It's a common financial predicament for most 20-somethings: You need credit to get credit. But even if you're older and have been through some credit-wrecking havoc in your life, you could face the same issue.
"The only way to build a credit history is to use credit," explains Maxine Sweet, vice president of public education at the credit bureau Experian®. Check out these six easy steps to help get you started.
1. Know the score.
Figure out what credit history you've established. Even if you've never had a loan or credit card, there's a good chance you have information on your credit reports that has been compiled by the three major credit bureaus: Equifax®, Experian® and TransUnion®. For instance, Experian now collects rental payment histories, so some landlords submit reports to credit bureaus, notes Sweet.
Under federal law, the three credit agencies are required to provide you with a free report every 12 months. JJ Montanaro, a certified financial planner ™ practitioner with USAA, suggests taking advantage of your free annual report from AnnualCreditReport.com.
Your credit score, however, isn't included in your free annual credit report. In most states, the credit bureaus each charge around $10 for your score.
The higher your score, the lower risk you are to lenders and insurers. This means you'll generally have a better chance of receiving credit along with lower interest rates. Be aware, though, that this all-important number, which ranges from around 300 to around 850, can vary depending on the scoring model used by credit agencies and lenders.
2. Research your choices.
If you have little or no credit history, your choices for loans or credit cards may be limited, says Montanaro. However, retail or gas cards, and loans secured by property, such as furniture or a car, may be easy to get. Montanaro also suggests asking your parents or someone else with good credit to cosign on a low-limit credit card with you.
Your bank or credit union may provide another alternative. Sometimes they offer special programs for customers who need to establish credit, such as a secured credit card program that is linked with a CD rate.
3. Establish a track record.
Once you have some credit accounts, it's important to use but not abuse them. "It's counterintuitive, but if you don't use credit, you won't be able to build a solid history," explains Montanaro.
A good habit: Use your card to make small purchases and pay off the balance each month. "By charging a small amount on at least one card and paying the balance on time and, ideally, in full, you will show that you can manage credit without charging more than you can afford to pay," says Sweet.
4. Use credit wisely.
If you want to be a credit superstar, you must follow two basic rules: Pay on time and don't go over your credit limits. For those of you just starting out, this is even more critical.
"It is important to start carefully -- at this point, you don't have a long and distinguished track record that can help alleviate the impact of a small mistake, so tread carefully," says Montanaro. "Using credit responsibly means you use and pay off your cards monthly, make payments on time every time, do not apply for numerous accounts and check your report periodically."
5. Don't make these mistakes.
The following are common blunders you'll want to steer clear of, says Gina Jordan, assistant vice president of product management at USAA.
- Submitting too many applications: Applying for several lines of credit and loans within a short period of time can give lenders the impression that you're in desperate need of money and may have trouble paying back the debt. Keep your number of applications at a minimum and only go for the opportunities that offer the best deal for you.
- Maxing out your accounts: Part of your score is based on the amount of credit you have available but aren't using. The lower your balance (in proportion to the credit limit), the better.
- Closing accounts: If you decide you no longer need a particular account, don't close it. The age of your accounts affects your score, so keep the oldest ones to show as long a credit history as possible.
6. Keep an eye on your reports.
Once you've established credit, get in the habit of keeping an eye out for fraudulent activity, as well as any reporting mistakes.