For some, building excellent credit might begin by applying for a secured credit card, and there are many banks out there that offer a secured card. In fact, they are practically lining up waiting to accept your application and their required minimum deposit in order to approve your secured credit card application.
Beware because a secured card usually has very high interest rates!
There are many factors that impact your credit score and you should definitely be aware of them. Watch each of these closely if you truly want to build excellent credit.
Factors That Impact Your Credit Score
- Payment history: Making on-time payments is one of the most important factors that contributes to your FICO score. A lender will take note of any late payments that are past 30 days, including collections activity and negative public records, if any.
- Amount of indebtedness: Suppose you have a credit card with a $1,000 credit limit and you make your payments on time every month, but your outstanding balance owed is $850. In this example, your credit score will be negatively impacted. Why? Lenders will view this type of credit usage as potentially careless and they will think you actually might not have enough income to make it through the month without using your credit card to hold you over until your next pay day. A good rule of thumb is that the percentage of your total credit usage should be no more than 30% to 40% (and that’s stretching it!) of your credit limit. If you have owe an outstanding balance of $850 and experience an interruption in employment, it would be more difficult to pay down $850 than it would be to pay $300. (For related reading, see: Credit Repair: How to Improve Your Credit Score.)
- Amount of new credit: How much new credit do you have and how long have you had it? When it comes to learning how to build excellent credit, keep in mind that time is the great revelator. Lenders understand that over time, your credit report will reveal a lot about your behavior as a personal steward of your finances.
Therefore, lenders prefer to deal with a borrower with an established credit history of at least two to three years. I have been asked numerous times whether a credit card with a high interest rate should be closed. Rather than closing a credit card with a high interest rate, it’s best to just pay that card down and to keep it open because the longstanding (hopefully good) credit history will improve your credit score over time. (For related reading, see: Should You Close Your Credit Card?)
Increase Your Credit Limit
The more you borrow—and pay on time—the more incentive creditors have to increase your credit limit. Therefore, if you have a credit card with a $1,000 limit, your credit limit could be increased to $1,500, which is good for your FICO score.
This is the creditors way of saying, “You are a good credit risk, we’re happy to have your business and look forward to doing even more business with you.”
Watch out for a little gimmick that some of these secured credit card companies use. If your payment history is good, some secured credit card companies will inform you that “you have been pre-approved for an increase in your credit limit...FOR A SMALL ONE-TIME FEE! They’re simply trying to earn an extra buck. A more reputable credit card company will simply increase your credit limit without charging you. (For related reading, see: 6 Benefits of Increasing Your Credit Limit.)
You might sign on to view your credit balance online and discover that your credit limit has been increased from $3,000 to $5,000. Or, if you call the credit card company, they might increase your credit limit simply because you asked them to.
Four Extra Steps To Build Excellent Credit
- How well can you mix it up? Your credit mix is very important. What is the composition of your various credit obligations? The more diverse your credit mix the better; especially if you make on-time payments and do not max out your credit balance. Your credit mix is important because it is a good representation of your ability to properly manage multiple financial obligations.
- I’m watching you watch me: A lender is going to observe the frequency of “inquires” into a borrower’s credit report over the most recent 24 months. For example, if you are applying for numerous credit cards, this will result in hard inquiries (vs. a “soft inquiry”) into your credit report, which negatively impact your credit score.
- Watch it like a hawk: One of the worst things you can do is ignore your own credit report. Good credit is monitored and maintained because the good credit steward (you) is actively engaged in learning as much as possible about what is being reported each month on their credit report. If you see something you do not agree with, then it is your responsibility to take the appropriate actions to inquire about it and have it removed if it shouldn’t be there. (For related reading, see: Check Your Credit Report.)
- Know your rights: Everyone should be familiar with the Fair Credit Reporting Act (FCRA). The FCRA's purpose is to ensure the accuracy, fairness and privacy of information contained in your credit profile by consumer reporting agencies. The U.S. Federal Trade Commission (my former employer when I was an undergraduate student at Howard University, I am very proud to say) enforces the FCRA, as outlined in 15 U.S.C. 1681.