During my latest financial planning workshop, I had the pleasure of meeting a few millennials. It was refreshing to see their hunger for financial knowledge. As we talked, some problematic issues of their generation surfaced, one being how to build a credit history. They conveyed that friends wanting to rent their own apartment were turned down because they didn’t have a credit history. Here’s one of life’s ambiguities. Like applying for jobs that require experience when you can’t get a job to gain experience, how do you build credit when you’re just starting on the path to financial adulthood?
To start building credit:
Start out with a store card or gas card.
Bank money in advance before making purchases.
Pay your bills on time.
Find a credit card with the most benefits. Look for a low interest rate, cash back rewards, and no annual fee. If you don’t qualify for a credit card, another option is a secured credit card.
A secured credit card requires a cash collateral amount as a deposit. It’s usually a denomination of $300 or $500. The cash amount becomes the limit for the account. It’s like a self-imposed credit balance. You may be able to add to the limit by depositing additional money.
Ask parents to be an authorized user on their account. If your parents have a good credit history, it will spill over onto your history.
Transfer balances to a zero percent account.
Plan spending. Related post: Spending
Get Into These Habits
Keep your credit usage well below your maximum limit. That would be using no more than 30% of your maximum allowed credit. It would be good to limit the number of credit accounts that you have. Your ability to manage your available credit is as important as your payment history.
Don’t open multiple accounts in a short period of time. Better yet, limit it to two credit cards in total. You only need one credit card in addition a debit card but I like to have two in case something happens with an account, then the other serves as a backup. For example, if your credit card number gets stolen, which is very common, the account will be frozen and you have to wait for a new card. The other credit account serves as a backup while the other account is frozen.
Make small purchases with banked money. The consistent usage in small paid amounts demonstrates responsible usage.
Use tech. I live and die by my phone’s calendar. Anything that’s important gets entered, even if many months in advance. Do you need a reminder to pay your credit card bill? Use your phone. You can set alarms and reminders on a one-time or recurring basis.
Redefine needs. Limit “emergencies” to keep expenses under control. If you can live without it, and have up until this point, you can get by. Don’t fill up your life with things because your friends have them. Also, you may not be able to have the lifestyle of your parents. They’ve been working a long time for their bounty.
Avoid taking cash advances. Taking regular cash advances is an indication that you are having cash flow problems. Even if it’s not true, it implies that you may be unable to meet your immediate financial obligations. Use your debit card for quick cash.
Keep your credit maximum low. Credit card issuers love to increase your credit maximum. If they do, call them and tell them to keep it at the level that it was. When they increase your maximum level of credit, another potential lender perceives that as a possibility to max out your borrowings, taking on unmanageable levels of debt. If they think you have taken on too much debt, they perceive it as a payback risk.
Check your credit score periodically. Make sure that vendors have reported your transactions properly. There are several online websites that will provide you with a copy of your credit score. You can go to freecreditscore.com, Experian, Equifax, or TransUnion.
Understand the components of your credit score
Excellent Credit: 750+
Good Credit: 700-749
Fair Credit: 650-699
Poor Credit: 600-649
Bad Credit: below 600
- Payment history: This accounts for 35% of the score.
- Amounts currently owed: 30% of the score is based on this. This includes not only credit card balances but also home loans and car loans. The credit card balances can do the most damage here. Obviously, it’s good to try to keep the credit card balances as low as possible.
- Length of credit history: This makes up about 15% of the total score. The longer the history, the better. Good payment history accounts should not be closed.
- Types of credit: This accounts for about 10%. There should be a healthy mix of accounts (i.e., not all credit card accounts). Credit card, home loan, and car loans should be balanced.
- Searches for new credit: This also accounts for about 10%. This category reflects how often a person is seeking credit. It shouldn’t be frequent; that’s a bad sign.
Credit card companies seduce young people with plastic money, so it’s easy to swipe and get stuff. They’re hoping that they will neglect the obligation. That’s how they make money. Interest charges and late fees can quickly snowball, putting the consumer on a hamster wheel of payments.
Be conscious of your billing cycle, interest rate, late fees, and payment due date. A credit history that looks like a hurricane blew through it leads to years and years of recovery.
My own personal experience with credit cards began when a department store gave me my first credit card. I was dying to use it and actually felt lucky that they had granted me credit. I bought a pair of blue jeans for twenty dollars. When I came home from the store, I put five dollars on my shelf. For the next three weeks, I put five dollars on my shelf. When the bill came, I put the twenty dollars in the bank and wrote a check to pay for the twenty-dollar pants. It’s really that simple. On a larger scale, having the money up front before making purchases is the smartest way to ensure that you will pay the entire bill.
Following my consistent behavior, I received a letter from one of my credit card companies. They knew I only had a few years’ worth of credit usage behind me, but they recognized me as a person who managed credit in a responsible manner. I was very proud of that and made sure it stayed that way. I’m certain that that’s what helped me buy my home.
The world is open to you when you use credit responsibly. By laying the groundwork as a competent user of credit, you’ll be clearing your own life path. Your choices will be unrestricted, allowing possibility to unfold. As your life expands, having credit at your disposal will manifest considerable conveniences, enhancing the enjoyment of your life.