Credit

How to Build Credit When You Are Just Starting Out (the Smart Way)

Credit scores can be a complete mystery for those just getting started. If you want to learn how to start building credit at 18 (or just for the first time) this article is for you. We show you how to start building credit.

Editor's Note

You can trust the integrity of our balanced, independent financial advice. We may, however, receive compensation from the issuers of some products mentioned in this article. Opinions are the author's alone. This content has not been provided by, reviewed, approved or endorsed by any advertiser, unless otherwise noted below.

It’s official. Credit scores are the most confusing aspect of personal finance. The FICO formula remains largely a mystery. And don’t get me started on the multiple versions of credit scores out there. Learning how to start building credit has become critical to your financial success.

By one account, you may have 49 different FICO scores, not to mention dozens of credit scores calculated using non-FICO formulas.

So it's understandable when folks (myself included) get a bit lightheaded when thinking about our credit. And that brings me to a great question sent in from a reader and podcast listener named Esther:

“Thanks so much for writing a fantastic blog and sharing your podcasts. My husband and I just started listening a few weeks ago and have learned a great deal. We’re still in our 20s, but we often tell each other how we wish we would’ve known about financial independence and building credit earlier on in our lives to prevent all of the mistakes we made in college. We really want to teach our children about financial independence so they can avoid the same mistakes we made. So my question is: how can an 18 year old start building their credit the right way?”

Esther's question is a good one, and one I've given a lot of thought to as my children are now young adults. I've written before on how to build credit for the first time. In this article, I'll share some new perspectives, tips, and resources on this topic.

You can also listen to an audio podcast of this article (which always includes bonus content):

First Things First

Let's start by making sure we put the question of credit and credit scores into the right perspective. There are three main financial priorities every young adult should have:

  1. Spend less than you make
  2. Invest wisely
  3. Avoid debt

Pretty simple. In fact, these are the three main financial priorities we all should have. Why? Because these priorities will enable us to achieve financial freedom. Financial freedom, in turn, will allow us to pursue our life's purpose, whatever it may be.

So what's this got to do with building credit? A lot. Building credit can involve some financially dangerous moves, particularly for those with little experience managing their finances. As we'll see below, credit cards are a great way to build credit. They are also a great way to ruin your finances. So as we walk through credit-building strategies, keep in mind the three priorities listed above.

Self Lender logo

Self (formerly Self Lender) is a unique company that offers to help you build your credit score. Instead of applying for a starter credit card which has high fees or a high interest rate, Self has created a way for you to increase your credit score through a self funded loan. After you’ve applied for your loan and selected a payment option, you’ll be on the path to building your credit. Once you’ve completed your payments, the entire principal is returned to you minus the interest rate.

Read more: Self Review

For example, if you take out a $525 loan on repayment terms of 2 years; the interest rate is 13.16%. This means that over the two year period you pay your loan back, you'll pay back a total of $609; $525 in principal and $84 in interest.

  • Initial loan activation fee of $9, $12 or $15
  • No repayment penalty. Pay your loan off at any time.
  • Four different loan options ($525, $545, $1,000, $1,700)
  • All funds are FDIC insured.

Become an Authorized User on a Credit Card

The first and easiest way to establish credit is to become an authorized user on a person's credit card. For most young adults, this will mean becoming an authorized user on a parent's credit card. There are some important things to keep in mind with this approach:

  • An authorized user doesn't have to use the card to build credit
  • As an authorized user, your credit can be harmed if the account holder makes payments late
  • If your credit is being harmed, you can call the credit card company and asked to be removed as an authorized user
  • Not all credit card issuers report authorized user status to the credit bureaus (here’s a thread on the myFICO forum that lists credit cards that report)

As a final word of caution, avoid what is known in the industry as piggybacking. With piggybacking, an individual becomes an authorized user on a credit card for a fee. These transactions usually involve complete strangers and are brokered by financial intermediaries and credit counselors in an effort to artificially inflate an individual's credit score. FICO has worked hard to detect these situations and to exclude them from the FICO formula.

Related:

Get a Credit Card and Use it Wisely

The next step to building credit is to obtain a credit card. Consistent with the financial priorities listed above, however, care must be used when selecting and using a credit card.

There are excellent reasons to use a credit card beyond building credit. The security of using plastic and the potential rewards are the two primary reasons. If used responsibly, however, plastic can help establish credit as well.

Here are some things to keep in mind:

  • Prepaid cards and bank debit cards do not build credit
  • Some credit cards are designed for those with no credit history, including student and secured credit cards
  • Keeping your credit limit low to start is an excellent way to remove the temptation to overspend
  • Paying the card off in full each and every month is a must

The Jasper Cash Back Mastercard, issued by WebBank, Member åFDIC, is one of our favorite starter cards. A good credit history isn’t required to qualify and there’s no annual fee¹ or security deposit requirement. It also offers cash back of up to 6% when you refer friends to Jasper² and provides unique auto payment plans that are designed to help you reach your credit goals.

You will need to provide proof of income to qualify for Jasper Cash Back Mastercard. But if you’re a working professional who happens to have a thin credit file, this might be the card for you.

