Your credit score is one of the most important numbers that you will deal with for most of your life. Not only is it used to determine what interest rates you pay on loans like traditional mortgages, it is also used in other key scenarios like qualifying to rent an apartment or applying for a job. Regardless of how we might feel about this, getting and keeping a good credit score is critical.
I often have young people ask me “how do I start getting credit?” I refer to this as your “credit journey” because it really is a journey. It is a long term process where you will learn and experience things along the way. In this article, I will lay out what I believe is the best step by step process to get started on your credit journey, and toward the end I will provide some tips for you to use along the way.
Step 1 – The Foundation
One of the mistakes that I made personally was just randomly applying for any credit card that caught my eye for my first card. I ended up canceling that card after a few years because it was a bad card, and that isn’t good for your credit history. You want your first card to be your “forever card” since it will be the anchor to your credit history and you want the longest account history possible down the road.
My recommendation for your first card is that it be from a local credit union. If you don’t have a credit union nearby, but you have a small local bank who issues cards, that is fine too. The important thing is that the credit union does not charge fees for basic checking and savings accounts and that the credit card you apply for has no annual fee. The no annual fee part is critical because it makes sure that you are able to keep the card forever without having to pay a fee every year to keep it.
- Head to your local credit union branch (or their online website) and open a basic checking and savings account to start. Before you open the accounts, make sure that the credit union offers no annual fee credit cards, since you will need that later.
- Deposit some money into both accounts, and if you are able to get your paycheck directly deposited into your checking account, do that too. You are building a relationship with this credit union, and this will pay off in the future – trust me.
- Use the account like you would a normal bank account.
- Deposit your checks into it.
- Use your debit card to make purchases like food, groceries, etc.
- Withdraw cash from the ATM if you need to.
All of this is showing account activity and showing you are able to manage your money without overdrafting. Again – do not overdraft.
After doing the above for at least three months, preferably six to twelve months, it is time to move on to step 2.
Step 2 – Your First Credit Card
After you have spent the better part of a year establishing a relationship with your local credit union and showing that you are responsible with money, it is time to apply for a no annual fee credit card.
While you can usually apply online, I would recommend that you actually schedule an appointment with the credit union and go in person to apply. Again, credit unions value relationships and looking eye to eye with a representative still means something in terms of a financial relationship. Ask the representative which credit card they would recommend for you for your first card.
Normally, the credit union will have a few basic cards with low interest, simple cash back or even a secured card for first time applicants. If the representative recommends a secured card, with an initial deposit, that is OK. Again, this is your first card and you are establishing your credit history.
A no annual fee secured card with a security deposit is perfect for this. Later on, when you have “graduated” to a non-secured card, you can look at other card options, but right now, you are just trying to get started.
Now, be prepared for what could happen while you are in the branch applying. You might try to apply for a non-secured card and get denied. That’s OK. The representative will then likely recommend you get a secured card (if they didn’t to begin with). There is no risk with a secured card, so if you go down that route to begin with, you will walk out having secured your new card and ready to move on to the next step. Congratulations! You are now on your way on your credit journey!
Step 3 – Building Your Credit
Now that you have your shiny new credit card, how do you use it to build credit? The first thing you should do is understand what credit card utilization means and work to stay under 30% utilization in any given month.
For example, let’s say you get a $1000 credit limit (secured or unsecured), 30% of that would be $300. To keep your utilization under 30%, you should not charge more than $300 to the card in any given month, and you should pay the full amount off after the statement close date, on or before the payment due date.
Over time, the card issuer (the credit union in this case) will increase your credit limit automatically (or you can request credit limit increases every six months or so). You will be able to charge more per month over time, but remember, always pay the balance in full every month and do not pay interest.
I recommend that people start off by picking one recurring bill per month that fits within the 30% utilization and pay that bill (and only that bill) to the card every month. For example, using the above example, let’s say your cell phone bill is $100 a month. For the first six months, use the credit card only to pay your cell phone bill, and then pay the card off every month.
Let’s say your internet bill is also $100 per month. The next six months, you should pay both your cell phone and internet bills with your credit card ($200 total) and pay the credit card off every month. You would have kept your utilization under 30% for a year now, while actively using the card and paying it off in full every month. This is how you build a good credit history.
By now, you should be getting an automatic or requested credit limit increase, and as that happens, the amount you can charge to the card per month while still remaining under 30% utilization increases over time. Just rinse and repeat the process being careful to always pay the entire card balance every month in full – never pay interest.
After a few short years of this, your credit score should be well into the 700s and on its way to the 800s. Congratulations!
What’s next?
Now that you have a solid credit score, your main task is to keep it that way. Keep using credit responsibly and paying on time and in full every single month. Never carry a balance and never pay interest. (I know, and I will keep repeating this until the day I die.) You should also consider freezing all three of your credit reports with the major three credit bureaus if you haven’t done this already. I will write a separate article on this soon.
So what do you do with this great credit score? Well, let’s start with what you don’t do with it. Don’t go and open a ton of credit cards just because you can. In general, it is best to stick to 2 or 3 cards total, and I will discuss my philosophy on this in a future article. Don’t go and finance automobiles. Again, I will write a separate article on this, but automobiles are a depreciating asset and one of the worst ways to use your credit. Don’t take out loans on random things that are not appreciating assets. I will also write a separate article on this topic soon.
So what are good things to use your good credit score on? As mentioned earlier, you want to use your good score to get approved for housing (apartments) that are within your means and for any pre-employment credit checks that may be required for a good job that pays well. If you are far enough along your credit journey and in a stable financial situation, you may want to buy a home and take out a mortgage. This is also a good use of your good credit score as a home is an appreciating asset. That’s about it. If you can live within the steps I’ve outlined above, you have a long, prosperous credit journey ahead of you. I wish you a stress-free life, peace and financial independence!