How to Build and Increase Your Credit Score When You’re Young
5 Tips to Help You Receive a High Credit Score In Your 20s
Are you thinking about applying for your first credit card?
Maybe you’re dreaming of going on a shopping spree with your newly approved card.
Or maybe you’ve seen your friends rack up free travel points in their cards, and you’re thinking of a vacation in the Bahamas.
Some of you might not even care about building credit. But now you’re researching online after your parents kept nagging you about it.
If that’s you, you’re not alone. I’ve gone through the same thing with my parents. And you might not want to hear it from them right now, but they’re doing this because they want what’s best for you.
And as cheesy as this sounds, I want what’s best for you too. I wouldn’t enjoy the benefits I have today if I hadn’t started building credit early on in my life.
Getting a credit card can feel exciting but also scary at the same time. It’s exciting because you hear about all the great benefits. Like racking up thousands of free travel miles. Just imagine all the free traveling you can do.
Or maybe you dream of buying a home with the person you love.
The possibilities are endless. But this can all seem overwhelming and scary too. You hear nightmare stories about people living in constant stress from debt. And you’re wise if you have this fear because it’s not just doom and gloom reporting.
There are real consequences for making poor choices with credit cards. But on the flip side, you get rewarded handsomely if you use them wisely.
So let’s get to the truth about credit cards. I’ll demystify what credit is and how you can leverage it for your benefit.
What is Credit?
According to the dictionary credit is:
- The ability of a customer to obtain goods or services before payment, based on the trust that payment will be made in the future
In other words, it’s your ability to borrow money with the agreement that you’ll pay it back at a later time.
The key phrase here is, “based on the trust that payment will be made in the future.”
And that’s what credit essentially is. It’s based on trust. Trust that you’ll pay back your lender.
In your everyday life, you tend to trust people that follow through on their words with their actions. You base your trust on their ability to deliver on their promise.
In the case of credit, it’s the ability to gather enough money by the payment date. And their ability is largely based on their income and expenses:
- How much money they make
- How much they spend
What is a Credit Score?
Even before credit cards, credit has always been around, dating back hundreds of years from today.
While a merchant during the Middle Ages didn’t have FICO Credit Scores, they did have reputations. And based on their reputations, people were able to receive loans.
And that’s what a credit score essentially is. It’s your reputation as a borrower.
Lenders let you borrow money based on your reputation. If you have a good reputation, you’ll have a higher credit score. This lets borrowers know that you’re trustworthy and more likely to pay back your debt.
If you have a history of paying back your loaned money on time, you’ll have a good reputation. The opposite is true if you keep missing your payments.
These credit scores range from 300 all the way up to 850. And they’re separated into 5 main categories.
These credit scores are given to you by credit bureaus. What are credit bureaus? They’re agencies that gather individual credit information. They then sell the information to creditors so that they can make sound decisions on giving out loans.
You may have heard of these agencies before. The three main Credit Bureaus in the U.S. are TransUnion, Equifax, and Experian.
So how do you build credit? Let’s dig deeper.
How Do You Build Credit?
Tip #1: Build Your Reputation
You build credit by building your reputation as a borrower.
Think of building your credit like building any friendship or relationship. Relationships are based on trust. The more you can trust someone, the stronger the relationship becomes. It’s the same way with your credit score.
Your credit score gets higher the more your lenders trust you.
So how do you build trust with your credit card company?
Tip #2: Pay Your Bills on Time
For starters, the best way to build trust would be to pay all of your bills on time. Put yourself in the creditor’s shoes. Wouldn’t you trust someone who always pays back on time?
So the basic building block for raising your credit score is to build a positive history of payments. You can do this by paying all of your bills on time.
If you don’t have a credit card yet, you can ask your landlord and utility companies to report your payments to Credit Bureaus.
Experian offers this as a service with their Experian Boost program. You can get credit for paying for any monthly subscription-based bills like Netflix or your electric bills.
Tip #3: Never Miss a Payment
Now let’s take a look at a person who borrows money from you but never pays you back. They constantly make excuses and always miss their payments. How would you feel about loaning them more money?
You’d probably get anxious when you think about lending them anything. And because you want to stop them from taking advantage of you, you’d ask them to pay interests and penalties.
This is what happens when you don’t pay your credit card bills on time. You’ll go further into credit card debt by making late payments. And it’s how banks profit from their business.
