What Purchases Help Build Your Credit?
Unlock the power of your spending to build a robust credit profile. Learn which financial actions elevate your creditworthiness effectively.
Unlock the power of your spending to build a robust credit profile. Learn which financial actions elevate your creditworthiness effectively.
Building credit involves establishing a positive financial history that demonstrates your ability to manage borrowed money responsibly. This history is compiled into credit reports and used to calculate credit scores, which lenders utilize to assess your creditworthiness. A strong credit profile can open doors to favorable interest rates on loans, easier approval for credit products, and even better terms on rental agreements or insurance policies. Understanding how various purchases contribute to this process is important for securing your financial future.
Your credit score, often referred to as a FICO score, is calculated based on several factors, with payment history being the most significant, typically accounting for 35% of the score. This factor considers whether you pay your bills on time and consistently. The amounts owed, also known as credit utilization, makes up about 30% of your score, reflecting the amount of credit you are using compared to your total available credit. Lenders prefer to see low utilization rates.
The length of your credit history, which generally accounts for 15% of your score, considers how long your credit accounts have been open. A longer history of responsible credit use is generally viewed favorably. New credit, representing about 10% of the score, looks at recent credit applications and newly opened accounts. Finally, your credit mix, making up the remaining 10%, assesses the different types of credit accounts you manage, such as credit cards and various loans. All these elements are influenced by the purchases you make on credit and how you manage those accounts.
Making everyday purchases with credit cards can be an effective way to build credit. When you use a credit card for small to medium-sized purchases, like groceries or gas, and then pay the full balance on time, you demonstrate responsible credit use. This consistent behavior is reported to credit bureaus and positively impacts your payment history.
It is also important to keep your credit utilization low, ideally below 30% of your total credit limit. For example, if you have a credit limit of $1,000, try to keep your balance below $300. Consistently paying off your credit card purchases in full each month ensures low utilization, which is favorable for your credit score.
Making regular, on-time payments on various types of loans also contributes significantly to building your credit. These typically include installment loans, which are used to purchase assets like homes (mortgages), vehicles (auto loans), or to cover educational expenses (student loans). Unlike revolving credit, installment loans involve borrowing a fixed sum of money and repaying it in predetermined, consistent monthly payments over a set period.
The consistent, timely repayment of these fixed amounts demonstrates a borrower’s reliability over an extended period. While revolving credit focuses on utilization, installment loans primarily highlight your ability to manage predictable debt over time. A mix of revolving and installment credit can also enhance your credit mix.
To maximize credit growth through your purchases, paying on time is the most important action. Even a single late payment exceeding 30 days can negatively impact your score. Setting up automatic payments can help ensure you never miss a due date.
Keeping your credit utilization low is another strategy. For instance, if your total credit limit across all cards is $10,000, try to maintain balances below $3,000. Some experts even suggest aiming for single-digit utilization, around 6%, for excellent scores.
Avoid opening too many new credit accounts in a short period. Each new application often results in a “hard inquiry” on your credit report, which can temporarily lower your score by a few points and remain on your report for up to two years. Instead, focus on consistent, responsible use of your existing accounts, including timely payments, to build a strong credit history.
Certain types of purchases do not contribute to building your credit history because they do not involve borrowing money. Transactions made with a debit card, for example, directly deduct funds from your checking account. This means you are spending money you already possess, not borrowing it, and therefore these transactions are not reported to credit bureaus.
Similarly, purchases made with cash or prepaid cards do not involve an extension of credit. Since no debt is incurred or repaid, there is no activity for credit bureaus to record. Even if you select “credit” when using a debit card at checkout, the transaction still draws from your bank account and does not function as a credit transaction for reporting purposes. These methods offer convenience but do not help establish or improve your credit score.