What Is Credit and Why Is It Important?
Credit is a critical financial concept that refers to the ability to borrow money or access goods or services with the understanding that you’ll pay back the lender at a later date. For individuals, credit is encapsulated in credit scores and credit reports, which are used by lenders to determine the risk of lending money or extending credit. Establishing a good credit history is important because it affects your ability to secure loans, credit cards, and even impacts non-lending situations like renting an apartment or obtaining certain jobs.
Where Should I Begin When Establishing Credit History?
Establishing a credit history can be a catch-22 situation: you need credit to build credit. However, there are several strategies to start building credit, even if you’re starting from scratch:
Secured Credit Cards: A secured credit card is often the first step for those who have no credit history. It requires a cash deposit that serves as collateral and the credit limit typically matches the deposit. It’s designed to minimize the risk for the lender while allowing you to build credit by demonstrating responsible use.
Credit Builder Loans: These loans are offered by some credit unions and banks to help individuals build credit. The money you borrow is held in an account while you make payments. Your payment history is reported to credit bureaus, thus building your credit history.
Authorized User Status: Becoming an authorized user on someone else’s credit card account can also help you establish credit. The account holder’s credit activity will be reported on your credit report as well, contributing to your credit history.
How Can I Use a Credit Card to Establish Credit History?
Using a credit card wisely is one of the most effective ways to establish a credit history:
Make Payments On Time: Your payment history is the most significant factor in your credit score. Always pay at least the minimum due on time.
Keep Balances Low: Utilization, or the amount of your credit limit you’re using, also impacts your credit score. Experts recommend keeping your utilization below 30%.
Be Patient and Consistent: Building credit is a marathon, not a sprint. Consistent, responsible credit behavior over time is key.
What Other Types of Accounts Influence Credit History?
Besides credit cards and loans, other types of accounts can influence your credit history:
Rent Payments: Some credit scoring models include rent payments. You can use rent-reporting services to ensure your rent payments are reported to the credit bureaus.
Utility and Phone Bills: While these bills are not traditionally reported to credit bureaus, some services now allow you to get credit for these payments.
How Long Does It Take to Establish a Credit History?
The time it takes to establish a credit history can vary. Typically, it takes at least three to six months of activity to get a credit score after opening your first credit account. Building a good credit score that will allow you to qualify for better interest rates and credit products can take much longer, often several years of responsible credit use.
Are There Any Risks When Trying to Establish Credit?
Yes, there are risks associated with trying to establish credit:
Overextending Yourself: It can be tempting to use credit for unnecessary purchases. Only borrow what you can afford to pay back.
High Interest and Fees: Be aware of the interest rates and fees associated with any credit product before you apply.
Impacting Someone Else’s Credit: If you are an authorized user or have a co-signer, your actions can affect their credit as well as yours.
Can Checking My Credit Score Affect My Credit History?
Checking your own credit score is considered a soft inquiry and does not affect your credit history. However, when a lender checks your credit score to make a lending decision, it is a hard inquiry and can have a small negative impact on your credit score.
Conclusion
Establishing a credit history is an essential step in achieving financial independence and security. By starting with secured credit cards, credit builder loans, or becoming an authorized user, and then using credit responsibly, you can build a strong credit history over time. Remember to monitor your credit, avoid high-interest debt, and pay your bills on time to maintain a good credit standing.
References
– myfico.com
– experian.com
– consumerfinance.gov
– creditkarma.com
– nerdwallet.com
