Building credit is important, especially if you are just starting out in your young adult life or you’ve gone through some rough times and need to start over. What’s helpful to understand in either situation is that how you go about building credit is what really matters. You’ll need to be organized and strategic about what things you need to do and when you do them. You don’t want to make your credit situation worse or create additional financial problems for yourself.
While there are other pieces to the rebuilding-your-credit puzzle, using secured credit cards is one strategic and significant piece. Other types of prepaid cards or debit cards will not help to rebuild your credit if the card issuers do not report your activity to the credit bureaus.
Using credit cards wisely can help you establish or improve your credit score within six to eighteen months. Hopefully, you’ll see your credit score climbing throughout that entire period.
Understanding What Influences Your Credit Score
Your credit report is simply a record of your credit-related transactions, including your payment history or whether you’ve applied for a credit card or loan recently. Your credit score is a number, sort of like a GPA or grade point average from your high school days. It presents the information in your credit report in a numerical format that lenders can use to determine your creditworthiness.
The most common credit score is called a “FICO” score. FICO scores are based on formulas that the company calculating them, does not reveal. They assign a higher or lower level of importance to each category in your credit history. The main categories in your credit report, and how they influence your score are:
- Your payment history. It counts for over a third of your credit score. Failing to make your payments on time greatly affects your credit score.
- The ratio of credit you are using to the amount available to you. This category counts for one-third of your credit score calculation. It could be better to owe less than 30% on each individual credit card that you have, than to have one credit card maxed out at 100%. Of course, having a zero balance on all cards at month’s end, is best.
- The length of time that you’ve had a credit history. About 15% of your score is based on how long you’ve had any credit from any source. Not having had credit in the past negatively affects your first credit score. As more time passes, your credit score will not be penalized for not having credit in the past.
- New credit, the type of credit you have and how many credit applications you make influence your credit score, but are less significant. The longer you hold your credit cards, the better your score will be. But, for now, the best course of action is not to open any new accounts. This category is less influential after 12 months.
- Having a mixed bag of credit factors more positively into your credit score than having all credit card debt. Having a car loan, a mortgage and one credit card looks better to the credit scoring companies.
Additionally, many other industries and people have access to your credit score and use it to determine everything from your insurability for life insurance to lending you money for a mortgage.
Tell Your Existing Credit Card Issuer To Leave Your Credit Limit Where It Is Now
Credit card companies will often raise your spending limits without giving you any notification. While it can be flattering, and make it seem like you deserve it “because of your good credit history,” it can invite more problems and lower your credit score.
As with opening new cards, you may be tempted to spend more and then, not have the income to pay off the balance. Keep the credit and spending limits low enough to charge what you need each month and so you can pay off your balance in-full every month.
Pay The Entire Balance Due On Your Bill Each Month
The way the scoring works, paying off your full balance on time each month indicates that you are responsible. But the only way you can pay off the same amount you charge each month on the credit card is if you have enough money to pay it off.
You need to set aside this amount of money each month and use it to pay off your bill. It may mean literally, taking the same amount of cash you just spent from your paycheck, depositing it into your checking account and making an early payment on the card so that you don’t spend the money.
Paying off your entire balance each month is one of the most important things you can do to demonstrate your financial responsibility. Showing you are responsible, will help improve your credit score dramatically.
Use A Prepaid Credit Card
This type of credit card requires you to make a security deposit with the issuing bank. Your available credit is equal to half or all of the amount of money you advance as a deposit. You must still make monthly payments and will be charged interest on any balance not paid at the end of the billing cycle. After about six months of on-time and full payments, your bank may upgrade you to an unsecured, regular type of credit card.
Use As Little Credit As Possible
If you use most or all of your available credit on your card, your credit score will drop. If you must carry a balance, try to aim for no more than thirty percent of the limit that the credit card company gave to you.
Don’t use the card the following cycle, except for a small purchase that you can easily pay in full along with the remaining balance. Be aware that the larger your balance is on your credit cards, and the longer you carry the balance, the lower your credit score is likely to go.
Using Secured Credit Cards To Build Credit Is Smart
Secured credit cards are a low risk and effective way of building credit. They keep your spending habits in check because your available credit is limited to the amount of the security deposit you provided to the bank. They come with decent interest rates and reasonable fees when compared to other cards offered to people without credit or who are trying to rebuild theirs. Because secured credit cards report to all major credit bureaus, they are ideal for building credit within a fairly short period of time when managed appropriately.