When you leave the nest and you’re on your own for the first time, credit may be the last thing on your mind. However, your credit history and score can affect your life in ways you might not realize. As Erin Lowry, author of Broke Millennial: Stop Scraping By and Get Your Financial Life Together explains, building credit isn’t just about taking out loans.
“Building a strong credit history is important because it works as insurance on your financial life,” she tells mental_floss. “Sometimes your credit report can be used for things other than borrowing money— for example, in a job hunt. Some employers may pull a copy of your credit report (not score) during the hiring process. Landlords are another group interested in your credit history.”
And, of course, if you do need to borrow money or get a new credit card at some point, you certainly want your credit to work in your favor. “It's never ideal to need to borrow money and go into debt, but if and when that time comes, you want to be able to have the lowest possible interest rates and the best possible products,” Lowry says. “Part of how that happens is by creating a stellar credit history and therefore a strong credit score."
So, how do you build good credit when you're just starting out? Follow these steps.
1. KEEP YOUR CREDIT UTILIZATION LOW.
The most tried-and-true way to build credit is to simply use a credit card responsibly, Lowry says. “Get one credit card, make one or two small purchases each month, and then pay it off on time and in full."
Your utilization rate is the amount of credit you’re using in comparison to the amount of credit that’s available to you. If your credit limit is $5000, for example, and your balance is $500, your utilization is 10 percent. The lower your utilization, the better. "You should never use more than 30 percent of your total available credit limit," Lowry says.
Beyond that, you also want to pay your balance in full and on time every month. Not only do you want to avoid late fees and interest that can trap you in a cycle of debt, but your payment history and utilization rate make up 65 percent of your total score.
2. GET A SECURED CREDIT CARD.
“A secured card is a credit card with training wheels,” Lowry says. “The credit card company is understandably a little wary about taking a risk on you because you've never proven yourself to be responsible with credit before, so instead of giving you access to an unsecured line of credit, you're required to put down a refundable deposit.”
These deposits are usually around $200, but they vary from about $50 to $500. In most cases, the deposit serves as your line of credit: If you put down $200, you have a $200 credit limit.
“Because the credit limit is often so low, it's important to only make one or two small charges a month in order to keep your utilization low,” Lowry says. “Once you've proven yourself and are approved for a regular, unsecured card, then you can close the secured card and get back your deposit as long as your account is in good standing.”
3. BECOME AN AUTHORIZED USER
A common credit-building trick is to sign up as an authorized user on someone else’s credit card account. You won't be the account's primary owner, but you will be issued your own credit card (with your name on it). Both your activity and the activity of the primary user will be reported on your credit.
This isn’t a method for everyone, though. “Being an authorized user can certainly help bolster your credit, but only if the person uses his or her card wisely,” Lowry says. “If you're the authorized user on an account with high utilization and missing payments, then it will negatively impact your credit report.”
Conversely, if you use the card to spend irresponsibly you can blemish the primary user's credit history. For this reason, some parents choose to add their children as authorized users to their accounts, then hold onto the cards in their name. This way, the children are able to begin building credit early, but there’s no temptation to overspend.