How to Build your Credit: The Definitive Guide for College Students

By March 18, 2016Personal

How to Build Your Credit

It’s safe to say, understanding how to build your credit can save you over a hundred thousand dollars over your lifetime.

Don’t believe me?

Let’s say in a few years you obtain a $250,000 home loan on a 30 year mortgage. With a 4% fixed mortgage, you will make total payments over 30 years of $429,674 or $1,193.54 a month for 360 months.

If your interest rate was instead 6% due to your credit history, your total payments over 30 years will be $539,596 or $1,499 per month for 360 months. A difference of $109,922!

Do I have your attention now?

The savings doesn’t stop. Your credit score is factored into how much you pay for renters,  home and auto insurance also…

…And it’s not a few dollars a year difference.

You can save hundreds of dollars a year on home and auto insurance by optimizing your credit score.

Other benefits include:

  • Other loans such as private student loans, car loans, and others will have a lower interest rate. You’ll also have more negotiating power as banks love to deal with clients with a high credit score.
  • When renting an apartment, even long-term vacation rentals, it’s easier to do so with good credit history.
  • Employers now check credit history to see if you’re financially responsible
  • You’ll get better credit card offers and interest rates
  • And much more…

In the post, you’ll learn:

  • What exactly is your credit score, where to find it (for free), and how to improve it
  • The difference between your credit score and credit report
  • How to build your credit by applying for your first credit card

How to Build your Credit

To build and optimize your credit score, there are two things you need to understand:

  • Your Credit Score
  • Your Credit Report

First, let’s look at your credit score also known as your FICO (named so after the Fair Isaac Corporation) score. Your credit score is a simple number between 300 and 850. The higher the number, the better your credit history.

The number was originally created to make it easier for lenders to determine if you’re worthy of a loan or not. Just by looking at your credit score, a bank can decide if they will lend you money and at what rate.

However, your credit score now impacts many areas of your finances.

Note: There are other services now maintaining your credit score. I used FICO because it’s the most well known. All the scoring services (TransUnion, Vantage, Experian, and Equifax) have a different formula; however, all are similar.

What Makes Up Your Credit Score?

FICO hasn’t released the exact formula for calculating your credit score, but it has released what your credit score is based on. Here is the formula from their website:

Here’s what you need to know about each factor…

Payment History – 35%

Your payment history takes in account the timing of your past payments on accounts such as your credit card, retail accounts, and your mortgage. It also takes into account any bills that have gone to collection.

In college I was in a car accident. Wasn’t my fault but the other driver didn’t have insurance. He was going to pay me out of pocket. I had the bill sent to my dorm room. However, I switched dorm rooms over semesters and didn’t receive the bill.

Turns out the bill ended up going to collections. This one mistake cost me when I went to apply for a mortgage six years later.

It’s not rocket science, if you want to improve your credit score, pay your bills on time. It’s the #1 thing you can do.

Amounts Owed – 30%

The amount owed is the next biggest weight on your credit score. It’s also commonly referred to as, your credit utilization rate.

This is a ratio of the amount you owe and the amount available. It also takes into account the number of accounts you have with balances.

This perfect credit utilization rate isn’t known. However, we do know some basic facts:

  • Don’t max or come close to maxing out your available. A good rule of thumb is to not go beyond 33% of your available credit.
  • You want to use at least some credit. Therefore, a utilization rate of 0% could actually hurt your credit score.

Length of Credit History – 15%

15% of your credit score is based upon how long you have had credit. The longer your credit history, the better.

This is why it’s a good idea to apply for a card when you’re in college and keep that card for life.

It’s also why it’s a bad idea to cancel your oldest card.

Although it’s not my primary card, I still have my first card for this reason. I use it to pay my cable bill, which is automatically billed each month.

I keep this card active because you want to always have some activity on your credit. Like I mentioned before, applying for a credit card and then never using it, can actually hurt your credit card.

New Credit – 10%

Would you lend $100 to a friend who just borrowed $100 from three other friends? Of course not.

Which is why lenders, don’t like to see a lot of new activity, including credit inquiries, on your credit history.

Types of Credit Used – 10%

Lenders prefer to see a variety of credit on your credit score. For example, it’s better to have a student loan, one credit card, and a car loan then three credit cards.

This is only 10% of your score, so don’t go out and buy or car just to get variety. The most common mistake made here is carrying too many credit cards.

What It All Comes Down To

Many people try to crack the FICO equation, to determine their exact credit score. FICO has never and will never release the exact equation.

It all comes down to common sense. Pay your bills on time, don’t use all of your credit available, and don’t close your oldest account.

How to Get Your Credit Score

So now that you know 99% of what there is to know about credit scores, you probably want to see what your score is.

