How Can You Start to Build Credit as a Young Person?

Establishing a positive credit history is an important financial step for young people. A strong credit profile can influence everything from renting an apartment to securing favorable loan terms. Understanding how credit works and proactively building it provides a significant advantage for future financial endeavors. Developing good credit habits early contributes to long-term financial stability and access to better financial products.

Foundations of Establishing Credit

A credit score provides a numerical summary of an individual’s creditworthiness, indicating the likelihood of repaying borrowed money. Lenders, landlords, and some insurance providers consider this score when evaluating applications. A higher credit score can lead to lower interest rates on loans or better terms on insurance policies. The score is influenced by several factors:

Payment history: Accounts for about 35% of a credit score, reflecting consistency in paying bills on time.
Amounts owed (credit utilization): Makes up approximately 30% of the score.
Length of credit history: Contributes around 15%, including the age of the oldest account and the average age of all accounts.
New credit applications: Accounts for about 10%.
Types of credit used: Accounts for about 10%, such as a mix of installment and revolving accounts.

Navigating Initial Credit Products

Young individuals seeking to establish credit have several product options. Understanding how these products function and their general application requirements is an important initial step. These avenues provide structured ways to demonstrate responsible financial behavior to credit reporting agencies.

Secured Credit Cards

Secured credit cards are a common starting point for those with limited or no credit history. These cards require a refundable security deposit, often matching the credit limit. For example, a card might require a minimum deposit of $200, which then becomes the credit limit. Responsible use, including making on-time payments and keeping balances low, is reported to the major credit bureaus, helping to build a positive payment history. After a period of responsible use, some secured cards may allow users to transition to an unsecured card and receive their deposit back.

Authorized User Status

Becoming an authorized user on another person’s credit card can also help build credit, particularly if the primary account holder has a long history of responsible payments. The account’s payment history and credit limit may appear on the authorized user’s credit report, benefiting from the primary cardholder’s good habits. While authorized users can make purchases, they are not legally responsible for the debt. The primary cardholder remains accountable for all payments. Ensure the issuer reports authorized user activity to credit bureaus for this method to be effective.

Credit Builder Loans

Credit builder loans offer a unique approach where the loan amount is held by the lender in a locked account, such as a certificate of deposit, while the borrower makes regular payments. Once all payments are completed, the borrower receives the full loan amount, minus any interest or fees. These loans are specifically designed to report on-time payments to credit bureaus, thereby establishing a positive payment history and building savings simultaneously. Loan amounts usually range from $300 to $1,000.

Federal Student Loans

Federal student loans, when managed responsibly, contribute to a credit history as a type of installment loan. Payments are reported to credit bureaus, and on-time payments can positively influence factors like payment history, length of credit history, and credit mix. Even if payments are deferred while in school, the loan may still appear on credit reports, contributing to the length of credit history. However, missed or late payments can significantly harm a credit score and remain on a report for up to seven years.

Co-signed Loans

Co-signed loans involve another individual, typically a parent or trusted adult, agreeing to be equally responsible for the debt if the primary borrower cannot pay. This arrangement allows individuals with limited credit history to qualify for loans they might not otherwise obtain. The loan appears on the credit reports of both the primary borrower and the co-signer, meaning responsible payments benefit both parties’ credit scores. Conversely, any missed payments or defaults will negatively impact the credit of both individuals.

Practicing Sound Credit Habits

Once initial credit products are established, consistent and responsible management is important for building a strong credit profile. Adhering to good financial practices ensures that credit-building efforts yield positive results. These habits demonstrate reliability to lenders and contribute to a favorable credit score.

Making On-Time Payments

Making on-time payments is the most important factor in maintaining and improving a credit score, as payment history constitutes the largest portion of the score. Even a single payment delayed by 30 days or more can negatively affect a credit score and remain on the credit report for up to seven years. Setting up automatic payments or calendar reminders can help ensure that all bills are paid punctually.

Keeping Credit Utilization Low

Keeping credit utilization low is another important practice. Credit utilization refers to the amount of credit used compared to the total available credit across all revolving accounts. Experts advise keeping this ratio below 30%. For example, if you have a total credit limit of $1,000, your outstanding balance should ideally not exceed $300. Maintaining a lower utilization, even below 10%, can further benefit a credit score.

Avoiding Excessive New Credit Applications

Avoiding excessive new credit applications within a short period is advisable. Each application for new credit typically results in a “hard inquiry” on a credit report, which can temporarily lower a credit score. While a single inquiry has a minimal impact, multiple inquiries can suggest a higher risk to lenders. Apply for new credit only when necessary.

Maintaining a Long Credit History

Maintaining a long credit history is beneficial because the length of time accounts have been open is a factor in credit scoring. Keeping older accounts open, even if rarely used, can help increase the average age of all credit accounts, which positively influences the credit score. Closing old accounts, particularly those with a long history, can shorten the overall credit history and affect the score.

Tracking Your Credit Journey

Monitoring credit progress is a necessary step for ensuring accuracy and understanding how financial actions impact creditworthiness. Regularly reviewing credit reports allows individuals to identify any discrepancies and track their score’s evolution. This proactive approach helps in maintaining a healthy financial profile.

Individuals are entitled to free access to their credit reports from each of the three major nationwide credit bureaus: Equifax, Experian, and TransUnion. These reports can be obtained weekly through AnnualCreditReport.com. Requesting reports directly from this authorized source ensures legitimate access without hidden fees.

Upon accessing credit reports, review them thoroughly for accuracy and completeness. Look for any unfamiliar accounts, incorrect payment statuses, or inaccurate personal information. If an error is identified, dispute it with the credit reporting company (and potentially the information provider) in writing, providing supporting documentation. Credit bureaus generally have 30 days to investigate disputes.

While credit reports do not include credit scores, numerous free resources are available to check credit scores, often provided by credit card issuers or financial institutions. These resources typically offer insights into the factors influencing the score and how it changes over time. Understanding these changes helps in assessing the effectiveness of credit-building strategies and making informed financial decisions.