Contrary to popular belief, it doesn't take years to build credit. If you know how credit scores work, you can achieve a good credit score in less time than you may think. With that in mind, here's what you need to know in order to build your credit as quickly as possible.
How credit scores work
Before you can learn how to build credit fast, you need to understand where your score comes from. There are several different credit scoring models, but the most popular is the FICO score, used by more than 90% of lenders.
Your FICO score is made up of five categories of information, with a weight assigned to each:
- Payment history (35% of FICO score) -- The single most important factor in your credit score is whether you pay your bills on time. Late payments, delinquent accounts, collections, and judgments can drag down this part of your score, and the longer you go without any of this derogatory information, the more of a positive impact this category will have.
- Amounts owed (30%) -- This doesn't refer to the actual dollar amounts you owe, as much as it refers to how much you owe relative to your credit limits and original loan balances. Keeping your credit card usage low and paying down loan accounts will boost this part of your score.
- Length of credit history (15%) -- This category uses certain information that tells creditors how long you've established credit. It takes into account when you opened your first account (even if it's been closed), the average age of all accounts, and the age of your individual accounts, among other time-related information.
- Types of credit in use (10%) -- This looks at whether you have a healthy mix of credit accounts, such as credit cards, store accounts, mortgages, student loans, auto loans, etc. The theory behind this is that it shows how responsible you can be with any type of credit.
- New credit (10%) -- As the name implies, this factors in how many of your accounts were recently opened. If you open several new accounts in a short time period, it could hurt your score. Also included in this category are your recent credit inquiries -- the number of times you've applied for credit. Only inquiries from the past year count, so it doesn't take long for this category to become all clear.
Good credit doesn't have to take long
As you can see, most of these categories can be positively influenced in a short period of time. Obviously, the "length of credit history" category takes years to capitalize on, and by definition the "new credit" category won't be stellar when you're just getting started. However, these categories represent just one-fourth of the total.
To establish an excellent payment history takes years, but you can create a good history fairly quickly. The actual FICO formula is a well-guarded secret, but you might be surprised how much of an impact a few months of on-time payments and no adverse information can have.
The "Amounts owed" category is perhaps the easiest way to have a quick impact on your credit score. Once you open a credit account, simply keeping your balance low as a percentage of your available credit is all you need to do. Experts generally say that usage of 30% or less is good, and lower is even better. People with the highest credit scores tend to use a single-digit percentage of their credit limits, so if you get a credit card with a $1,000 limit, carrying a balance of less than $100 could be a highly effective way to boost your credit.
"Types of credit in use" is a tough category to crack when you're just starting out. After all, you probably won't have a mortgage, auto loan, and several credit cards at first. Still, something is better than nothing, and if you can establish just a couple of account types (say, a credit card and department store account), you could see your score rise rather quickly.
So, while an excellent credit score takes years of responsible habits, it is possible to build a good credit score in a short period of time.
The best plan of attack
The best way to build (or rebuild) credit is to establish an account and use it responsibly. For those just establishing credit, this usually means getting a credit card, and there are several cards out there designed specifically for first-timers.
A secured credit card can also be an excellent way to get started. In fact, this is how I established my own credit years ago. Since you're required to put down a security deposit equal to your credit limit, it's not difficult to get approved for these, even with a lack of credit history. They report to the credit bureaus just like a standard credit card, and tend to have more favorable terms than other "starter" credit cards.
Once you open an account, and use it with the credit scoring formula in mind, you might be surprised how much credit you could build in a short amount of time, which can make your large financial purchases like a house and car both easier and cheaper.