Your credit score determines whether you will be approved to borrow money, and it determines the interest rate you are charged for borrowing money. Credit scores range from 300 to 850, with higher scores being preferable to lower scores. The majority of Americans have scores in the 600s or 700s, according to WhatsMyScore.org. The difference between a low credit score and a high credit score can mean many thousands of dollars over the course of your lifetime, so it is important to understand how to build a credit history properly to achieve a high score.
Understand How Your Score Is Determined
The best way to build a credit history is to understand the factors that lenders will use to judge you. Most lenders use your credit score to evaluate your credit worthiness. Credit scores are calculated by each of the three major credit bureaus-- Equifax, Experian and TransUnion, using a formula created by the Fair Isaac Corporation. The formula considers five factors: your payment history (35 percent), your borrowing behavior (30 percent), the age of your credit history (15 percent), the different types of credit you use (10 percent) and the number of inquiries (requests for your credit report from perspective lenders) in your report (10 percent).
A history of on-time payments, with no bankruptcies or judgments against you, is essential to having a high number for your payment history. Maxing out your credit cards (borrowing up to the maximum amount available to you) lowers the portion of your score concerning your borrowing behavior, while having a low debt-to-credit ratio (borrowing less than you have available) raises this component of your score. Having a long history of credit is better than a short history of credit for average age of cards. Having a mix of different types of debt (including secured debt like mortgage and car loans and unsecured debt like personal loans) is better than only having credit card debt. Finally, it is better not to open too many accounts in a short period of time, as this will result in too many inquiries on your record and a lower score in this area.
Use Your Knowledge to Borrow Responsibly
Once you understand how your credit score is determined, you can use this knowledge to build a credit history. Building a credit history can't happen quickly. It takes time for a long history of on-time payments to build up, and for the average age of your credit cards to become long. However, behaving responsibly from your first interaction with credit will ensure that ultimately you will end up with a high credit score. Open credit cards slowly, so you do not have too many inquiries on your record. Charge amounts that are lower than your credit limits, and pay the balance on time and in full.
As you use your credit cards responsibly, call your lenders periodically and ask them if they will raise your credit limits. Often, creditors will do this without pulling your credit report (which would result in an inquiry) if you have been a good customer and have a good payment record. This can improve your debt-to-credit ratio.
Take on several different types of debt--when you buy a car, take out a car loan even if you plan to pay it in full the next day. This record of a paid loan will help lenders to see that you can be responsible with different types of credit.
Each time you make a decision when it comes to borrowing, think of how that decision will affect the five factors that make up your credit score; the result will be a strong credit record and a high credit score.
Shortcuts
For the most part, there are few shortcuts to building a credit history. However, the best available shortcut is to take advantage of someone else's credit history. You can do this by becoming listed as an authorized signer on someone else's account. When you become listed as an authorized signer, no inquiry is required. However, the credit card shows up on your credit report. If that card has longevity, this can make your average age of credit longer (15 percent of your score). If the card has a good payment record, this will improve your payment history (35 percent of your score). If the card has a high credit limit and a low balance, this improves your debt-to-credit ratio (30 percent). But be sure that any card that you become listed on as an authorized signer is in good standing and will have a positive effect on your credit report. In addition, practice responsible behavior with that card, since the person listing you as an authorized signer is trusting you with the responsibility of having access to their credit account.
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