Whether you're heading off to college in the fall or recently graduated and set off into the world of work, it isn't too early to start building a strong credit history. Your credit score, which is based on that history, carries a lot of weight when it comes to some of life's biggest milestones and by starting now, you can ensure you'll be on the right side of the equation when the time comes. Here are some ways you can earn—and keep—a high credit score.
- As a student or young adult, you may qualify for a student credit card or a secured credit card, either of which will help you build a credit history.
- A high credit score could lead to better interest rates, more favorable repayment options, or a larger loan in the years ahead.
- Remember to pay on time and keep your credit usage low. Otherwise your credit score will decline.
What Is a Credit Score?
Financial institutions like banks and credit card companies are risk-averse by nature. Whether you're borrowing money to buy a home or entering into a leasing agreement with an auto dealer, lenders want to know that they can trust you to make your payments on time. Originally conceived in 1989 by the Fair Isaac Corporation (FICO), a credit score attempts to do that by assigning a single, three-digit number to your overall creditworthiness.
Your credit score is based on information supplied by lenders to the major credit bureaus and compiled in your credit reports. Scores typically range from 300 and 850, and the higher, the better.
Several factors play into what your credit score will be, including how much debt you have, how many loans and credit cards you have open, and how much of your credit limit you are currently using. Some types of information, such as how many late payments you've made, carry greater weight than others. Though credit bureaus vary slightly in how they categorize scores, Experian, one of the three major ones, says that a good credit score starts at 670.
If you can build and maintain a high credit score, you will enjoy numerous financial benefits, including generally lower interest rates when you borrow money, access to a wider range of credit cards, better odds of being approved for various loans, and higher credit limits. Your credit score can also affect the price you pay for insurance, whether a landlord will rent you an apartment, and even whether an employer will offer you a job.
Steps to Take to Build Your Credit Score
Building your credit score as a college student or young adult isn't difficult. These are some of the steps that can put you in the right path.
- Check your credit history. If you've never had credit before, the credit bureaus may have little or no information on you. Even so, you should request a credit report from each of the three major credit bureaus (Equifax, Experian, and TransUnion). It's possible that someone has stolen your identity and opened accounts in your name. According to the 2018 Child Identity Fraud Study by Javelin Strategy & Research, more than a million children were affected by identity fraud in 2017. By checking your credit report at the start, you can make sure that you have a clean slate and, if not, dispute any discrepancies you find. You can obtain free copies of your credit reports at the official website for that purpose, AnnualCreditReport.com.
- Open a student credit card. There are scores of credit cards on the market, but some banks issue student credit cards. Though they come with a low credit limit and higher annual percentage rate (APR) than your typical credit card, they don't require that you have an established credit history. In addition, some provide student-related perks.
- Or apply for a secured credit card. If a student credit card doesn't seem to fit the bill, or you don't qualify for one reason or another, you may be able to obtain a secured credit card. These cards pose little risk to the lender since they require you to put money on deposit to serve as security. As you use your secured card, your payments are reported to the credit bureaus, which allows you to establish a record of paying on time. After a certain period, you should be able to graduate to a conventional, unsecured credit card.
- Make your payments on time. How reliable you are in paying your bills—including credit cards, student loans, and other debts—is one of the most important factors in determining your credit score. Once you start using credit, you'll want to make sure you never miss a payment, because doing so—especially repeatedly—can drag down your score. Conversely, making all of your payments on time can give your score a boost. If you're prone to forgetting, consider setting up automatic payments through your bank account. That makes it almost impossible to miss a payment.
- Keep your credit usage low. Having a lot of credit available to you at any given time can be a good thing. It shows your spending power, as well as your ability to keep balances low or completely paid off—both great signs to any lender. A key factor in your credit score is your credit utilization ratio, which is the amount of credit you're using at any given time compared with the amount of credit you have available to you. The lower your utilization ratio, the better.
Debit cards won't help you build a credit history because they don't report your account activity to the credit bureaus.
Common Mistakes to Avoid
For some people, having access to credit makes it all too easy to overspend and get into financial trouble. Here are some of the pitfalls to watch out for:
- Going overboard. Even if you qualify for multiple credit cards, having too many of them can overcomplicate your financial life. What's more, each time you apply for a card, the lender will conduct a hard inquiry into your credit history, which has a negative effect on your credit score.
- Maxing out your credit. By refraining from spending the entire credit limit on your credit card (or cards), you'll help keep your credit utilization ratio low.
- Missing a payment. Missed and late payments are a black mark on your credit history and can damage your credit score for years. They may also result in penalty fees.
- Closing accounts prematurely. If you're no longer using a particular credit card, you may still want to keep that account open. For one thing, closing the account won't do anything to stop interest from accruing or make the outstanding balance go away; the credit card company will still expect to be repaid; it will report your delinquency to the credit bureaus and eventually turn your account over to a debt collection agency—all of which will have a severe impact on your credit score. Even if your balance is paid in full, experts suggest you keep the account open in order to increase your credit utilization ratio.