How to Build Good Credit and Why It Matters

Once you download your free credit report produced by any of the agencies (don’t be alarmed if the scores or the information contained vary) you can see the numerous data points maintained on your credit history.  Such items include consumer loans, credit cards, mortgages and more you have now or have had in the past.  

For each, you will see your important credit factors like your payment history, balances, as well as debt collection agency information if you have dealt with delinquent debts.  Review this information to understand what it means and then verify its accuracy. Should a mistake exist on one of your credit reports, you have the ability to dispute an error.

Errors can have unintended consequences because your credit report determines so much of your access to financial resources.  Your reports contain pertinent information about where you live, how well and frequently you pay your bills, and whether you have ever been sued or arrested for a crime, or have filed for bankruptcy.  

man disputing error on credit report

In exchange for tracking this treasure trove of information about your past and present, credit reporting bureaus sell your history of financial decision-making to lenders, insurers and employers as a means for evaluating your current applications for credit, insurance, and employment, respectively.  

Given the wide use of this centrally-tracked information, your credit has far reaching implications from landing a job to renting a home, applying for an auto loan, or even getting a cell phone plan.  Correcting any errors you see becomes vital should you have any major needs on your credit. Further, as a result of its importance, Congress passed the federal Fair Credit Reporting Act (FCRA) into law with the intent of promoting the accuracy and privacy of information contained in your credit reports.

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What is a Credit Score?

The second item you will need to understand regarding your credit history involves your credit score, a numerical representation of your creditworthiness. Higher scores indicate better credit and can make you a prime borrower, whereas lower scores place you in the subprime borrower category.

Numerous credit scoring models exist and lenders can pick and choose which one they use when evaluating your creditworthiness.  A common system lenders rely on for understanding the risk of lending to a potential borrower is the FICO Score system.  This model scores your financial decisions and weighs items such as how much existing credit you have and how timely you repay your outstanding debts.

To earn scores in the higher brackets (i.e., more creditworthy) and land the best credit terms, you will need to build a solid credit profile.  This involves making timely payments, restricting how often and how much you rely on credit (low credit utilization), how long your accounts have been open, your mix of credit, among other items.

For the remainder of this article, I will dig into some of these factors, starting with your credit mix.  Your diversity of accounts can have a strong impact on your credit score. Because of this, you will want a good combination of credit cards and loans on your credit report. 

The following sections address some financial tips you can put to use to begin building your credit profile and increasing your credit score today.

how to build good credit

Credit Cards

Credit cards represent one of the easiest and most commonly-used forms of credit.  These financial tools provide access to lines of credit for you to finance common consumer purchases instead of using your own money at the time of purchase.

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They compare to debit cards, which pull only against money you already have instead of a line of credit. Many banking apps for minors offer these to get them started with money management decisions.

These money apps for kids help them learn about money in a constructive way.

In most instances, credit cards represent an unsecured line of credit, meaning they do not have hard assets backing the balance you borrow when you make purchases.  The types of credit cards can vary with cards like co-branded retail store credit cards (e.g., a J. Crew credit card issued in partnership with Comenity Bank), rewards credit cards, cash back credit cards, and more.

Applying to Different Types of Credit Cards

For the purposes of credit scores, you will want a diverse mix of retail store and major credit cards. As a good place to start building excellent credit, you can begin by applying for a small specialty retail store card, and then proceed with another major retailer.

Typically, these retailers offer incentives in the form of bonus points or added cash back for using their branded credit card at their store.  If you have a good control over your spending and know you will need to frequent certain stores, it may make sense to target stores where you can leverage the most benefits.

After you have obtained some of these retailer credit cards, you can apply directly through your bank for a Visa or MasterCard credit card.  My first credit card came from MasterCard through my bank, CapitalOne. I still use my CapitalOne Quicksilver card to this day and only received approval for the card because I had an established relationship with the bank.

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However, if you have trouble receiving approval for a traditional, unsecured credit card, you may instead consider applying for a secured credit card.  This works by your bank or other credit card company extending you a line of credit based on your deposit balance secured by a savings account. 

Because this method essentially has you borrow money from yourself, this represents the simplest method to qualify for a credit card. Further, it represents a step in the right direction for building good credit.  You should not have major difficulty finding a credit card company which specializes in offering secured Visa and MasterCard credit cards to aid you in establishing credit.

However, if you have a desire to monetize your spending with well-suited rewards credit cards, you might consider checking out which cards best fit your spending patterns.

My wife and I put everything imaginable on our rewards credit cards because we earn cash back and rewards points for our spending. For these cards, you want to be mindful of your spending habits, self control, and any applicable fees and interest rates.

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