Credit allows adults to borrow funds to make important purchases too costly to buy with their own cash: a house, an education, a car, among other things. "Credit” is borrowed money in various forms: credit cards, retail store credit, car loans, personal loans, college loans, and a mortgage (a large loan used to buy a house).
Next to earning a good living, an excellent credit score is the most important financial goal to pursue, and young adults can begin to do so as soon as they turn 18. Credit scores range from 300 to 850, and your goal should be to keep yours at or above 760, the point at which you’ll get the most favorable terms (lowest interest rates, down payments, etc.) when borrowing money.
The way you create and maintain a high credit score is simple: pay all your bills in full, on time, always.
Below is a rough outline of the steps I followed to help our daughter to establish and grow her credit score once she graduated from high school.
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Before Age 18:
Work and save
This project will take $1500 or so to get started, so you’ll need to earn that seed money before you can begin the process outlined below.
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Age 18:
Regular income
You’ll need a source of regular monthly income greater than you expect to spend each month. To be safe, it’s preferable to earn at least twice what you’ll be using credit to pay for.
** Note: Each month, on a regular basis, you must deposit earned income into your checking account. Without that regular deposit of income, in large enough amounts, this project will not work.
Checking account – backed by an overdraft savings account
Put $500 into a fee-free checking account, and $500 into a linked overdraft savings account that will automatically pay your bills if you overspend your checking account.
Set up your accounts at a bank or credit union near you. I recommend credit unions over big banks. Credit unions support the local area economy and generally providing better service to customers.
Credit Card 1
First, apply for a “secured credit card” or "student card." This is a special kind of credit card for first-time borrowers with no credit history.
With a secured credit card account, you pay a deposit to the bank issuing the card (perhaps $500) to guarantee your purchases will be paid, as promised. Once you’ve shown a six-month history of responsible payments (paying all charges each month in full and on time), the deposit will be returned to you. Your “secured” card then becomes an ordinary “unsecured” card.
Use you credit card sporadically to pay for restaurants and other low cost items. Be sure to keep your spending well under the spending limit for that card (known as your “credit limit”).
* Note: If at any time you have questions about your card, you can call the customer service phone number listed on the back of the card to get answers.
Set Up Autopay on Credit Card 1
From the beginning, you should enable “auto-pay” through your bank’s online banking system to automatically pay credit card charges and other regular bills and payments directly from your checking account. Autopay ensures that all your bills are paid in full, on time, each and every month.
With autopay, all you have to do is check online at the beginning of each month to make sure your checking account balance (the amount in your account) is large enough to easily cover the automatic payments that will be withdrawn from your account that month (if possible, maintain a checking account balance at least double the amount withdrawn by autopay each month to pay bills).
In this way, you won't have to write paper checks to pay your monthly bills, add stamps to payment envelopes, and actually drop them in a local mailbox on time. Making manual payments like this is not just a hassle; it raises the possibility that you might make a payment late, or forget to do so altogether. With autopay, that never happens – as long as you keep your checking account balance at the proper level.
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Age 19:
Become an “Authorized User”
Now that you have some clean credit history, you can apply to become an “authorized user” on a credit card owned by someone else who trusts you, like your mom or dad.
You’ll be able to use the card to make purchases, which helps strengthen your credit history, but you won't be responsible for any payments. This is where “trust” comes in.
To make the most of this score-building opportunity, be sure to remain as an authorized user on this account, making sporadic purchases with it, for at least one year.
Credit Card 2
Now that you can show a longer history of good credit habits involving two credit accounts, you can apply for another unsecured credit card under your own name. Having more open credit accounts improves your credit score – as long as you always pay the full amount due on every one of your accounts, every month, on time. Search online for info on the best credit cards to get.
Use this card sporadically. As usual, have payments for your second credit card made through your checking account autopay service.
* Note: Once you’ve established at least one year of clean credit history, you can remove yourself as an authorized user on your parents’ card. Time spent as an authorized user has served its purpose. Now that you’ve got your own cards, you don’t need to have your name on theirs any longer.
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Age 20:
Retail Store Credit Card
A “mix” of different types of credit also helps build a higher credit score. In addition to bank-issued credit cards, retailers ofter issue credit cards to customers.
Go to a favorite retail store, and sign up for a store credit card to make a some additional purchases. As usual, pay the balance on that card in full each month using autopay.