Option # 1 – Mint.com

Mint.com is an all in one personal finance tool.

You can track your account balances, get notifications of bills, create budgets and more.

I use Mint to track my finances and have recommended the software to many others.

They have a feature which allows you to view your credit score. The score is pulled from Equifax, one of the big three credit scoring agencies.

Option # 2 – Credit Karma

Another free option is to use CreditKarma.com.

I love the service but there are a few things you should know to get the most out of it.

  • Your score at Credit Karma can be different from your score at Mint. As mentioned, there are many different credit score reporting services and Credit Karma doesn’t use FICO. For more, read their FAQ.
  • Sign up the alerts. This will let you know of any new activities.
  • Use the Report Card to identify strengths and weaknesses

Personally, I login to Credit Karma a few times a year just to make sure there’s nothing unexpected. Plus, I’ve signed up for their alerts.

It’s a convenient way to monitor if you are on the right path.

Note: Both Mint and Credit Karma are free sites that earn money through affiliate commissions from credit card companies. Their recommendations are not always was it’s in your best interest.

How to Build Your Credit – The Credit Report

Your credit report is a more detailed report of your past credit history. It provides a future lender with just about financial transaction from your past. A little scary, but true.

Getting your credit report is simple and free.

Go to annualcreditreport.com.

You’re entitled to a free copy of your credit report from each of the report agencies once a year. You can get these all at once or over a period of a year.

I prefer to spread it out, just in case someone requests a copy (most landlords will) of my credit report, I don’t have to pay to get one.

Once you get your credit report, review it!

You want to double check everything.

Even basic information such as your name, social security number, address, etc.  You won’t believe how many stories I have heard of this information being incorrect, and consequently, negatively affecting someone’s credit without them knowing it.

Besides your basic information, you need to review everything on your credit history. Start from the first page and work your way toward the end.

To show you what you should be looking for, I’m going to take you through a recent copy of my credit report. (The report varies depending on what credit bureau you obtain it from, so don’t worry if yours isn’t the same).

Potentially Negative Items or Items for Further Review

If you have any unpaid bills that were sent to collections, this is where they’re listed.

Worth mentioning is that, Chapter 7, 11, and 12 bankruptcies and unpaid tax liens will remain up to ten years.

Accounts in Good Standing

The next section gives my accounts that are paid up to date, along with a balance history. Mine include three credit cards and one mortgage. All accounts status currently list “Open/Never late”, a great sign.

On one of my credit card accounts, I’m listed as an authorized user.

Meaning it’s not responsibility to pay the bill. Even though this isn’t my credit card, being an authorized user still affects my credit rating.

A bit of history on the authorized user because this has been a back and forth issue. One of the ways you used to be able to increase your credit score was to add yourself as an authorized user to an account in good standing. For example, if your parents had good credit, you can ask for them to add you as an authorized user and their credit history would go on your credit history.

FICO figured out this trick quickly and decided to eliminate authorized user status from the credit score equation for a short time. About two months after, the reversed their decision after the changed reversed their decision stating:

“After consulting with the Federal Reserve Board and the Federal Trade Commission earlier this year, Fair Isaac has decided to include consideration of authorized user trade lines present on the credit report in the FICO 08 model.” – Tom Quinn, Vice President of Global Scoring Solutions for Fair Isaac Corporation

I don’t know this for a fact, but from reading in between the lines I’m guessing that there is no way being an authorized user helps your credit. If the account holder is in good standing and has a good history of paying its bills, it will have no effect at all.

If the account is in bad standing, it will negatively affect your score. Therefore, if you’re an authorized user on an account with a bad credit history, ask to be removed immediately. =

Record of Requests for Your Credit History (Hard Inquiries)

Hard inquiries are done when you’re taking on additional financial obligation. Unfortunately, many businesses don’t come right out and tell you that they are performing a hard inquiry on your credit. However, it does make its way into the fine print.

The most common hard inquiries you will find on your credit report include:

  • Banks & Credit Unions
  • Credit Card Companies
  • Car Dealers
  • Insurance Companies – They’re required by law to ask.
  • Property Management Companies & Landlords
  • Phone & Cable Companies
  • Utility Companies

Here’s the statement from Experian on my credit report:

“We make your credit history available to your current and prospective creditors and employers as allowed by law. Experian may list these inquiries for two years so that you will have a record of the companies that accessed your credit information. 

The section below lists all of the companies that have reviews your credit history as a result of action you took, such as applying for credit or financing or as a result of a collection. The inquires in this section are shared with companies that view your credit history.”

Each hard inquiry on your credit report will lower your anywhere between 5 and 10 points. If you’re worried about your credit score, anytime before you open a new account just ask if they perform a hard pull on their credit.

