If you’re young and fairly new to the concept of credit, there’s a good chance that it’s a complete mystery to you. “Let’s face it: Financial literacy isn’t a focus of our school systems,” says…
If you’re young and fairly new to the concept of credit, there’s a good chance that it’s a complete mystery to you.
“Let’s face it: Financial literacy isn’t a focus of our school systems,” says Alison Norris, certified financial planner and strategy manager at online lender SoFi. “While building good credit affects many of the major financial decisions you’ll make in your life, you likely weren’t taught early on about its importance.”
The numbers agree. A recent survey of college students by U.S. News found that more than 40 percent of respondents weren’t educated by their parents or teachers on important topics related to credit use and management before getting a credit card. In fact, more than 25 percent said they either don’t know how to check their credit score or don’t know what a credit score is.
That’s a big problem, especially considering that you should start building credit when you turn 18, if not sooner. Here’s what you need to know about building credit from an early age.
Why Start Building Credit Early?
Good credit might seem like something you don’t need to worry about until you’re out of college, in a career and about to get a mortgage or finance a car. The truth is that credit affects your life as soon as you become an adult and only continues to do so. That’s why 18, or younger, is a good age to start building credit.
“Unfortunately, a lot of students and young adults do not realize the impact this three-digit number will have on their entire financial lives,” says Steven Millstein, certified credit counselor and editor of credit repair service site CreditRepairExpert. For example, he explains that your credit can come into play when you apply for a job, buy a cellphone or purchase auto insurance. If your credit history is limited or poor, you may be viewed as risky, which means you could be skipped over for job offers and pay more for cellphones and insurance. Plus, when you do want to borrow money for a home, a car or another reason, your credit will determine the interest rates you pay — or whether you’re approved at all.
Fifteen percent of your FICO credit score depends on the length of your credit history. Lenders want to see that you have a lot of experience managing credit. So the longer your credit history, the better your score will be. “Establishing credit early allows you to demonstrate a long credit history compared to someone looking to establish credit later in life,” says Nathalie Noisette, founder of credit consulting agency Credit Conversion.
Noisette adds that there’s another benefit to building credit early: more time to make up for your mistakes. “Credit mistakes do happen,” she says. For instance, you might miss a payment here or there, or even have an account go to collections. The good news is that most negative items drop off your credit profile in seven years or less. “If a mistake is made, the individual still has a chance to make things right by the time they are in their mid-20s,” Noisette says.
How to Start Building Credit on Your Own
So how can you establish your credit when you’re starting from scratch? Though some strategies are tougher than others, you have several options:
Open a secured credit card. If you have a limited credit history and little to no income, it may be hard to qualify for an unsecured credit card. But you can likely get your hands on a secured credit card. With a secured card, you pay a deposit upfront, which serves as your line of credit. Then, you make purchases and pay your monthly bill as you would with a regular card. Over time, your positive payment history will help you build a good credit score, and eventually, you should be able to graduate to an unsecured card. “Just be sure the secured card doesn’t have fees that eat into the credit limit and start you off with a balance,” Noisette says. You’ll also want to verify that your secured card issuer reports payment activity to the credit bureaus.
Take out a loan. Another option is to take out a loan and build positive credit as you pay it back. With limited or no credit history, you might find some loans just as difficult to qualify for as a credit card. But there are certain types you might have more luck with. For instance, a secured loan, which requires you to put up collateral, can be easier to qualify for because the lender takes on less risk than with an unsecured loan. Car loans and personal loans are examples of secured loans. You might also need to take out student loans for school. Although taking on student debt can be a slippery slope, borrowing a manageable level of federal student loans can help you build credit. Federal loans, unlike private student loans, also come with protections and benefits that can help if you struggle with payments. Plus, you don’t need to go through a credit check to qualify.
Try a credit-builder loan. If you don’t qualify for a secured loan — or simply don’t want to take on unnecessary debt — you can also try a credit-builder loan. As its name implies, this loan is designed specifically to help borrowers build their credit. Here’s how it works: A financial institution deposits the money you borrow into a savings account that you can’t access until you have repaid the loan. As you make regular monthly payments, you build credit. Once you’ve paid back the bank, you get the deposit and any interest it earned — plus the positive payment history.
How Your Parents Can Help
Enlist your parents to help you build a good credit history. They can help you build your credit in several ways:
Add you as an authorized user. If your parents have good credit, you might be able to take advantage of it by becoming an authorized user on one of their credit cards. As an authorized user, you’ll have the account added to your credit history. And this option works even if you’re a minor. Most cards allow authorized users younger than 18; some have age minimums, while others don’t.
Norris explains that the parent — the primary cardholder — continues to hold responsibility for paying the balance. Although the authorized user can make purchases with the card, the primary cardholder is legally liable for charges or balances, she says. Noisette adds that a card doesn’t even need to be issued to the authorized user, “so you don’t have to worry about your child maxing out your card. It’s just the history of the card that’s added to their credit report.”
Co-sign a loan. If you can’t qualify for a loan on your own, one of your parents might be willing to co-sign. Again, this involves leveraging their good credit to help you qualify. However, this option is not to be taken lightly. If you fail to make payments, your parents are liable for the debt. And if you mismanage the loan, you can harm both your credit and your parents’ credit.
Offer guidance. Considering how few young adults receive any kind of guidance from the adults in their lives regarding credit management, it can be helpful to encourage your parents to get involved. “It’s a truism of parenting that we all want our children to do better than we did,” Norris says. “Parents can instill great financial habits in their children by emphasizing the importance of making on-time bill payments and avoiding credit card debt.” Your parents can pass down their wisdom and help you establish a healthy relationship with money — but you might need to ask for that help.
Establishing Credit Responsibly Is Key
There’s no getting around it: Building good credit is crucial to accomplishing your financial goals. But it can also be risky, especially if you’re borrowing money without much experience handling debt. To make sure your credit-building efforts are successful, be sure to manage your credit wisely.
One of the best moves you can make is to pay all your bills on time. That’s because payment history is the most heavily weighted factor in calculating your FICO credit score, accounting for 35 percent. “Late payments or delinquent accounts can be reported to the credit bureaus and hurt your credit score,” Millstein says. “To build credit, you need to show that you are responsible for borrowing money and paying it back in a timely manner.”
You should also be cautious about spending and avoid taking on more debt than you can afford to pay back, especially high-interest debt. “Credit cards can really be a double-edged sword, as they come with high interest rates and potentially lots of fees,” Millstein says.
“Make sure you have all of your income and expenses laid out so that at the end of each month you know exactly how much money you have left over,” he says. Millstein recommends picking one budget item, such as a utility bill or cellphone bill, to charge to your credit card each month, and then pay it off right away. “This is the safe way to use credit to improve your credit rating without getting bogged down with credit card debt.”