Store branded credit cards are also an option, but not one I recommend for two reasons. First, store cards encourage frivolous spending. With a generic card, you can buy everyday essentials, such as gas and groceries. A Macy's store credit card doesn't qualify as essential. Second, the interest rate that comes with these cards is usually very high.

What About Other Loans

I’ve not included other types of loans, such as auto loans and student debt. These types of loans will, of course, affect your credit. Further, having different types of loans (revolving credit like credit cards and installment loans like a car loan) can affect your credit score. For me, however, it’s not worth going into these types of debts just to build your credit. Pay cash.

Pay Your Debts on Time, Every Time

It is absolutely critical that every monthly payment on credit cards or other debt is paid on time. Payment history is the single most important factor in the FICO formula, accounting for 35% of the overall score. A late payment, moreover, remains on your credit history for seven years. If you don’t have the funds to pay your debts on time, try to at least make the minimum payment each payment cycle.

Now there’s a way you can use your positive payment information to increase your credit rating. The best part is it’s free! When you sign up for Experian Boost your monthly payments including utility bills and mobile phone bills can be tracked to see if you make the payment on time. When you do, this information is used to give your FICO Score a boost. Find out more and sign up for free here.

Learn More:

Putting it All Together Make an Action Plan

At the end of the day, a good credit score doesn’t exist in isolation. A good credit score is a combination of habits that work toward building your credit score over time, and will require a persistent effort toward this goal. Excellent credit is attainable, but it requires knowing what these habits are, and staying consistent over a long period.

Use all the advice I’ve given above, and turn it into a set of actionable routines. It’s much easier to stay on track toward your goals once they become habits. Here are the most important habits that I recommend:

  • Make a Payment Schedule Set aside a day and time for monthly bill/loan payment. Put it on your calendar, and stick to it - every month. Pay all of your monthly obligations during this time, rather than paying them separately when they come due. This not only ensures that you don’t forget about any outstanding payment, but you’ll also save time by meeting all your obligations at once.
  • Use a Fraction of Your Credit Limit A portion of your credit score is decided by your credit utilization," which is the percentage of your credit limit that you actually use. The less you use, the better your credit score. Try to keep this number below 30-40%. Make a habit out of alternating payment methods. In other words, pay with debit or cash when you can.
  • Understand Your Credit Score This has been a recurring theme throughout the article, but it’s no less important to mention. A credit score is complicated, but having a general idea of what makes up that score is your safest bet toward keeping it in good standing. Understand the things that build your credit score (including all the information I’ve given above), and implement these lessons into your financial routines.

Establishing Credit is Different Than Repairing Credit

Finally, there are some important differences between establishing credit for the first time and repairing credit. When repairing credit, keep a few things in mind:

  • Checking your credit report for errors is a must. It's the quickest and easiest way to improve your score.
  • Baggage on your credit report stays there for a long time (7 years for late payments as noted above). However, the effect this baggage has on your score decreases over time.
  • Checking your credit report for errors is a must. It's the quickest and easiest way to improve your score.
  • Baggage on your credit report stays there for a long time (7 years for late payments as noted above). However, the effect this baggage has on your score decreases over time.

It’s generally hard to get a credit card with bad credit than it is with no credit. A secured credit card is generally the best option for those recovering from bankruptcy, foreclosure, or other credit mishaps.

FAQs

Do You Have to be 18 to Start Building Credit?

Strictly speaking no - but many of the most effective ways to build credit will be limited to those 18 and over (taking on loans or owning a credit card primarily). However, many credit card companies will allow a child under 18 to become an authorized user on a parents credit card. This allows the child to benefit from their parents prompt payments. Perhaps the best way that children under 18 can start to build good credit is through education. Children can be taught financial literacy before they turn 18, so that they know the habits to build good credit when they are able to do so themselves.

Do You Need a Credit Card to Build Credit?

No, you don't need a credit card to build good credit. However, having a credit card, using it properly, and making payments on time is one of the most effective ways to build good credit. There are, of course, other factors that determine your credit score which don't require owning a credit card. Additionally, having a credit card and using it irresponsibly (carrying a balance, missing payments, etc.) will end up giving you poor credit. A credit card is a double-edged sword.

What is the Age Limit for a Credit Card?

Children cannot own a credit card, and the legal age to own a credit card begins at 18. However, children can become an authorized user on their parents credit card, which was a process I detailed above.

Can You Build Credit with a Debit Card?

Strictly speaking, no, you cannot build credit with a debit card. This is because a debit card represents your own money, and is not affiliated with credit in your name. Debit card activity is not reported to a credit bureau. This said, using a debit card can certainly help you maintain positive financial habits that contribute to good credit. For example, paying your debts on time, making sure you aren't over your available credit limit, keeping an acceptable credit utilization ratio, eliminating over-reliance on credit, etc.

For more insight into credit scores--

Here’s my interview of Tom Quinn, credit expert at FICO

Disclosures

¹Review the Jasper fee schedule.

²Your cash back rate will be increased by 1% for 12 months for each referred applicant that activates their card, up to a limit of 6% total cash back. To earn 6% cash back, you must successfully refer 5 new cardholders within the same 12-month period. To become eligible to redeem cash back, you must first make three on-time payments. The purchases on which you can earn cash back are limited each billing cycle to an amount equal to your credit limit. Review the Rewards Terms and Conditions.


Recommended Stories