Other Ways to Limit Hard Inquires include:

  • Ask – Anytime you’re opening a new account, ask if they are pulling your credit, when they are pulling your credit, how many times they are going to pull your credit, and how you can get that removed.
  • Don’t Rate Chase – A common, but damaging trend is to chase low introductory rates on credit cards. The more accounts you open, the more hard inquiries you will see on your credit.
  • Avoid Applying to Receive 10% Discount – When you’re checking out at a popular retail store they will ask you if you want to save 10% today by applying for a store card. The same “trick” is done by issuing free T-Shirts at sporting events. Every time you fill out an application, they pull a hard inquiry.
  • Don’t Do Business With Companies That Routinely Check Your Credit – A lot of businesses will make it a habit to pull your credit on a regular basis. Unfortunately, this is legal because they put it on the 22nd page of their terms and conditions that you had agreed to.
  • Avoid A Sharp Increase in Inquiries – This isn’t exactly a tip to eliminate a hard inquiry, but it’s still important. Many people, who want to get a credit card, will go out and apply for 4 or even ten credit cards at once. Please avoid doing this. It shows you’re in desperate need for credit, which isn’t what a future lender wants to see.

Getting Rid of Hard Inquiries

There used to be a common technique to get rid of hard inquires, that if you did a soft inquiry on yourself once a day, hard inquires would eventually get bumped. Credit reporting agencies are smart and quickly caught onto this.

If you don’t recognize or don’t remember giving authority for a hard inquiry on your credit, you have the right to get it removed by mailing or faxing a request to the creditor. You want to do this immediately, before they make another unauthorized inquiry.

The contact information for the creditor should be on your credit report. If it’s not, visit the company’s website and search for a contact number. Then call the creditor, and ask for either a fax line of mailing address to submit your formal letter. (Note: I wouldn’t ask for it to be removed over the phone because there is no paper trail)

Below is a copy sample letter you send via fax or certified mail to each creditor.

 

Your Name

Your Address

Your Phone Number

 

RE: Unauthorized Credit Inquiry

 

I was recently going over my credit report from (Insert Creditor’s Name), and I happened to see a hard inquiry listed from your company. 

The details of the inquiry are below. 

Date of Request: (Insert Date of Request)

Creditor Name: (Insert Creditor Name)

In which I am aware of, I have never approved your company for this inquiry. Under the Fair Credit Reporting Act, it is stated that you must have my authorization to perform a hard inquiry on my credit. 

Unless you can provide me a written proof of authorization signed by me, I’m asking you to contact each credit reporting agency to have your illegal inquiries removed, immediately. I also ask that you remove any personal information of mine from your records.

I’m sending this letter through certified mail, to ensure it’s delivery. 

Thank you for your attention to this matter,

Your Name

Your Signature

Removing a hard inquiry on your credit report, can give your credit rating a slight boost. The biggest benefit to doing so is less information in the hands of careless organization. The less personal information about you is circulating around, the less chance you have of getting your identity stolen. (More on this to come)

Inquiries Share Only With You (Soft Inquiries)

Soft inquiries are inquiries that you’re not even aware of. For example, the companies that send you pre-approved credit card applications through the mail perform a soft inquiry before sending you that application. When it comes to learning how to build your credit, soft inquiries have no bearing on your credit score.

On my credit report from Experian it states in bold letters:

“We offer credit information about you to those with a permissible purpose, for example to:

  • Other creditors who want to offer you pre approved credit
  • An employer who wished to extend an offer of employment
  • A potential investor is assessing the risk of a current obligation
  • Experian Consumer assistance to process a report for you
  • Your current creditors to monitor your accounts
  • A static copy of your credit report provided to a subsequent user necessary to complete your mortgage loan application

These inquiries do not affect your credit score.”

Although they don’t have any bearing on your credit score, it’s still interesting to take a look at what companies are looking up your credit history each year.

Common Questions about Credit Reports

What do I do if there is an Error on my Credit Report?

If something is wrong on your credit report, you want to immediately contact the reporting agency that issued the report.

The FTC has great instructions on what to do if there are any errors.  Follow their steps, including using their template. Make sure to copy anything you send, for your own records and record dates of everything you send.

What is Revolving Credit?

Revolving credit is a term used for credit that has no expiration. For example, a car payment, student loans, or a mortgage isn’t considered revolving because you eventually pay these types of loans off. Otherwise known as installment credit.

A credit card is a revolving payment because the credit is always available. As long as you pay it off each month, it’s always there for you.

Your FICO score looks at the amount of revolving credit you have compared to installment credit. The less revolving credit the better, in the eyes of FICO. If you’re looking for a quick increase in your credit score, a great way to achieve this is by paying off your revolving credit.

