As a young person, you can establish credit in several ways. For starters, you could open a credit card in your name or take out a loan. Or, you can ask a parent to add you to one of their credit cards.
Whichever path you choose, it’s best to start sooner rather than later because a positive credit history can help you in many ways—and save you money—during the transition into adulthood.
Why You Should Start Building Credit Early
Young people often have limited experience with credit and might not realize all the ways that good credit can make life easier.
- Applying for credit: Your credit history and scores are important when you’re applying for loans and credit cards. If you have good credit, it will likely be easier to get approved, and you may be offered better terms, such as a lower interest rate.
- Renting an apartment: Your landlord may check your credit report before agreeing to take you on as a tenant. Also, if you have poor or no credit, you might need to pay a larger security deposit to rent the apartment, turn on utilities, and set up internet or cable services.
- Getting your own phone plan: You may need good credit if you want to get off your parents’ plan and get a new cell phone and monthly payment plan.
- Obtaining insurance: In some states, your credit history can impact your insurance rates. Also, having good credit could lower your monthly premiums. While you may still be on your family’s car insurance policy now, that won’t always be the case.
- Getting a new job: Some employers may consider your credit when deciding whether to offer you a position.
- Refinancing your loans: You may be able to refinance private student loans at a lower interest rate if you have good credit and a steady job.
Because the length of your credit history can be important to creditors and is a factor when calculating credit scores, starting at age 18 or even earlier could give you a leg up.
What’s the Best Way for a Young Person to Build Credit?
There are many ways to build credit, and they all involve creditors reporting your bill payment information to the major credit bureaus: Experian, Equifax and TransUnion. To begin establishing credit if you have none, try one or more of these options:
- Become an authorized user on a parent’s credit card.
If one or both of your parents have a good credit history and keep their credit card balance low, you could ask them to add you to the account as an authorized user. As an authorized user, you may or may not have your own credit card for purchases, depending on your agreement with the primary cardholder, but assuming they continue to pay the bill on time and keep their balance low, your credit could benefit. Make sure the card issuer reports authorized-user activity to the credit bureaus, because not all do.
- Open a student or secured credit card.
College students can apply for a student credit card, which is often easier to get approved for than a non-student card. Whether or not you’re in school, you could also consider getting a secured credit card. Secured cards require a security deposit, which typically becomes your credit limit. This makes secured credit cards easier to obtain than regular unsecured cards because the deposit limits the issuer’s risk. Some card issuers will transition you to a regular unsecured credit card once you’ve shown responsible use of your secured card.
- Pay your student loans on time.
If you took out student loans to pay for college, your lender(s) will usually report your accounts and payments to the credit bureaus. Even if you defer making payments until after you leave school, student loans can help you establish credit—as long as you make your payments on time every month once you do start paying them back.
- Take out a credit-builder loan.
Some lenders offer loans geared to helping borrowers establish credit. With credit-builder loans, the bank sets aside the loan amount (usually $300 to $1,000), and you receive the money after you’ve made all the monthly payments. You’ll generally have to pay interest on credit-builder loans from banks and credit unions, but some may return all or a portion of that interest once you pay off the loan. Mission Asset Fund offers a no-interest lending circle program, which could help you build an emergency fund and your credit at the same time. In either case, these loans will help you establish credit and show future creditors you are a responsible borrower.
- Add utility and telecom bills to your Experian credit report.
If you’re living on your own and responsible for your cell phone bill and utility bills, you can add these accounts to your Experian credit report with Experian Boost™. Once they’re in your report, your on-time payments may improve your credit history and increase your credit scores.
Common Mistakes Young People Make When Building Credit
Building credit doesn’t need to be difficult, but misconceptions can set you back and cost you money. Young people are often brand new to credit and may be particularly vulnerable to believing credit myths and making mistakes. Here are actions you should avoid:
- Missing payments. Even one late credit card or loan payment can negatively impact your credit. Setting up automatic payments could help you avoid accidentally missing a payment, but make sure you have the funds in your bank account to pay the bills. Also, if you fall far behind on payments—including utility, phone, medical and other payments—your account could be sent to collections, and the collection agency may report your collections account to the credit bureaus.
- Forgetting about closed accounts. Similarly, if you close an account that has a balance, such as a utility or cable account when you move, make sure to pay off the balance. Leaving the bill unpaid could result in the account getting sent to collections.
- Taking on too much credit card debt. Access to a credit card leads some young people to spend more than they can afford to pay off each month. Carrying a balance leads to interest charges, and having a high balance can hurt your credit scores. It’s best to treat your credit card as a debit card and only use it for purchases that you can afford to pay off.
- Not paying off credit card balances. You don’t need to maintain a credit card balance to build credit. On the contrary, it’s best to pay your bill in full each month to avoid interest charges. Also, paying off your credit card bill each month keeps your credit utilization ratio low. Your utilization ratio, or rate, is the amount of credit you’re using compared with how much you have available, and it’s an important factor in your credit score. Experts recommend keeping your utilization ratio under 30%. So if you have a card with a credit limit of $1,500, always keep your balance under $500, and pay off your balance when you pay your bill each month.
- Submitting back-to-back loan applications. When a lender requests your credit report from one of the credit bureaus to make a lending decision, it’s called a hard inquiry, and it could lower your credit scores. Multiple hard inquiries can increase the negative impact, so be cautious about submitting one application after another. This is a red flag to creditors, who may see your many applications as a sign of financial distress. This translates into risk, which most lenders try to avoid.
There is one exception, however: Most credit scoring models don’t ding your score when you’re shopping for one type of loan, such as an auto loan, because looking for good terms and the best interest rate is considered good practice. For example, with FICO® Scores, multiple auto loan, student loan or mortgage hard inquiries only count as a single inquiry for scoring purposes when the inquiries occur within a 14- to 45-day window (depending on the type of FICO® Score).
How Long Does It Take to Establish Credit?
Your credit file is established as soon as your first account gets reported to the credit bureaus. However, building good and useful credit can take some time. For example, FICO® can’t score a credit report that doesn’t have an account that’s at least six months old. In addition, if you have fewer than five credit accounts, also known as having a thin file, lenders may not be able to assess your creditworthiness.
Because the age of your accounts is a credit scoring factor, the longer you’ve had open and active accounts, the better (assuming you’ve been making on-time payments). While this takes time, you’re making a long-term investment in your financial future and establishing credit while you’re young—which is better than waiting until you need to apply for a rental apartment or loan.
How to Monitor Your Credit
Once you’ve begun establishing credit, you may want to sign up for a credit monitoring service that can help you track changes in your credit reports. AnnualCreditReport.com offers one free report every 12 months from each of the three credit bureaus.
Monitoring your credit is important because if there’s a new inquiry or account on your report that you don’t recognize, that could be an indication that someone is using your identity to fraudulently open accounts. You’ll want to act quickly to file a dispute and resolve the matter.
Don’t Wait—Start Now
By this point, you probably realize why your credit is important and the benefit of establishing your credit as early as possible. The next step is to decide which type of accounts you want to open and how you’re going to make sure you can make on-time payments and monitor your progress. Then you’ll be on the road to financial independence.
About the Author:
Louis DeNicola works with Fortune 500 financial services firms, FinTech startups, and non-profits to teach people about money and credit. He is a writer for Experian.