What’s the best way to build credit? The secret to building and keeping a high credit score is done by forming good habits when it comes to managing your credit and overall finances.
A lot of people think that just using credit cards (or loans) and paying them off every month is all that is required for having and building good credit. The truth is this! It’s a good start, but there is much more you need to know about in order to keep a good credit rating once you get it!
We’ll discuss what you need to know in the below lessons.
In this guide, you’ll learn how to increase your credit score by doing the following:
- Limiting your credit applications
- Building a strong credit age and payment history
- Keeping a low credit utilization
- Using auto-payments to help make on-time payments
- Filing disputes when errors appear on your credit report. The dispute process keeps the credit bureaus in check.
Maintaining a strong a strong payment history is mandatory no matter what!
Lesson #1: Limit Your 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 open your credit accounts wisely.
What’s the difference between a hard and soft inquiry? Check out this article from Credit Karma for an answer: Hard and Soft Inquiries
Department stores are always pushing you to sign up for a new department store credit card to save 10% on a first purchase. It’s best to skip this kind of sign-up offer, especially if you’re just doing it for the discount.
Also, when you’re shopping for a big ticket item and need a new loan, be wary of getting too many pre-approvals. They sound harmless but will generate a hard inquiry and also ding your credit.
Consider the following scenario
You’ll be out shopping for a new car, and you’ll want to test drive that car. Some dealers won’t let you test drive the car unless they pull your credit and pre-approve you first. Never let them do this! What if you’re out test driving several kinds of cars? I’d just walk off the car lot and go somewhere else to buy that new car.
Sometimes your best bet is getting a pre-approval ahead of time from a credit union. Then you can say “That’s OK, I’m already pre-approved from my credit union, here’s a pre-approval letter.”
The only exception is if you’re going to test drive a high-end luxury car; pulling credit is almost mandatory for that.
A hard inquiry can stay on your credit report for up to 180 days. However, your actual credit score should start improving over a short amount of time.
Sometimes, a unique situation may require you to get more than one pre-approval when shopping around for credit. Such as when you’re doing a refinance on your home, and you need to find the best rate. If you must do this, do it in a short period of time (within 30 days), the inquiries will look better to an underwriter. The same rule applies when purchasing a new home too.
BTW, It always looks best if the hard inquiries are all for the same type of loan too!
Lesson #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 this (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 drop your credit score.
Lesson #3: Low Credit Card/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.
Above 30%, and your credit score could go lower.
Be especially careful with large balance transfers, which can really max out a credit line fast!
The lenders hate it when you pay off your credit card balance every month; I do it anyways. I’ve seen credit scores bump up much faster as a result because it keeps the utilization ratio at almost 0%. Plus making the minimum monthly payments will cost you a lot in interest payments. SO PAY OFF THE BALANCE IN FULL EVERY MONTH!
Lesson #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 the down principal balance when needed.
REMEMBER! You want to keep that credit utilization below 30%.
Lesson #5: Dispute All Erroneous Negative Items On Your File
This lesson is pretty straightforward. 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 these errors the moment you see or suspect they might be on your credit report. I’ve written an entire article on the process of checking your credit report and disputing errors. Be sure to check it out.
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.
Maintaining and building a good credit profile and score is not really hard to do if you follow the lessons we discussed in this article. Be proactive, responsible, and monitor your credit report for errors. In the end, you’ll be just fine!