Your “credit history” is one of the most important factors behind that magical three-digit credit score, and one that takes years to establish. Hence the word history.
Over time, the use of things like credit cards, student loans, auto loans and leases, and mortgages will play a major role in determining whether you’re able to obtain subsequent financing, and at what kind of terms.
If you’re a good borrower who always makes on-time payments, prospective creditors will be glad to have you “come aboard.” But if you haven’t always paid on time, and let balances get away from you, creditors might tell you to hit the road, Jack.
Establishing Credit History Is a Catch-22
It’s important to make the right decisions early on to ensure you’re able to get credit in the first place. The funny thing is that establishing credit is a bit of a catch-22 because it’s tough to get any if you don’t have it to begin with.
Perhaps the best way to get started is by opening a checking and/or savings account, which is NOT a line of credit.
Once in place, the issuing bank will more than likely try to upsell you by extending lines of credit, such as a credit card to go behind your existing account. This is a simple way to build your credit history, and should open the door for more offers from outside companies.
One alternative is to open a secured credit card, which requires an associated account that acts as collateral for the credit line.
An even easier way to build credit is to get added as an authorized user on a parent or guardian’s credit card. This method doesn’t even require that you have any credit history because the initial/main credit card holder assumes all responsibility for your actions. The caveat here is that they must trust you to add you as an authorized user.
Tip: You can add a child as an authorized user, but not actually give them access to the credit card in question. This will facilitate the building of credit history, without the risk of the teen getting into debt.
For the record, this method works for anyone, including spouses and even parents of children.
Large Lines of Credit Hard to Come By Without Credit History
Typically, it’s difficult to secure a large line of credit if your overall credit history is thin. For example, if you’re in the market for a new home, a bank probably won’t extend a mortgage unless you’ve got years of solid, documented credit history. In fact, most mortgage lenders require at least three seasoned credit tradelines with a two-year history on each. So it really is essential to establish your credit history early on.
The best way to do so is sequentially, starting with a bank issued credit card or through a store credit card or gas card, and then moving on to an auto lease, and finally a mortgage. As time goes on, if you make timely payments and prove to creditors that you’re able to carry large amounts of debt, you’ll gain their trust and more (and better) offers will become available.
At the same time, it’s important to note that many accounts aren’t often included in credit reports, such as common utility bills. And if they’re not included, you won’t receive any benefit credit score-wise. However, they can be added manually by contacting the credit bureaus and providing the accompanying paperwork to prove your timeliness.
This can be helpful if you’ve got a limited credit history, but good enough credit otherwise. As I mentioned earlier, lenders have certain requirements, and even with an excellent credit score, a lack of history or depth could stop you in your tracks.
Good Credit History Insulates Credit Scores
Also take a look at how long negative items remain on a credit report just to see how serious a delinquency can be. These mistakes can stick with you for a long period of time, wreaking havoc on your credit score and preventing you from obtaining credit.
That said, the longer and deeper your credit history, the less impact a bad mark will have on your overall score. Think a pebble making ripples in a puddle vs. the ocean.
For example, if you’ve got limited credit history, one 30-day late payment could sink your credit score by 100 points. Conversely, if you’ve got years of solid credit, one late payment will have considerably less impact.
It’s important to keep an eye on your credit report from time to time to ensure things are being reported accurately. You can order a free credit report from the credit bureaus once a year, which will display all of your information except for a free credit score. This is a good way to stay on top of things, and in the event that you find any misinformation, quickly report it to the bureaus via a credit report dispute.
In summary, remember that credit history and credit score are two very different things. And someone with a 700 credit score (seemingly good credit) may get denied credit while another consumer with a 660 credit score (average credit score) gets approved.
So work hard to fortify and protect your credit history to ensure you never get denied when you’re in need of new credit.