If you hope to buy a house, rent an apartment, take out a car loan, or even get certain jobs, you’ll need to know how to build good credit.
And, if you have great credit, you can save thousands of dollars over the years because you can qualify for rock-bottom rates on any loans you take out.
Building your credit can seem like a daunting prospect, whether you’re building it from scratch or rebuilding it after it’s taken a hit. But, rest assured: building credit is actually not rocket science at all. In fact, most of what you need to know can be summed up in this very article.
So, let’s get started.
What Goes Into A Credit Score?
The exact formula for calculating your credit score is held under tight lock-and-key, but we generally know the gist of how it works. Here are the factors that are taken into account when determining your credit score number:
- Payment history — 35%
- Amounts owed — 30%
- Length of credit history 15%
- New credit — 10%
- Credit mix — 10%
If you know these percentages, it’s easier to understand what you need to do in order to boost your score and build good credit.
Now, let’s focus on specific things you can do within each of these categories.
Ask to be an Authorized User on a Trusted Friend or Family Member’s Credit Card
Here’s one way to build your credit quickly: ask to be an “authorized user” on someone else’s credit card.
This means that you aren’t the account owner, but you do have permission to spend with a separate credit card, which the company will issue you.
Doing this has two benefits:
First, you’ll get a credit card without having to apply for it on your own (a useful thing if you might be denied based on bad credit or a lack of credit history).
Second, that account — including its entire history, even before you were added on as an authorized user — will be added onto your credit report.
If your friend or family member has good credit, then suddenly it may look like you have good credit too.
This is a really delicate thing to ask of your friend or family member. If you rack up credit card debt and don’t pay it back, this will hurt that person’s credit too. It’s a big risk for them, and that’s why this is such a big ask.
But, you don’t actually need to use the credit card in order to get the benefit from it. Everything your friend or family member does will typically be recorded on your credit report as well. In fact, if it makes that person feel more comfortable, you can offer to hand your newly-issued credit card over to them for safekeeping.
Open a Credit Card of Your Own
Of course, the best — and least risky to other people — way to start building credit is by opening up your own credit card. There are a few different places where you can get credit cards:
- A bank
- A credit union or caisse populaire
- A merchant
Opening up a new credit card has several benefits for your credit score. You’ll establish a credit history. The longer, the better, and everyone has to start somewhere. With a new card, you’ll also establish a payment history. The more on-time payments you make, the higher your credit score will be.
This new credit card will also add a new type of credit onto your account and this serves to help you build credit.
Take Out a Loan
Speaking of new types of credit, it can also help your credit score to take out a new loan.
Auto loans, student loans, personal loans, and mortgages, all count as different types of credit.
The more types of credit you have listed on your report (i.e. the more types of loans you open), the higher your credit score will be over time.
One huge caveat here is that it’s best to wait until you actually need a loan before applying for one. Why? Because each loan costs money (via interest and fees).
Furthermore, if you overextend yourself by taking on too much debt, you may default on your loan or make a late payment — and this will really hurt your credit score.
Instead, if you’ve been waiting to buy a car or make some other large purchase, now might be an opportune time so long as you are financially prepared to make the payments. You should also use a vehicle loan calculator if this is the case, as it’ll give you more insight into the loan repayment.
Make All of Your Payments On Time
The biggest factor on your credit report is your payment history. Lenders want to know one thing: if you take out a personal loan in Canada, will you pay them back in full and make each payment on time?
Each on-time payment will help you build your credit. On the flip-side, even a single late payment can lower your credit score. Even worse, missed payments can stay on your credit report for up to six years.
One easy way to make sure you never miss a payment is to put all of your loan and credit card payments on autopay. This way, you never have to remember to do it — it just happens automatically, and protects you from getting a huge ding on your credit score.
Don’t Rack Up a Lot of Debt On Your Credit Card
The second-biggest factor that goes into calculating your credit score is the amount of money you owe. The less, the better – it’s simple.
In fact, many experts advise keeping your credit utilization ratio below 30%. This just means that you ideally owe less than 30% of your available credit limit, calculated across all of your credit cards.
For example, let’s say you have two credit cards, each with a $5,000 limit. Your total credit limit would then be $10,000. If you follow the 30% rule, it would be best to have no more than $3,000 in credit card debt (i.e. 30%) spaced out across one or both cards at a time.
But, an even better way to manage your debt is to pay off your credit card balance in full at the end of each month.
If you pay off your entire balance before the bill is due, you won’t owe any interest at all. This is like having a free short-term loan, plus free perks if you have a rewards credit card.
Don’t Close Your Old Credit Cards
Lenders like to see a long credit history because it usually means you’ve been around the block a few times and know what you’re doing when it comes to credit.
Old credit cards help show lenders that you do have experience managing your credit card. When you go to close that old credit card, it’s removed from your list of open accounts. All of a sudden it looks like you’re a new credit user, even though you know you’ve got the chops to manage using a credit card wisely.
This is why it’s always a good idea to keep old credit card accounts open, if possible. The only exception would be if the credit card carries an annual fee, and you’re not using it anymore.
In this case, the fee probably isn’t worth it and it may be a better idea to save the cash and close the card.
How to build good credit shouldn’t be a mystery. If you follow a few important rules, like always making your payments on time, avoiding too much debt (especially credit card debt), and establishing a long credit history, you’ll be well on your way to a good credit score.
These tips will help optimize your credit-building journey so that you can build the best credit score possible.