Does Applying for a Credit Card Hurt Your Credit Score?

Yes, applying for a credit card is a hard inquiry, which can negatively affect your credit score in the short-term. You can expect your credit score to go down around 5 points for six months any times a hard pull is done.

Keep this in mind, if you’re applying for a loan in the near future. For example, don’t apply for a new credit card right before applying for a car loan, to increase your credit utilization rate.

Opting Out of Credit Card Offers

Once I moved into a home, the amount of credit card offers I received was startling. Every day, I would receive at least one and sometimes more of the following applications in the mail; credit card, home equity line of credit, and mortgage insurance.

Luckily, I discovered OptOutPrescreen.com, where I can stop this junk mail from filling up my mailbox. The site was created as a result of Fair Credit Reporting Act and a link to the site can be found on the Federal Trade Commission’s website.

There are many advantages to stopping junk mail:

  • No chance of someone stealing your credit card applications through the mail.
  • Out of sight, out of mind. You willn’t be tempted to sign up for any credit card offers that you don’t need.
  • Save paper.
  • The fewer the amount of companies with your social security number the better.

You can choose to either opt out electronically or permanently by mail. If you choose electronically, you will be opted out for only 5 years. If you choose to opt out by mail, you will never receive a credit card offer again.

I wasn’t tracking the days to the exact date, but I would estimate that around four weeks after opting out, I was no longer receiving any prescreened offers through the mail.

Another tip, if you’re also tired of receiving catalogs, there is a free service Catalog Choice that can help you reduce your junk mail even more. It’s pretty simple; you just enter in your address and the catalog number of the catalog you want to eliminate.

Applying For Your First Credit Card

Applying for your first credit card is a big financial decision. When it comes to learning how to build your credit, it is the decision.

As you learned, length of credit history makes up 15% of your total credit score. Therefore, it’s possible you may keep this card open for the rest of your life.

The Credit Card Act of 2009 requires anyone under 21 to either have a co-signer or show proof of income.

A co-signer simply means that someone with income, typically your parents, have to personally guarantee you’ll pay the balance. If not, the credit card company has the right to go after the co-signer to pay.

If you do have proof of income, you’re able to apply for a card without a co-signer.

Credit card companies have designed specific cards marketed towards college students.

There are two types of cards:

  1. Secured
  2. Unsecured

With a secured card, you put down a cash deposit with the bank and that cash deposit is your limit.

What you’re doing here is giving the bank a lump sum of money (you get it back once you close the account) that they make available to you each month.

Why would you want to give a bank money, that if you don’t pay back you would get charged interest?

First of all, it builds financial responsibility. Second, secured cards are easier to obtain as you don’t need a cosigner.

Next are unsecured cards. As the name implies, with an unsecured card you’re not putting up a balance upfront. This is the biggest advantage here but there are downsides as well.

The biggest downside is the need for financial willpower on your end.

Credit cards make spending money easy. This is both an advantage and disadvantage.

An advantage because you don’t have to walk around with cash to pay for goods and services.

A disadvantage because it makes it very easy to spend money you don’t have. When you spend money you don’t have, you’re charged interest and it’s not a small amount of interest either.

So if there’s a unsecured credit card offer that interests you, it’s important that you’re able to pay in full every month the balance.

If you have the cash to put down a deposit on a secured card, my opinion is that this is the way to go as it promotes better individual financial responsibility.

What to Look For In Credit Card Offers

The first decision you’ll make is whether or not to apply for a secured or unsecured card.

There’s no right or wrong answer. There are both good and bad secured and unsecured cards.

Once that decision is made, you can then look at different card offers.

What do you need to look for?

Here are 3 tips to choosing your first credit card.

  • Review All Potential Fees – Each credit card has a different fee schedule. There’s the APY, which is the interest rate you’ll pay on any balances. There are late payment fees, which are flat one-time fees for missing payment. Unfortunately, the list goes on. The amount of fees credit card companies collect each year is startling. Know the fees ahead of time.
  • Bonus Offers – Don’t worry about rewards and sign up bonuses for now. The goal here is establishing and building your credit. If you do that, there will be opportunities to earn lucrative rewards down the road.
  • Automatic Payments – When you get your card, set up automatic payments through your checking account. Missing payments result in not only fees but a potential ding to your credit. Even if it’s just the minimum amount, setting up your automatic payments will help you avoid these nasty fees.

Now I’ve got a Question for You…

Was this guide on how to build your credit helpful?

Let me know in the comments.

The goal was to create the guide I wish someone handed me in college.

At Weiss Insurance Agencies, I’ve seen time and time again how the impact of ones credit score impact their auto insurance premiums.

I had no idea how much of an impact credit had on my future.

You now do.

Good luck!