw again until your credit limit is reached.
The lender (or issuing bank) will give you checks which you can use for making purchases or getting a cash advance.
It’s common you’ll also be given a credit card that will draw from the same account too.
Typically there is a higher credit limit with lines of credit than with a normal credit card. If the account has a really high credit limit amount of $25k or more, it will most likely need to be secured with some type of real property or an asset.
Home Equity Line Of Credit (HELOC)
For personal use, a HELOC is the most common type of revolving line of credit account for homeowners, and it works just like a general line of credit.
It has access to very large credit limits because home equity is used as collateral. Most home equity lines of credit I see advertised start for amounts of $50,000 dollars or more.
Small Business Line Of Credit
Small businesses can get a line of credit to cover operating expenses during the slow season. They work just like a personal line of credit but are made out for business use only.
Bigger lines of credit can be secured by assets of a business such as equipment, real estate, etc.
8) Home, Auto, and Personal Loans Will Also Boost Your Credit Score
Below, we discuss why fixed installment loans like Mortgages, Auto Loans, and Personal/Business Loans are an excellent way to build your credit and increase your credit score.
Fixed installment loans can be better than credit cards and revolving lines of credit because:
Fixed Installment Loans build up a payment history without the risk of having a revolving balance maxed out, like on a credit card or line of credit. Having a maxed-out credit card (or line of credit) balance looks bad for your credit report because you’re utilizing more than 30% of the available credit.
Fixed loans are not measured by having available credit because you are just paying down the balance which is owed slowly over a 5 – 10 year (or longer) term. There is no risk to run the balance up again.
Some fixed installment loans can be secured such as mortgages or auto loans, these loans will typically have better interest rates than unsecured credit cards or lines of credit. Whenever the lender has collateral for a loan, it’s less risky for them to loan you the money, so you get a better interest rate.
Overall, any type of fixed installment loan is an excellent way to build your credit history up over time.
It’s always a good idea to maintain at least 2 – 3 credit accounts so that if you ever decide to close an account, your credit score won’t take a big hit because you’ll have some other credit accounts still reporting to the credit bureaus. This will help sustain your credit score for the next time you need to apply for another loan.
I know there are a lot of people out there who don’t believe in going into debt or using credit. The reality for most people is that one day you’ll want to get a mortgage to buy a home and without established credit, this dream will not happen!
I think it’s important to understand how credit works and how to use it responsibly, so remember, use as little debt as you can and pay everything off asap!