How Does a Young Person Build Credit?
Discover how young people can strategically build and manage their credit for a strong financial future.
Credit is a contractual agreement that allows an individual to receive goods or services now with the promise to repay the lender later, often with interest. This concept also refers to an individual’s financial history, specifically their record of borrowing and repaying debt. Establishing a positive credit history is important for young people as it influences future financial opportunities, such as securing an apartment lease, obtaining loans for education or vehicles, and even certain employment prospects.
Understanding Credit Basics
A credit score is a three-digit number, ranging from 300 to 850, that summarizes an individual’s creditworthiness. Lenders use these scores to evaluate the likelihood of an individual repaying borrowed money on time. FICO and VantageScore are the most common scoring models, though their weighting and calculations differ.
Primary factors influencing a credit score include payment history (approximately 35% of a FICO score), which tracks on-time bill payments. Amounts owed, or credit utilization (about 30% of a FICO score), measures the proportion of available credit used; a lower rate is better. Length of credit history (around 15% of a FICO score) considers account age; a longer history of responsible use is beneficial. Credit mix and new credit inquiries each contribute about 10%. These components directly impact credit building strategies.
Practical Ways to Start Building Credit
Young individuals with limited or no credit history can establish a credit profile through several practical methods. Each method involves reporting financial activity to major credit bureaus.
Secured credit cards are a common starting point, functioning much like traditional credit cards but requiring a refundable cash deposit as collateral. This deposit, usually $200 to $500, becomes the credit limit. Regular, on-time payments on a secured card are reported to credit bureaus, demonstrating responsible credit use. After responsible use, often 7 to 12 months, some issuers may upgrade the card to unsecured and refund the deposit.
Becoming an authorized user on an established credit card account can also help build credit. This involves being added to someone else’s credit card, allowing the young person to benefit from the primary account holder’s positive payment history. The primary user must maintain good payment history and low credit utilization, as their activity reflects on the authorized user’s report. This leverages existing good credit without incurring new debt.
Credit-builder loans are another effective tool, designed specifically for individuals with thin or no credit files. Unlike traditional loans, the borrowed amount (often $300 to $1,000) is held in a locked savings account or Certificate of Deposit (CD). The borrower makes regular payments over a set term (typically 6 to 24 months), which are reported to credit bureaus. Once repaid, funds are released, providing both credit history and savings.
Student loans can also contribute to a credit history once repayment begins. While not primarily a credit-building tool, on-time student loan payments are reported to credit bureaus, positively impacting scores. Approach student loans with caution, as they are a significant financial obligation for necessary educational expenses.
Finally, some services allow on-time rent and utility payments to be reported to credit bureaus. Since these payments often don’t automatically appear on credit reports, these services are useful. Reporting consistent payments adds valuable positive data, demonstrating reliability.
Maintaining and Improving Your Credit Profile
Maintaining and improving a positive credit profile requires consistent, responsible financial habits after establishing initial credit. Payment history is the most significant factor influencing credit scores, so making all payments on time is paramount. Even a single payment 30 days or more overdue can significantly harm a credit score and remain on a credit report for up to seven years. Automatic payments or reminders help ensure timely submissions.
Keeping credit utilization low is another important strategy. This refers to the amount of credit used compared to the total available credit. Experts advise keeping credit card balances below 30% of the available credit limit; lower percentages are more favorable. For example, on a card with a $500 limit, maintaining a balance under $150 helps demonstrate responsible credit management.
Regularly checking credit reports for accuracy is necessary. Consumers are entitled to a free copy of their credit report from each of the three major credit bureaus (Equifax, Experian, and TransUnion) once every 12 months through AnnualCreditReport.com. Reviewing these reports helps identify and dispute errors, such as incorrect personal information, accounts that do not belong to the individual, or inaccurate payment statuses. Errors can be disputed directly with the credit bureau and the information provider.
A diverse credit mix, including revolving accounts (like credit cards) and installment loans (like student or auto loans), can positively influence a credit score. This demonstrates the ability to manage different credit types responsibly. A long credit history naturally develops with consistent, responsible use over time, benefiting credit scores. While new accounts can temporarily lower the average age of accounts, the positive impact of a lengthy history of on-time payments and low utilization outweighs this minor effect.