Credit is rarely constant. In fact, the only constant about your credit is that it’s constantly changing each month, depending on your daily credit decisions. For those trying to build credit, change can be good. With the right credit practices (more on that later) you can build credit over time. And, if your credit score has recently declined, in ways you didn’t expect or want, there are things you can do to rebuild your credit too.
The good news is that the rules of credit are mostly consistent. As long as you know a few simple facts and financial guidelines, building and rebuilding credit becomes much easier to understand.
Explaining Credit Changes
Your credit score gets updated every month. And, fluctuations in scores from month to month are completely normal. As you go about your life and make decisions that impact your credit, your activity is reported by your lenders to credit reporting agencies, commonly called credit bureaus. These agencies collect your information and compile it into a credit report, complete with a credit score to summarize your overall financial picture. And, every month each of the three main credit reporting agencies—Equifax, Experian, and TransUnion—update your credit report and credit score, based on the past month’s activity.
The easiest way to understand these changes is to take a look back at the credit decisions you made in the last month. Maybe you made some purchases on your credit card, applied for a loan, made on-time payments to your loans, etc. Or, maybe you accidentally forgot to make a payment or you have a past-due balance on one of your credit accounts. All of these factors are taken into consideration and updated every month to adjust your credit report and score. Of course, it stands to reason that if credit scores can change for the worse, they can also change for the better.
Understanding the Factors That Affect Credit
Even though each of the three main credit reporting agencies has differences in the way they collect, calculate, and report your credit, each bureau relies on the same basic financial factors, even if they’re all weighted slightly differently. Those factors include:
- Payment History: The most important factor impacting your credit, payment history takes into account your on-time, late, and missed payments.
- Utilized Amount: Also known as credit utilization ratio, this is the amount of credit you have used, compared to your total available credit.
- Length of Credit History: The length of your credit history, from your oldest to your most recently opened account. A longer credit history is usually better for your credit score.
- Credit Mix: The variety of credit accounts you have open, including credit cards, car loans, home loans, student loans, and more. Usually, a more diverse mix is better for your credit score.
- New Credit Accounts: Several newly opened credit accounts and multiple hard credit inquires within a short span can negatively impact your score.
As long as you understand these five credit-affecting factors, you can work to build your credit, no matter what your current score may be. Similarly, if you’re trying to rebuild your credit, keeping these factors in mind as you make future financial decisions can help you make and keep good credit habits.
Knowing the Difference Between Good and Bad Credit Scores
There are many ways to calculate credit scores, but the two most widely used models are FICO® Score and VantageScore. Both scores range from 250 to 900, with 670 and above being considered a good credit score and 800 and above being considered exceptional.
Credit Score Ranges
- Poor: 250-579
- Fair: 580-669
- Good: 670-739
- Very Good: 740-799
- Exceptional: 800-900
If you have a poor credit score (or no credit score at all), it may be difficult to get approved for a loan. If you have a very good or exceptional score, you may receive better interest rates and may be more likely to be approved for larger loan amounts.
The irony of the financial industry is that you have to have credit to get more credit. It’s one of the unfortunate facts of finances that sometimes gets lost on new credit consumers. But there are ways to build credit, no matter where you’re starting from.
If you’re starting at ground zero with constructing your credit, there may be no better building block than a secured credit card. A secured credit card lets you build a credit foundation by including a cash deposit with your approved application. Your secured credit card limit will likely be the same as your collateral, which all but eliminates the risk your lender takes on by extending credit.
A secured credit card allows you to make purchases on credit while simultaneously building a credit and payment history, just like you would with any other credit card. As you look for a secured credit card, try to find a lender that will report to all three of the major credit bureaus, so you can build a more comprehensive credit history.
Of course, any credit account will allow you to build credit, but a secured credit card may be easier to qualify for than a car loan, personal loan, or unsecured credit card, for example. No matter where you start building credit, once you have one or multiple credit accounts, there are a few things you can do to keep building on your financial foundation.
If you don’t feel that a secured credit card is the right fit, there are other options for new credit builders, like store branded credit cards.
Building Credit Best Practices
- Use a credit card responsibly: Whether you opt for a secured card or you have an unsecured credit card, using it responsibly is one of the very best ways to build credit. That means keeping your credit card usage as low as possible. It also means making at least your minimum payment on time every month, no exceptions.
- Make on-time payments: Probably the most important credit building rule you can remember is to make your payments on time, every time, on every credit account. As already mentioned, it’s important to keep on top of your credit card payments (a principle so imperative it’s worth mentioning twice), but this also extends to car payments, home payments, personal loans payments, and more.
- Keep track of your credit: As with any goal, checking in with your credit often can help you keep it moving in the right direction. You can check your credit report for free once per year through each of the three main credit bureaus. You may also be able to monitor changes to your credit score for free through your financial institution every month. Doing so can alert you to changes in your credit score and help you spot the warning signs of fraudulent activity, identity theft, or help you correct course on your credit. You can also correct any negative entries or mistakes on your credit report when you know what it contains.
- Keep track of your credit accounts: On a similar note, keeping track of your actual credit accounts can help you stay on top of your payments, keep your credit utilization low, and spot suspicious activity (ensuring that every charge posted to your credit card is yours and not someone else’s, for example). Find an easy way to keep track of your accounts—like using a spreadsheet, app, or software—so you can know every change and take ownership of building your credit.
Rebuilding Credit Best Practices
- Take a long look at your credit report: Especially if it’s been a while, pull your credit report from each of the three main credit bureaus and go over them with a fine-tooth comb. Look for reasons your credit may have taken a hit and highlight each of the negative entries. If you see any entries that appear incorrect or fraudulent in any way, report them to the credit bureau. Otherwise, look for outstanding payments and try to bring your account back into good standing with your lender by making past-due payments.
- Make a financial plan: After you’ve brought all your accounts current, make a plan for your money so that you don’t make the same credit mistakes twice. Set up a budget, complete with your income in one column and your total expected expenses in the other. Make sure that you have enough money to cover each expense, and try to find room to save for emergencies and miscellaneous expenses that pop up. Include your credit card as part of your financial plan. Set a monthly limit for how much you will charge to your card. Similarly, ensure that your budget accounts for making payments on all your credit accounts.
- Start saving: Closely related to your financial plan, having a strategy in place to save money to ensure that you have a cushion to fall back on, in case your original plan gets derailed by the realities of life. When you have savings, you can avoid overloading your credit card, taking out new loans, and missing payments on your accounts—all of which can set you back in your credit rebuilding goals.
- Follow the best practices for building credit: You guessed it. Every item listed above in the section for building credit can help you rebuild your credit too. Use your credit card responsibly, make on-time payments, keep track of your credit accounts over time, and you can rebuild your credit and avoid any setbacks along the way.
Whether your credit has seen better days or you’ve never seen your credit at all, learn and review these ideas and implement the above best practices in your life to build or rebuild your credit and accomplish your financial goals.