Credit Card 3 – Rewards Card
Now that you’ve had two years' clean credit history on three different credit accounts, you’re ready to apply for your “go-to” credit card: a Rewards Card. “Rewards Cards" offer users extra advantages.
The best card to get is a “Cash-Back” card, one that offers at least 2% back on each purchase. Your rewards card now becomes your “go-to” card that you'll use for nearly all purchases.
If you shop on amazon, you’ll want to get an amazon Prime credit card, which gives users 5% off on all amazon Prime purchases. Costco members can get a Costco membership credit card that gives 4% back on all purchases of gas, which could save a lot of money for those who do a lot of driving.
* Note: Don’t keep too many cards in your wallet. I keep only two, my rewards card, and my Costco card. I keep the amazon card at home, since I only use it for online amazon purchases. Still, it’s good to have more than one credit card with you, just in case one doesn’t work for some reason. It's unnecessary to have more than three or four credit card accounts, total.
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Age 21:
Consumer Tech Loan
The Apple Store and other tech retailers will give loans to customers to pay for major purchases of tech gear: laptops, iPads, desktop computers, etc. Buy a good product (something you need and were going to purchase anyway) new or refurbished from one of these major retailers, and have the loan payments made automatically through autopay.
Keep the term (length) of all loans under three years (less is better, but never pay off a loan in less than a year, to give your credit score the best boost).
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Age 22:
Personal Loan
With a fairly long credit history, you can now apply to a bank for a “Personal Loan.” This is a loan you take for something personal, like a vacation. Apply at the bank or credit union holding your checking and savings accounts.
Take a short trip with a friend, and pay for it with funds provided by your personal loan. Then, as usual, put the loan payments on autopay.
Don't borrow more than you can easily afford to pay back. But a small personal loan of $1000-$2000 paid over a two year period will help you credit score a lot.
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Age 23:
Pay BillsGet a cell phone account, put your name on your house utility bill, and sign up for a streaming service or two; then, put all these bills on autopay though your checking account or pay them automatically using your go-to credit card (call your credit card company to set this up).
Signing up for
special credit services can give scores a boost for those who pay basic bills on time (especially phone and utility bills). Renting an apartment may require a such a history.
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Age 24:
Car Loan
At this point, you’ve established excellent credit over a period of several years, and have a score at or above 760, proof of top-tier “credit worthiness.”
With such an excellent credit record, you can make your first major purchase using credit – a car. Either arrange a car loan in advance with your bank or credit union, or buy the car through a dealership and use their financing department to arrange the loan.
To save money (and get a better deal), it’s best to buy a car that’s used but only a few years old. Going through a dealer is super-convenient and makes a lot of sense for first-time buyers. Be sure to research best models and prices, before making your purchase.
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Age 25:
Home Mortgage
With three or four credit cards, a store card, a consumer loan, a personal loan, and a car loan on your credit history, each account over one year old and with a flawless repayment history, you’ll be able to realize the American Dream: home ownership.
The largest purchase most people will ever make is buying a home. A home loan, called a "mortgage," a huge step, but one you’re ready to make, now that you’ve learned how to earn and deposit money and handle spending and payment responsibly though auto payment.
The only other requirement is a regular income from work large enough to handle the mortgage (monthly income will need to be at least four times the monthly mortgage payment).
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Search online for other suggestions relating to building and maintaining excellent credit. The more you know, the better. Next to your career, and your home, your credit rating is the most valuable asset you possess.
Following the approach above, in five years, by age 23, one year out of college, your credit score is now well over 800. You're in rarified air with one of the best of credit scores, with a credit history strong enough to qualify to buy your first home under the best possible mortgage terms.
* Never close a credit card account, once opened, even if you owe nothing on the account. Generally speaking, it’s best to keep all credit card accounts open forever, since the older your credit history, the higher your credit score.
At this point, further credit isn't necessary, and you should avoid opening any additional accounts, unless truly necessary. Just maintain your excellent credit history, use the few credit cards you have, always pay all your bills in full and on time each month using autopay, and make sure your checking account balance is higher than you'll need to cover auto payments for at least two months (with a similar sum in your linked overdraft savings account, for extra safety and as an emergency cash fund).
You have arrived. Good job.
Enjoy!
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Copyright © 2006-present: Christopher R. Borland. All rights reserved.
