3-Step Guide To Building A High Credit Score in your 20s
Your credit score is probably the most important number in your financial life. It determines how much you interest you pay when you borrow money. In fact, it determines whether you even have the credit worthiness to borrow money in the first place. Your credit score will determine how easy or hard it is for you to do things like buy a care, buy a house or borrow money to start a business.
Every 20-something will eventually run into their credit score head on. It might be when you try to rent your first apartment or maybe it will be when you apply for a department store credit card. Your credit history impacts nearly all financial matters in your life.
And eventually, it will impact whether you qualify for a mortgage, car loan or credit card and also what interest rate you have to pay. Not to mention it is now being used by some employers.
Millennials are avoiding the steps necessary to build a strong credit score
According to data from Experian, millennials are lagging behind other generations when it comes to their credit score. On average, millennials have a credit score of 625, which is the lowest of any generation. And about 50 points below the national average. However, it’s important to note that this doesn’t necessarily mean that millennials aren’t paying their bills. It often means that they haven’t yet started taking steps to starting building a strong credit history that translates into a good credit score.
Some credit experts suggest that millennials are more skeptical of financial institutions because of having to shoulder massive student loan debt and watching their parents struggle with debt and financial trouble during the financial crisis of 2008.
However, all this credit avoidance is also preventing millennials from building a good credit score.
How your credit score is determined
Your credit score is determined by the information the three credit bureaus compile in your credit reports. Your credit report is basically a documentation of your history of paying back money you’ve borrowed. Which means that if you have never opened a credit card or taken out any loans then the credit bureaus don’t have any information to compile in your report. When you have a credit card or take out a loan, the financial institution that you are borrowing money from reports your account status to the three main credit bureaus every month. They generally report whether you made your payments on time or if your payments are late, what your account balance is and the amount of your payment each month.
How to build a high credit score
At this point, you are probably thinking, okay enough about how and why we all have crummy credit scores – what can I do to build a high credit score.
Step 1. Start by checking your credit score and report
You can’t start building your credit history and improve your credit score if you’ve never checked your credit before. You should request all three of your credit reports – one from the each of the big three credit bureaus, Equifax, Experian and TransUnion.
*Important Note*
All three credit bureaus have their own products they sell related to building and protecting your credit. But these all cost money and often the information is available to you for free.
You should start by going to annualcreditreport.com because under federal law, you get your reports for free once per year.
When you’re looking at your reports, scan for incorrect information. If you find something that looks wrong or unfamiliar, get it fixed right away.
Once you’ve reviewed your credit reports you should then sign up for a free credit score service like CreditKarma.com or CreditSesame.com to find out what your credit score is.
Credit scores range from 300 to 850. Anything above 780 is considered very good. And anything below 600 is considered fair to bad. Generally, having a credit score above 720 will get you the lowest available interest rates.
Step 2. Start by opening a credit card
Opening a credit card is usually the simplest and most effective way to start building your credit history and eventually a strong credit score. Credit cards are also much easier to open than other kinds of accounts that build your credit history like student loans, car loans or personal loans. Most banks offer credit cards for young adults that have little to no credit history.
The other reason to start with opening a credit card rather than a different kind of loan is that if used properly, a credit card you the least interest. Again, we should stress the words “if used properly.” Credit cards charge you interest for the balance you carry each month. Which means if you pay off your credit card each month then you don’t pay any interest. However if you don’t pay back the full balance then your interest charges start adding up.
When we say to use a credit card properly, we mean using your credit card for a portion of your everyday expenses. Things you would have bought anyway like groceries or cell phone bill – things like paying for a vacation you can’t afford to take. By using your credit card on your everyday expenses and paying the card off each month you are building a strong credit history which will reflect itself in a high credit score.
When you are applying for your first credit card, the credit card issuer will ask you things like your employment status, occupation, annual income and housing expenses in an attempt to understand your ability to pay your credit card bill. They will also pull your credit report and score. If you don’t have strong enough credit you may get rejected. However, don’t worry there is still another option to open your credit card.
If you can’t open a traditional credit card, you should ask your bank about opening a secured credit card. A secured credit card is essential for people who don’t have suffient credit history or a strong enough credit score. The way it works is that you will deposit a certain amount of money with the bank, say $500. And that $500 is the security the bank has against the credit they are about to extend you. Over time as you pay your bill on time each month, you will build your credit and be able to open new lines of credit and no longer need to have your credit secured by a bank deposit.
Another option if you are rejected for your first credit card is to ask a parent to add you as an authorized user on one of their credit cards. This will essentially let you piggyback off their credit payment history with that card to build your credit history. You get a credit card to use and the credit card activity will show up on your credit reports. But eventually, you will still need to build your own credit.
Step 3. Use your credit responsibly
Building a strong credit score is actually pretty simple if you follow some basic rules.
First, always pay your credit card bill on time. If you pay a bill late, that gets reported to the credit bureaus who will place that information onto your credit reports – which results in a lower credit score. One way to avoid late or missed payments is to set up auto-pay with your banks to ensure you always pay on time. And if you do accidentally miss a payment date you should make the payment as soon as you realize because the credit bureaus are often only notified after it has been 30 days.
Second, always pay your credit card in full. You also need to remember that carrying a balance on your account doesn’t help you build credit – so pay it in full every month to avoid having to pay costly interest charges.
Third, don’t max out your credit card. This is another really important point to remember, just because you have a credit card doesn’t mean you need to spend as much as the bank will let you spend. Maxing out your credit card will not only make it harder to pay off but it will also drive your credit score down. Why, you may ask? Because one of the most important factors in determining your credit credit score is what is called your credit utilization ratio. Having a low credit utilization ratio will increase your score. For example, if your credit limit is $1,000, you should keep your credit utilization at 30% or below meaning not to charge more than $300 in any month.
However according to Experian, the average millennial is using 43% of their credit limit which is far above the 30% or less that is reccomended.