They profit from people missing payments by charging interests and penalties on the outstanding balance. What’s an outstanding balance? It’s the amount of unpaid credit card debt on your account.
From an investment perspective, this gives high returns. Most credit card interest rates run from 14.5% to 17%. These rates consistently outperform the S&P 500, which sits at an average of 10% in annual returns.
Tip #4: Stay on The Good Side of Banks
Banks and Credit Card Companies offset their risks by putting credit limits on your card. This way, it limits how much you can borrow until your credit card is paid off.
How you use your credit card can set the trajectory of your wealth for the rest of your life.
Use it wisely, you’ll be rewarded with good credit… plus all the perks and benefits that come with having a credit card.
Use it poorly, you’ll drown yourself in debt and prevent yourself from building wealth. Why? Because most of your income will go towards paying off your debt.
All of the interests and fees paid will go towards the credit card company and to customers that cash out their credit card points.
It’s a classic example of positive and negative reinforcement. Credit card companies reward good behavior and punish bad ones.
They reward good behavior at the expense of credit cardholders that made poor financial decisions.
Reward yourself by using your credit card responsibly. Pay your bills on time so that you can enjoy the benefits credit cards offer.
Tip #5: Keep Your Usage Rate Low
When you get your first credit card, you actually want to use your card as little as possible. Now, this might seem counterproductive since you want to build your credit history by using it. But here’s something they don’t teach you in school.
Your credit card is affected by your usage rate.
What is a usage rate?
It’s the percentage of credit you’re currently using on your card. For example, on your $500 credit card, if you spend $400 on groceries, this would put you at 80% credit usage.
You can calculate this by dividing the amount of money you charged on your credit card over your total line of credit.
And this won’t be good for your credit. Why? Because usage rates over 30% lower your credit score. To keep your usage rate as low as possible, you would make small monthly purchases with your $500 credit line.
For example, if I spend $50 weekly on gas, I would charge my card once a month instead of every week. This will put you at only about a 10% usage rate. You can use your debit card or cash to pay off the rest of your bills.
If you consistently pay off your credit card, you can get a bigger line of credit either by asking your bank. Or eventually, you can qualify yourself for a new credit card.
Consider getting your credit line extended because you can lower your credit score by opening too many credit card accounts in a short period. You can do this by simply calling your credit card company and asking.
How Do I Get Approved For a Credit Card?
When you’ve never had a credit card, getting approved for one might seem impossible. You seem to enter into a Catch-22. You can’t get a credit card because you don’t have any credit history. And you can’t build your credit because you don’t have a credit card.
But this is actually not true. I explained earlier that you can build credit by having your landlord and utility companies report your bill to Credit Bureaus.
Now, you might be thinking… but how long is that going to take before I’m approved?
And you’re absolutely right to think this. It’s not the fastest way to build your credit. And it’s also not the quickest way to get you approved for a credit card either.
But what if I were to tell you that there are credit cards specifically made to help you build credit?
Read on to find out what these credit cards are and how you can get one.
Bonus Tip: Get Yourself a Secured Credit Card
If you have trouble getting approved for a credit card, a secured credit card can help you. A Secured Credit Card works similarly to signing a lease agreement with a landlord. They both require you to pay down a deposit.
In exchange for your down payment as collateral, you can start building your credit without any credit history.
These cards won’t give you all the great benefits you hear about from other credit cards. But they’re not meant for long-term use. As soon as you build enough credit history, you should apply for an Unsecured Credit Card. These are the cards you usually hear raving reviews about.
But before you can enjoy the benefits, you have to go through a short-term trial period. Just think of having a Secured Credit Card as a rite-of-passage in the credit world.
Start Building Your Credit Now
Now that you’re armed with great foundational knowledge about credit, what steps will you take to start building your credit?
Do you plan on calling your utility companies to report your bills to Credit Bureaus? Or maybe you’re planning on signing up for a Secured Credit Card.
You might feel like you have a long way to go, but today, you’ve just gotten way ahead of your peers. So what do you want to do when you build your credit? Go on that dream vacation?
Buying a home for your parents?
Whatever your dreams are, I hope that they come true for you.
So what are you waiting for? Get out there and work on your dreams.
Give your future self a gift and start building your credit now.