Have you ever thought about what it would be like to be invisible? When it comes to your credit rating, you do not want to be invisible. Being “credit invisible” doesn't necessarily mean you have not had any credit activity; it means that the activity you had was not reported to any of the three major credit bureaus. Without a credit score, it can be challenging to qualify for loans or even credit cards because a lender cannot assess your credit risk.
A recent study from the CFPB found that 26 million consumers in the United States are “credit invisible”. It also estimated that an additional 19.4 million Americans, approximately 8.3% of the total adult population, had credit records that contain insufficient information, credit histories too limited to generate a credit score (i.e. “unscorable”), or credit histories that have become “stale” because of a lack of recent credit history.
What you’ll learn in this article:
- Why You Need to Build Credit
- What You Must Know About Credit Scores
- What You Need to Know about the Scoring Models
- How Long Does Credit Take to Build?
- How to Build Credit
- Why is it so Easy to Destroy Your Credit Score?
To have a good credit history, you have to use credit responsibly.
Why You Need to Build Credit
Establishing credit is possibly one of the most important things you need to do once you turn 18. Having good credit is essential in many areas throughout your life. This includes buying a house or car, getting a school loan, opening a credit card, or even getting a cell phone. Just about anything that requires borrowing money requires having a credit history. The longer and better your credit history, the greater the likelihood that you’ll be approved for a loan.
What You Must Know About Credit Scores
A credit score is a 3-digit number, typically ranging from 300 to 850. Lenders use this score to evaluate the probability that you will repay the loan in a timely manner. Your credit score is based on your credit history, number of open accounts, total amount of debt, and repayment history.
The majority of lenders use your credit score to decide whether they’ll approve your request for a credit card or a loan. FICO® and VantageScore® are two main credit models that are used to create your scores.
What You Need to Know about the Scoring Models
Once you have taken out a credit card or a loan and start paying on them, you begin to build your credit history. Once you have enough history, you will develop a credit score. This score works as a prediction of your reliability to repaying your financial obligations. Let’s look at the two main credit models.
FICO®[1]
Originally founded in 1956 as Fair, Isaac and Company by Bill Fair and Earl Isaac, FICO is a data analytics company based in San Jose, California focused on credit scoring services. The use of FICO Scores as a measure of consumer credit risk has become the standard for consumer lending in the US.
The majority of financial institutions in the United States use FICO Scores to decide the risk of loan and credit card applicants. Lenders can access your FICO Score from any or all of the three major credit agencies to help determine your credit risk. Each credit agency calculates your credit score somewhat differently, so your credit score could vary a bit among them, as some creditors don’t report all activity. Your FICO Score will range from 300 to 850 and is calculated using five factors:
- Payment history: 35%
- Amount of debt owed: 30 %
- Length of credit history: 15%
- Types of credit used: 10%
- New credit: 10%
There are 5 credit scoring ranges that are generally accepted:
- 800+: Exceptional. Can typically experience an easy approval process and be offered the best available lending terms and lowest interest rates.
- 740 to 799: Very Good. Can typically qualify for attractive interest rates.
- 670 to 739: Good. This range includes the average U.S. score. Lenders view borrowers in this range as acceptable. Can typically qualify for loans and credit cards but are likely to be charged higher rates than the best available.
- 580 to 669: Fair. It’s possible some traditional lenders will decline credit applications. This below-average score labels you as a subprime borrower. If you do get a loan or credit, you will likely be charged a high-interest rate.
- 579 and below: Very Poor. Many lenders may decline loan or credit applications, as this is the riskiest group of borrowers. If a loan is approved, it will most likely be at a very high-interest rate and typically, only secured credit cards are approved, which require a cash deposit equal to the card’s spending limit.
Having good credit means you've proven that you can handle credit responsibly by managing your credit obligations and have paid those obligations on time.
VantageScore®[2]
In 2006, a joint venture between the big three credit bureaus led to the creation of VantageScore. It is managed by an independent firm and competes with FICO. If you don’t have a long credit history you will want to monitor your VantageScore.
Scoring for FICO Scores and VantageScore are similar, but they do have their differences.
- VantageScore looks at multiple hard inquires for all types of credit, including credit cards while FICO Scores considers only mortgage, auto, and student loans.
- VantageScore allows for a shorter credit history, requiring one month of history and one account reported to the credit bureau within the past two (2) years. FICO Scores requires at least six (6) months of credit history and at least one account reported to the credit bureau within the previous six (6) months.
- FICO Score treats all late payments the same while VantageScore judges them differently – penalizing late mortgage payments more harshly than other types of credit.
- VantageScore and FICO Scores both penalize consumers who have multiple hard inquiries in a short period of time, and they both do “deduplication.” Deduplication is important for things like auto loans, where your application may be sent to multiple lenders, thereby resulting in multiple inquiries. Both FICO and VantageScore consider them one inquiry. However, FICO Scores uses a 45-day span to deduplicate your credit inquiries. VantageScore limits its focus to only a 14-day range.
