When Should I Start Using Credit?
Whether you’re turning 18 or watching your kids graduate high school, it can be intimidating to start using credit. Where do you start? Whom should you trust? And how do you avoid getting into trouble?
Here’s some advice to hopefully make your journey into the world of credit a little easier to navigate.
- What is credit?
- Credit building options
- Why earning good credit is important
- When can you start building credit?
- 4 steps to managing credit for the first time
- Make payments on time
- Keep your credit card balances low
- Monitor your 3 credit reports for errors
- Don’t apply for too much new credit at once
- Benefits to building credit when you’re young
What is credit?
Credit is borrowing money or services now and agreeing to pay later. Any time a company agrees to give you something upfront (money or services) that you will repay in the future, that’s credit.
Here are a few examples of credit.
- You apply for a credit card and promise the card issuer you’ll pay back any charges you make (plus any applicable interest and fees) within an agreed-upon period of time.
- You apply for a loan and promise the lender you’ll pay back the amount borrowed (plus any applicable interest and fees) at an agreed-upon amount per month.
- You apply for a utility account and promise to pay the service provider back for the services you used the previous month (plus any applicable fees).
Here’s where it gets a little complicated. In order to get credit, you generally need to have good credit first.
Credit building options
Getting a lender to take a chance on you when you’re a credit newbie can sometimes be challenging. Yet there are lenders that offer financial products designed with new credit users in mind.
Here are a few options the Consumer Financial Protection Bureau (CFPB) recommends if you’re building credit for the first time.
Secured credit cards
A secured credit card is a type of credit card that requires you to make a deposit upfront. Your deposit is typically equal to your credit limit and is used as collateral to secure the account (thus the name “secured”). If you can’t qualify for an unsecured credit card (no deposit required), a secured card can be a good alternative.
Secured cards are available from many banks, credit unions and online card issuers.
Credit builder loans
Another financial product that offers easier qualification standards for credit beginners is the credit builder loan. When you take out a credit builder loan, the lender will deposit the money into a savings account instead of handing the funds over to you right away. Once you’ve made your final payment on the loan (typically around six to 24 months later), the funds are released with any interest earned.
Credit builder loans are available from many local credit unions as well as a few online lenders.
Retail store cards
Retail store cards are another option for those new to credit. However, these cards come with a few drawbacks to consider. First, there are restrictions on where you can use them. Second, retail store cards are known for having low credit limits and high interest rates — not the most attractive combination. Nonetheless, if you manage them well, retail store cards could potentially help you build better credit, and that’s the goal.
Retail store cards are available from many department stores, retail chains and gas stations.
Why earning good credit is important
When someone says you need to earn good credit, they are referring to your credit reports and credit scores. You have many credit scores, but they are all based on the information found on your three credit reports — Equifax, TransUnion and Experian.
When you apply for new financing, a lender will typically check at least one of your credit reports or scores to determine whether doing business with you is a good risk. If your application is approved, your credit scores may also determine the interest rate and terms you’re offered.
Higher credit scores mean you’ll be more likely to qualify for new financing or services. Higher credit scores might help you to pay less money in financing costs as well, if you’re approved.
When can you start building credit?
When it comes to building credit, you shouldn’t wait. That said, there are limits in place that prevent you from doing much before you reach adulthood.
“Generally speaking, the credit bureaus would prefer if you waited until you’re 18,” said John Ulzheimer, an Atlanta-based credit specialist formerly with FICO and Equifax. “There are some exceptions, of course, as it is possible to have a credit report prior to your 18th birthday.”
There are several reasons to start building credit as early as you can.
- It takes time to earn good credit. If you wait until you need credit to begin building it, you might be disappointed.
- Without good credit you may have a hard time leasing an apartment, qualifying for loans and credit cards or getting a job.
- Good credit can save you money on mortgages, loans, credit cards and even your insurance premiums.
4 steps to managing credit for the first time
Regardless of when and how you ultimately decide to open credit, it’s crucial to learn how to manage your new accounts properly. If you make mistakes, that new account could backfire and hurt your credit instead of helping it.
Check out these four simple steps and you could be managing your credit like a pro before you know it.
Make payments on time
When you apply for new credit, one of the first things the lender will want to know is how you’ve managed payments in the past. Payment history is so important that 35% of your FICO credit scores and a significant portion of your VantageScore credit scores are based on it.
If you want a chance to earn good credit scores for the future, developing the habit of paying on time is key.
Keep your credit card balances low
How much debt you owe, especially credit card debt, is almost as important as paying your bills on time. The percentage of your credit limits you use on credit card accounts greatly influences both your FICO and VantageScore credit scores.
Paying off your credit cards in full each month is the smartest way to manage your accounts. Doing so can both save you money on pricey interest fees and help you to build solid credit scores at the same time.
Monitor your 3 credit reports for errors
Mistakes on your credit reports could hurt your credit scores. Credit reporting mistakes could also make it more difficult or more expensive to qualify for new financing.
It’s your responsibility to keep an eye on your credit reports to make sure they contain accurate information. Thankfully, the Fair Credit Reporting Act (FCRA) gives you the right to check all three of your credit reports for free once every 12 months at AnnualCreditReport.com.
If you find mistakes on your credit reports, the FCRA goes one step further and gives you the right to dispute errors with the credit reporting agencies.
Don’t apply for too much new credit at once
Shopping around for credit can be smart if you’re trying to find the best deal on financing. However, if you apply for new credit too frequently, there’s a chance you could damage your credit scores in the process.
Why would applying for credit impact your scores? According to FICO, research shows that opening a number of new credit accounts in a short space of time represents a higher credit risk.
Remember, checking your own credit reports will never hurt your scores. You also don’t need to be afraid to rate shop (within a short period of time) when you are preparing to finance a major purchase like a car or home.
However, it’s a smart idea to get into the habit of only applying for new credit when you really need it. In other words, don’t apply for a new retail store credit card just to score a free sweatshirt at the mall.
Benefits to building credit when you’re young
Once you understand how to properly manage credit, it’s good to start building it as soon as you can. As Ulzheimer points out, the benefits of establishing credit while you’re young are clear.
“Scoring systems will reward you for having older data on your credit reports,” he said. “If you wait until later in your life, you’ll have ‘younger’ credit reports in the middle of your peak credit usage years, which could cost you in the form of higher interest rates.”
“It’s better to begin building credit as young as possible, so when you hit your peak credit usage years, you already have a well-aged credit report,” he said.
If you’ve over 18, there’s no reason to put off building your credit another day.