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5 Steps to Building (and Keeping) Good Credit

If there’s one upside to the economic mess we’ve been in for literally years now, it’s that interest rates are near an all-time low [1]. If you’re keeping cash in a high-interest savings account [2], you probably wish rates would go up. But for people looking to finance a house, car, education or other major purchase, you will probably never pay less in interest than you will if you lock in a loan right now. And the new credit card protection laws [3] make it a good time build credit, even if you don’t need it right now.

Of course another effect of the recession [4] is a credit crunch, meaning that interest rates are very low…but only if you can actually qualify for a loan. And to qualify for a loan, you need a good credit history. If you’ve never had debt before, good for you! Unfortunately, you do not exist in the eyes of the credit gods and so you may have a hard time qualifying for credit now. Follow these tips to build and keep good credit without going into unnecessary debt.

Credit-Building Tips

  1. Start Early: The best time to begin building credit is when you are young. Notice that I did NOT say that this is the best time to take on unnecessary debt [5]!  Just like anyone else, students and young adults can put expenses on a credit card and pay that card off in full at the end of the month, building credit without racking up debt. As soon as you are able to qualify, you can take on a credit card with a small credit line or a student loan [6] for the amount  that you actually need (NOT thousands of dollars to finance partying!). Even if you have the money to pay for school, consider a loan if you can get a subsidized loan (interest-free until graduation) and pay it back as soon as you graduate. Avoid unsubsidized loans unless you really need them. If you have never had any kind of credit, your college alumni association and local credit union are great places to start your search for your first credit card. You can also take advantage of college student credit cards [7] offering cash rewards for good grades.
  2. Diversify: Just like in the stock market, diversification helps when building credit. If you have the chance to use different types of credit, do so. These can include student loans, car loans, store or bank issues credit cards, and even accounts for services such as cable or your cell phone. Opening and remaining current on several different types of accounts will help build your history and ultimately raise your credit score. Keep in mind, though, that each account you open will have a temporary negative impact on your credit score [8]. So you really don’t need one card from each of your 10 favorite retailers – maybe just one retail card (because they’re easy to get) and one starter bank-issued credit card [9].
  3. Use the Credit You Have…: Once you have opened a few accounts, make sure to use them from time to time to keep them current and active. I’ve had a few credit card accounts that were either closed or had their credit lines significantly reduced. A good rule of thumb is to try to use each account at least once every six months.
  4. …But Don’t Pay Unnecessary Interest: As stated above, you want to build credit, not take on debt. Pay your bills in full when you are able. For things like car or student loans, pay as much beyond the minimum as you can. This will both reduce the total amount of interest you pay overall and also reduce your credit utilization, which is a big part of your credit score [8]. Someone asked me recently if it is better to make a few small purchases on a credit card and pay them off immediately or make a large purchase and pay it off over time. For purposes of your credit score, the difference is minimal, but for your financial bottom line it is always better to pay things off immediately. So don’t use building credit as an excuse to finance the big screen TV you’ve been wanting. Save up for it and buy it only when you can truly afford it.
  5. Pay Bills On Time: If you open new accounts for the purposes of building credit, the plan only works if you are responsible with that credit! Make sure to pay AT LEAST the minimum payment on time. As I keep stressing, avoid the downward spiral into debt [10] by paying the full amount. Remember that phone companies, cable and internet providers, libraries and even fraternities/sororities can report a late or missed payment and hurt your credit. Bad credit means that it will be hard to get the best rates on credit in the future, if you can get it at all. So stay current and avoid taking on any payment that you can’t afford comfortably.