How to Build Credit From Scratch

You have probably heard that having a solid-gold credit score is important when it comes to big-ticket expenses like your car payment and mortgage. With an excellent credit rating, you can qualify for better rates (which equals lower payments), saving you literally tens of thousands in interest payments over your lifetime.

But if you’re just getting started building your financial life, you might not have any credit at all. And how do you get credit without credit? The good news is that there are steps you can take to build your credit from scratch. Here’s what you need to know.

Why your credit score matters

First, it’s important to realize why your credit score is so important, and that’s because it shows potential lenders that you’re a good “risk.” In other words, when you have a history of paying back your debts and keeping your financial house in order, they can feel confident you are liable to do the same going forward.

But without that track record, which is reflected in a strong credit score, lenders are going to charge you more for the right to borrow their money. That essentially means it’ll cost more to borrow money, thanks to increased interest payments.

Here’s how to start the cycle in your favor.

Step 1: Check your current credit status.

If you’ve never had a credit card, you might assume you don’t have a credit report. But, believe it or not, you might have one anyway—and, unfortunately, you might be starting out on the wrong foot. Yes, even those who’ve never applied for credit could have score-damaging blemishes on their report.

“Too many times, we see young adults who weren’t aware certain things would be reported, or worse, who have been unwitting victims of identity theft,” says Thomas Nitzsche of Clearpoint Credit Counseling in Atlanta, Georgia.

That’s because even though the data breaches that make headlines typically involve credit cards, there are other ways that someone could have been misusing your name and damaging your credit. Kids can be a top target of identity theft—in fact, a report from Javelin Research found that more than 1 million children had been victims of identity theft or fraud in 2017. So, first you’ll want to make sure that no one has been fraudulently using your name.

Then you’ll want to check to make sure that your report doesn’t contain negative information that doesn’t belong to you. This could happen if, for example, a person whose Social Security number is one digit different than yours has a delinquent debt that mistakenly shows up on your report, says Bruce McClary, vice president of communications for the National Foundation for Credit Counseling. (It happens.)

Finally, it’s possible that the damage does belong to you, after all. For example, if you were delinquent on your cell phone or cable bill, your company may have turned your bill over to a collection agency, a fact that would then be reported to the credit agencies and could end up in your file.

That’s why you should eyeball your report from all three credit bureaus (TransUnion, Equifax and Experian) via Annualcreditreport.com. It’s free once a year from each agency. If you spot a mistake, dispute it with the credit agency as soon as possible.

Step 2: Apply for an entry-level credit card.

When you’re ready, start shopping for a credit card. A good place to start is with your bank or credit union, since you already have a relationship with them. Another option is to search online for the best cards for those with no or low credit—and look for those with no annual fee.

Chances are that your first card is likely to have a low limit and high interest rate. After all, as McClary points out, without credit history, lenders don’t know if you’ll pay your bills on time—or at all. If you’re bummed by the high rate or lack of perks, remember that 1) you won’t have to rely on an entry-level card forever, and 2) if you pay your balance off each month, you won’t have to pay any interest. “This just serves the purpose of getting your foot in the door,” McClary says.

Having trouble finding a lender? Look into secured credit cards, which require a deposit equal to your credit line. (For example, a $1,000 deposit gets you a card with a limit of $1,000.) Because the bank has your cash as collateral—meaning it won’t touch that money unless you default on the card—these cards are generally easy to qualify for, regardless of your credit history. Just remember: “A secured credit card is not a prepaid card, and you still must pay for charges each month,” Nitzsche says.

As a last resort, ask a family member or partner if you can become an authorized user on their credit card, or if they’ll cosign a new account for you. The reason this is a less-than-optimal strategy is that sharing credit can be dangerous—so it’s important that you trust your cosigner to handle credit responsibly, and you do the same.

Step 3: Establish and maintain good credit habits.

Once you’ve been granted credit, you have to make sure that you build and maintain great habits, to ensure that your credit score goes nowhere but up. McClary cautions that even a minor slip as you’re building credit can cause your score to drop substantially because you don’t have other accounts to offset a misstep.

“If you drop a pebble into an ocean, it only makes small ripples, but if you drop it into a mud puddle, it splashes,” he says.

To keep your credit clean, make sure to:

Pay your bills on time, every time

Timely payments account for 35 percent of your credit score, with all other categories, such as percent of credit used and length of credit history, accounting for smaller slivers, McClary says.

Avoid overspending, so that you are able to pay your balance in full each month

First off, this will save you a bundle in hefty interest charges, but it also ensures that your utilization ratio—or the amount of credit used compared to your limit—remains under 30 percent, which is where you want it to stay. If you notice yourself running a monthly bill that exceeds 30 percent, you can make two payments each month, so that you’ll be safe no matter when your lender reports your balance to the credit bureaus.

Sidestep multiple credit inquiries

Every time you apply for credit, the request is noted by the credit bureaus. Multiple credit inquiries over a short period of time—such as applying for three new cards at the mall—might indicate that you have an appetite for credit and give lenders pause, McClary says.

Step 4: Diversify your credit.

While you’re climbing the credit ladder, remember that every on-time payment helps build your score. There are multiple variables, but a two-year cycle of timely payments is a solid benchmark for when you can expect more attractive credit offers to come your way, McClary says.

As you get closer to the top, you may want to diversify your lines of credit by applying for another credit card, for example—and maintaining your good habits, of course. “This shows you’re able to manage multiple creditor obligations,” McClary says.

But don’t close your older account, even if you stop using it. That’s because part of your credit history is based on longevity, so the longer you have a card, the better.

There are other ways to improve your credit “mix,” or the types of credit that you have on your file. Lenders are looking for diversity in your credit file—assuming that you are responsibly paying it back, of course. A student loan, for example, represents an installment loan (while a credit card is a type of revolving credit). It’s money that has been lent to you that you are paying back in installments, so a history of on-time payments of your student loans will boost your credit score.

Also, some management companies report your on-time rent payments to the credit bureaus through a program like Experian RentBureau. Unfortunately you cannot self report that you’ve been paying your rent month in and month out, but you can ask if your landlord will.

However, note that even though we mentioned earlier that your cell phone carrier or utility provider might have reported delinquent payments that hurt your credit, they don’t typically report those on-time payments as well. So even though you’re responsibly paying those bills—as you should—it likely won’t be giving your credit score a boost.

Step 5: Check your credit report regularly.

Although it’s true that excessive credit pulls can hurt your score, you can check up on your own credit without penalty in what’s called a “soft hit.” Even though you started with this step, taking another look at your credit report for a snapshot of your progress—and to ensure new mistakes haven’t popped up—is key to maintaining the good credit you’ve built.

As we mentioned, each of the three credit reporting agencies must offer one free credit report every 12 months at AnnualCreditReport.com. In order to make the most of that freebie for ongoing monitoring, just request one at a time and then go back in four months and request a different credit bureau’s report. In that way, you can check your credit once every four months to stay on top of your score. Although the three agencies have some differences in how they track your credit, most have relatively similar information so this staggered strategy is a good way to spot a red flag early.

You can also take a peek at your credit report from TransUnion and Equifax at Credit Karma or see your credit score at WalletHub. Another option is to consider getting one of the many credit cards from major issuers, like Citi and Capital One, that offer a monthly credit score update as a cardholder benefit.

Building good credit won’t happen overnight, but paying attention to your credit score and following a diligent process to improve it is an important step to your overall personal financial health.