What’s the best way to build credit and how do you improve your credit score? The secret to building (or rebuilding) and keeping a high credit score is done by forming good habits when it comes to managing your credit applications, loan types, payments and overall financial health.
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.
Below, we’re going to review what is exactly required to increase your credit score, as well as how to keep one!
Keep this mind as you go through the rest of this article; Maintaining a strong payment history is mandatory for building and keeping a good credit score no matter what!
Boost Your Credit Score Fast By Having Good Financial And Credit Habits
Following the below tips will quickly build up your credit score instantly once you break bad habits and change your behavior!
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 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. This happens because your signing a permission form to let them pull a full credit report on you.
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.”
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, to an underwriter it will be obvious that you’re just shopping for the best loan program.
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.
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 increase much faster as a result because it keeps the utilization ratio at almost 0%. Never make just the minimum monthly payments, 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 the down 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. 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.
Improve Your Credit Score Fast By A Opening Credit Card
Below, we’ll discuss three popular credit card options that most banks offer and let people apply for.
- 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.
- Unsecured Credit Cards – Out of all the credit cards, 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 and not utilizing more than 30%! (As your credit score improves, you can apply for better credit card offers later on.)
- 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 who 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!
Revolving Lines Of Credit (LOC’s) Will Raise Your Credit Score
Below, we discuss the different types of Lines Of Credit credit accounts that can raise your credit score.
- Revolving Lines Of Credit – operate 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 even give you checks and a credit card together. Typically there is also a higher credit limit than with a normal credit card. If the account has a really high credit limit amount of $25k or more, it will most likely 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. It has access to very large credit limits because the home equity is used as collateral. Most home equity lines of credit I see advertised start at 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.
Fixed Installment 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 rebuild your credit and increase your credit score.
Fixed installment loans can be better than credit cards because:
- Fixed Installment Loans build up a payment history without the risk of having a balance maxed out like on a credit card. 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 this way.)
- Some fixed installment loans can be secured such as mortgages or auto loans. They will typically have better interest rates than unsecured personal loans. When the lender has secured property as collateral, it is a much lower risk for them, compared to an unsecured credit card or personal loan.
- If you take out a loan for the full amount, then pay the principal down over a set amount of time like 1, 3, 5, 10, 15, or even 30 years, it forces you to pay the money back and pay your debt off because you can’t run the balance back up unless you get a whole new loan to refinance into. Revolving lines of credit or credit cards let you run the balance back up.
What Happens Next?
It’s always a good idea to maintain at least 2 – 3 credit accounts so that if you ever decide to close one out, 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’s 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. Without established credit, this dream will not happen! I think it’s important to understand how credit works and how to use it responsibly. That is the reason I wrote this article.
What’s your best credit card interest rate or rewards program? Do you care about building credit? Comment below.