The best ways to build your credit

With credit card debt reaching record levels, it's never been more important to understand what's happening with your credit profile. Credit refers to your financial history, particularly your record of borrowing money and paying it back over time. Although it's a simple term, it can have a big impact on your everyday life.

When you apply for credit, the lender uses your credit history to determine if you're likely to repay what you borrow. A strong credit profile can help you access home loans, credit cards, auto loans, personal loans, and lines of credit. Your credit also affects your ability to qualify for employment, desirable insurance rates, and rental housing.

Use this step-by-step guide to build credit wisely and avoid some of the most common mistakes.

A credit scoring model is the formula used to calculate your scores. Although many companies have their own models, lenders typically use the FICO and VantageScore systems.

FICO scores, developed by the Fair Isaac Corporation, typically range from 300 to 850. The FICO system has two general score versions, FICO Score 8 and FICO Score 9, along with several versions designed for specific types of lending.

VantageScore has two standard scoring models: VantageScore 3.0 and VantageScore 4.0. Like FICO, scores calculated using these models range from 300 to 850. (Not all lenders use VantageScore when making lending decisions, so your score may vary depending on which model a lender checks.)

FICO and VantageScore consider these factors when calculating your credit scores:

• Payment history: Payment history helps lenders determine if you have a track record of repaying your debts. Making on-time payments and repaying loans and credit cards as agreed can help you develop a positive payment history.
• Credit utilization: Credit utilization refers to the amount of credit you're using. It's expressed as a percentage. For example, if your credit card balances total $2,000 against total limits of $10,000, you have a utilization ratio of 20%.
• Length of credit history: The length of your credit history reflects how long you've been using credit. It considers your average age of accounts, the age of your oldest account, and the age of your newest account.
• Types of credit: Credit mix refers to the types of credit accounts you have. Lenders prefer to work with applicants who have experience managing more than one type of account.
• New credit inquiries: When you apply for a loan or a credit card, the lender checks your credit report. This leaves a hard inquiry on your record. Popular credit scoring models include the number of new credit inquiries in their calculations.

Credit affects personal finance in several ways:

• Interest rates: When you open a new account, the lender uses your credit history to set an interest rate. Borrowers with strong credit typically qualify for the lowest rates, while borrowers with poor credit must pay higher rates to account for the increased risk involved in extending them credit.
• Apartment rentals: If your credit history doesn't meet a landlord's expectations, you might not be able to rent the apartment you want.
• Insurance premiums: In some states, insurance companies are allowed to charge more if you have a spotty credit history. This can increase the total cost of maintaining auto, renters, or homeowners insurance.
• Job applications: Your credit can even affect your job prospects, as some employers believe your credit history is a direct reflection of how responsible you are.

For these reasons, your credit plays a significant role in your long-term financial health. A solid profile can help you start a business, buy a reliable vehicle, or make the dream of homeownership a reality.

Building credit takes time, but it's well worth the effort, so try to be patient. Small steps now can help you make your financial dreams come true later.

One way to build credit early is to open a secured credit card. Unlike unsecured cards, secured accounts require an initial deposit. Once you deposit funds, you'll be able to spend up to your credit limit.

Secured cards work just like regular credit cards, so you can use them to make online payments or pay for merchandise in a local store.

Another option is to become an authorized user on someone else's credit card. Once you're authorized to use the account, you'll receive your own card, allowing you to access the account owner's credit line.

Before becoming an authorized user, ensure the account owner makes their payments on time and isn't near their credit limit. If the account isn't in good standing, you won't benefit from having access to it.

Finally, consider a credit-builder loan, which is a small loan secured with a cash deposit. The lender reports your payments to the credit bureaus, helping you build a credit profile.

No matter which credit-building method you choose, it's essential to make your payments on time and keep your balances low.

Once you establish a credit profile, you can improve it by following these tips:

• Pay your bills on time, every time. 
• Keep your credit utilization ratio below 30%. You can do this by paying more than the minimum each month or using your credit accounts only when necessary.
• Avoid opening too many new accounts at once. Some lenders view this as a sign of financial instability.
• Pay off old debts or catch up on any missed payments. It will take time, but taking care of delinquent accounts can help you improve your credit.
• Review your credit reports regularly. If you find any errors, dispute them with the original credit and the credit bureaus. Regular reviews are essential for spotting signs of fraud and identity theft.

In the rush to build credit, it's easy to make a mistake that affects your scores for years to come. To avoid lasting consequences, avoid these common errors:

• Missing payments
• Making late payments
• Maxing out your credit cards
• Applying for several new accounts at once
• Ignoring your credit reports

If you're working to build credit, you might receive some loan offers that seem too good to be true. These offers typically come from predatory lenders who don't have your best interests in mind. If you're thinking about accepting a credit offer, review the terms carefully.

Credit-repair scams are also common. Scammers promise to boost your score overnight if you pay them a lump sum, but they disappear once you send the money. 

Late payments, collections, and bankruptcy can affect your credit for years. The best way to avoid these negative consequences is to make on-time payments and pay back what you owe.

AnnualCreditReport.com is the only government-approved source for free credit reports. You can use this site to get free weekly reports from Equifax, Experian, and TransUnion. All three credit bureaus also offer credit monitoring to help you keep track of your credit profile.

Using a budgeting app, such as EveryDollar and YNAB, can help you keep your spending in check, making it easier to afford your minimum monthly payments. You can also use your favorite spreadsheet software to keep track of what you have coming in and going out every month.

If you need additional help building credit, seek advice from a nonprofit credit counseling agency.