How Can I Build Good Credit?

Hello, and welcome to Ask USAA. My name is Scott Halliwell, and we have a question today from Karen in Tennessee regarding building good credit. And it’s kind of a good news/bad news story. She says, “I’m 21 and have no debt.” That’s the good news. “But, I also have no credit.” That’s the bad news. So she wants to know, “How can I go about building good credit.”

Text version:

Well first, Karen, congratulations on being 21 and still being debt-free. I can’t tell you how many people I’ve talked to at a similar age to yours that have already begun to bury themselves in debt. So I think it’s great that you’ve avoided that and haven’t done it. That being said, having credit is important, so let’s look at how to go about building it the right way.

To me, I think a great place to start is to understand how credit is measured. It’s all about your credit score. So let’s look at what goes into the credit score to help you understand what actions you should take and what actions you should try to avoid.

There are five major components that typically make up one’s credit score.

  • The first component, and it’s the biggest one, is payment history or how well you manage the credit you’ve been given. As you can see, it accounts for about 35% of the overall score.
  • The second component that goes into a credit score is the length of that history or how long you’ve had the credit. And you can see that represents about 15% of the total.
  • The next piece is how much you owe as a percentage of the credit that’s available to you. You can see here that accounts for about 30%.
  • Finally, 10% of your score is determined by the types of credit that you have.
  • And 10% comes from credit applications or inquiries.

So with these components as a backdrop, let’s look at some of the things you can do that will help you get a good credit score and some of the things you could do that would hurt you. You know one of the first helpful actions that you can take is to get started. You know it’s called credit history for a reason. Remember, this makes up about 15% of your overall score.

The next helpful action you could take would be to make timely payments. The idea here is once you get this going, you don’t want to mess it up. So always, always, always pay on time or even early if you can. You know I tell people if you need to, set up an automatic payment so that you don’t ever have to think about it. You just don’t ever want to be late. Remember, how well you manage this credit that you’ve been given makes up about 35% of the overall score.

The final helpful behavior that I’d like to address today is to limit your use of the credit. Why? Because the amount you owe, as you can see, represents about 30% of your credit score. Coincidentally, that’s about the same upper percentage limit of your available credit that you should use. So as an example, if you had a credit card with a $1,000 limit on it and you needed to borrow something, or needed to buy something and use that credit card, if you need to carry the balance, you should try to keep it below $300. You know just because a company gives credit to you or makes credit available doesn’t mean you have to use it.

So now that we’ve looked at some of the helpful actions that you can take to help your credit, let’s look at some of the things that could hurt it and things you should try to avoid.

First would be missing or making payments late. You know just as making timely payments positively impacts your overall score, doing the opposite, making payments late, is going to negatively affect your overall score.

The next hurtful thing that you can try to avoid is, but it’s not an issue for you yet, Karen, is avoid closing older, unused cards. Why? Because if you close an older card that you no longer use, it can negatively impact your score in two ways. First, it’s going to remove established history from your credit record. And second, it can cause your ratio of utilized credit to increase. Remember, we’re trying to keep that below 30%.

The final hurtful action that I want to discuss today is having too much debt. You know the bottom line here is don’t overdo it. Remember, everything that you buy and use credit to pay for, whether on a credit card or some type of loan, has to be paid off eventually.

Finally, Karen, when it comes to credit and debt, please heed this warning. Be careful. Always treat credit with the respect that such a valuable and dangerous tool demands. You want to establish budgets. You want to save regularly. And you only want to use credit when it’s absolutely necessary.

Thanks again for the question. I hope this explanation gives you a better understanding of how this all works. And I wish you all the best.

Views and opinions expressed in this video are provided for informational purposes only and are subject to change. This discussion is not tax, legal, estate planning or USAA product advice and is unique to the member only. The law concerning tax and retirement plans is complex, penalties are severe, and the laws of your state may differ. Consult with your tax, legal or estate planning professional regarding your specific situation.
This material is for informational purposes. Consider your own financial circumstances carefully before making a decision and consult with your tax, legal or estate planning professional.
Examples given are hypothetical illustrations and not necessarily an indication of the benefits or features of any USAA product.
Certified Financial Planner Board of Standards, Inc. owns the certification marks CFP® and CERTIFIED FINANCIAL PLANNER&trade in the United States, which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
Financial planning services and financial advice provided by USAA Financial Planning Services Insurance Agency, Inc. (known as USAA Financial Insurance Agency in California, License #0E36312), a registered investment adviser and insurance agency and its wholly owned subsidiary, USAA Financial Advisors, Inc., a registered broker dealer.

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