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Credit 101: What credit is and how to get it

Whether to fund a major purchase or cover emergency expenses, you – like all the rest of us – will likely need to borrow money at one time or another. Even the youngest among us can benefit from understanding how credit works and what you must do to get it.

How credit works

When you get a loan from a bank, you agree to pay back the amount you borrow, plus interest and, in some cases, additional service fees. The lender provides a schedule for repayment, which you are obligated to follow.

Your bank isn’t the only one concerned with the timely repayment of your debt. Credit bureaus also track your credit history and compile credit reports that reflect how well you managed your finances over time. They also assign you a credit score, which future banks and lenders will use to assess your credit-worthiness.

How to build credit
Building credit takes time – at least six months of making on-time payments. High school and college-aged students are wise to begin creating a credit history as it improves their chances of being approved for a loan when they need it. You can build a credit history by:

  1. Opening a secured credit card account When building credit from scratch, a good place to start is with a secured credit card. This type of card requires you to deposit funds with a card issuer that can be used as collateral if you fail to make payments. By paying on-time and in full each month, you raise your credit score and will eventually become eligible for a regular unsecured credit card.

  2. Becoming an authorized user on someone else’s credit card – You can also build a credit history if a family member or friend is willing to add you to his or her card as an authorized user. But be forewarned: you must contact the card issuer to make sure it reports your authorized user activity to the credit bureaus. Also, you’ll want to be faithful in paying your portion of the bill. While not legally liable for payment, you want your friend or relative to consider you trustworthy as well.

  3. Applying for a small credit-building loan – Similar to a forced-savings program, these loans are designed for people with little or poor credit history. The money you borrow is held by the lender until you repay the loan. Your on-time payments are reported to the credit bureaus, helping to boost your credit score.

  4. Getting a co-signer on a loan – Many lenders will make loans to people with little credit history if they have a co-signer – a qualified person who agrees to pay the debt if the borrower fails to do so. Again, you don’t want to take advantage of the co-signer’s goodwill by not meeting your responsibilities, so it’s important to have a financial plan in place to ensure you’re able to make the monthly payments.
Build your credit score with good habits
Paying your utility bills, rent and other expenses on time can also help build credit. Other ways to demonstrate your credit worthiness include:

  • Make all payments on time. Bills that go into collections hurt your credit.
  • Avoid “maxing out” or reaching your maximum credit limit on your credit cards. Pay in full every month to avoid interest charges, if possible, and don’t let your balance exceed 30% of your credit limit.
  • Keep accounts open for as long as possible to demonstrate your payment history.
  • Review your credit score and credit report frequently and report errors and discrepancies annually.
You can’t build credit overnight. But with smart financial planning and prudent spending habits, you will eventually build your credit profile.

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