VantageScore also looks at multiple hard inquiries for all types of credit, including credit cards. FICO Scores considers only mortgages, auto loans, and student loans.
How Long Does it Take to Build Your Credit Score?
How quickly you can establish and build your credit score depends on several factors, including the number and amount of loans you have open, how often you use the credit you have, and how often your payments, both on-time and late, are reported to the credit bureaus. It might be possible to build a good credit history within six (6) to twelve (12) months and get a FICO score. It is likely you will get a VantageScore even quicker.
You most likely will not be able to build a credit score in the 800 range in that time frame; however, you may be able to get it to 700 or even a little higher. It will probably take many years of excellent credit practice to build a score over 800, as the length of your credit history is part of the scoring model.
The first step to building credit is actually to get credit.
How to Build Credit
Start building your credit history and show lenders that you pose a relatively low credit risk. Otherwise, you may find it harder to acquire a loan when it is really needed due to a financial emergency.
Here are 7 keys to building your credit.
- Check Your Credit Report
Start your credit building process by checking your credit report to ensure a criminal has not already established credit for you and potentially ruined your credit history. Get your free credit report at AnnualCreditReport.com. They offer a free credit report yearly from each of the big three credit agencies.
- Open a Credit Card
Blindly applying for credit cards is counterproductive as each application results in a “hard inquiry” into your credit history. This could lead to temporary credit history damage. You should research and determine which card offers the best terms for your specific needs, then apply just once. Seeking out a card for people with limited credit and with no annual fee might be the best option for your first credit card.
If you can’t get approved for one of those type credit cards, place a deposit on a no annual fee secured credit card. A secured credit card is a card that requires a refundable deposit that you are borrowing from for your available credit limit. A minimum $200 deposit is typically required.
- Never Miss a Payment
Since payment history accounts for up to 35% of your credit score, you should strive to make your payments on time. The more on-time payments you make, the more your credit score will improve over time. There may be some monthly bills, like utilities and cell phone payments, that won’t show up on your credit report unless they are sent to a collection agency.
A couple of ways to help with this is to keep your expenditure under control by spending only what you can repay, in full, each month. You could also set up automatic monthly payments from your bank account. You must make sure there is enough money in your account when the bills are due to ensure you don’t overdraw your account and have to pay additional overdraft fees.
- Double Down on Credit
Once you have had your first credit card for a year, and have made all of your payments on time, consider applying for a second card. Adding another line of credit, even if you only use it once every six (6) months, will increase your available credit. This will help your credit utilization ratio, a factor that could increase your credit score.
- Get a Different Line of Credit
The credit agencies also want to see that you can responsibly handle multiple types of credit. So, after the successful use of your first credit card, consider getting a small installment loan, if you’re in a financial situation where you are ready to, of course. Remember that you must continue making your payments on time.
- Be Consistent
Your credit success is all about consistency. Only spend and borrow what you can repay in full and keep your good standing credit accounts open as long as possible. If you cannot consistently do this, then you will only build a low-quality credit history.
- Monitor Your Credit
It is impossible to keep an eye on your credit report 24/7. Too many consumers have never checked their credit reports or have not checked them in the last 12 months. This is why it is so easy for criminals to steal your identity and wreak havoc on your credit history. The longer you wait to identify and address them, the worse it will be for you and, ultimately, your wallet. Therefore, it would be a good habit to review your credit reports once a year.
There are apps for your phone that offer 24/7 credit monitoring. Most will let you know when a significant change is made to your credit score. If you decide to use one of these apps, you need to understand that considerable credit score improvements may take months, but small fluctuations do occur daily.
Why is it so Easy to Destroy Your Credit Score?
Building and improving your credit can be a lengthy and challenging process, but ruining it is something that can be done in a matter of days. Missing a payment can harm your credit. Credit agencies will list your late payments in the following categories: 30 days late, 60 days late, 90 days late, 120 days late, 150 days late, or charged off.
A single late payment can negatively affect your credit score if it is reported to the credit bureau(s), based on how late it was, how recent it was, and how often late payments are made. One late payment could take you months or evens years to recover from depending on your credit score when the late payment happened.
Final Thoughts
Now that you know what can be done to build credit from the ground floor, it’s time for you to get started. If you follow these tips, you’ll be well on your way to building your credit and creating a brighter financial future for yourself. Remember to check your credit score and credit reports as you work to build your credit history and then continue to check them at least once a year.
[1] FICO is a registered trademark of Fair Isaac Corporation. Any reference obtained from this blog to a specific product, process, or service does not constitute or imply an endorsement by the Big Picture Loans of the product, process, or service, or its producer or provider.
[2] VantageScore is a registered trademark of VantageScore Solutions, LLC. Any reference obtained from this blog to a specific product, process, or service does not constitute or imply an endorsement by the Big Picture Loans of the product, process, or service, or its producer or provider.
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