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How do I build credit?

Find out how to build credit and what determines a credit score.

A good credit score is important when taking out loans. [© Shutterstock Images, 2010]
© Shutterstock Images, 2010
A good credit score is important when taking out loans.

Building a good credit score is important for numerous reasons. Businesses use this score to determine financial responsibility, the likelihood a person will pay back a loan on time and what interest rates to charge. Credit scores range from the 300s to the 900s and the higher the number, the better the score. A good credit score generally grants access to low interest rates, rental and auto purchase approvals, and personal loans, besides making someone less susceptible to predatory lending.

How to Read Credit Reports

A credit report includes basic information about a person's financial history. Based on that information, creditors assign a credit score, which is usually made up of five basic elements:

 

  • Payment histories, reflecting the timely or untimely payment of credit accounts
  • Outstanding debts with creditors, regardless of regular payment
  • The length of time someone has been a credit user
  • Recent financial history
  • The mix of credit held, including what types of loans, leases and mortgages make up a person's debts

A credit score also reflects how someone's credit report compares to that of similar consumers.

The components of a credit score carry different weight, with the two most important elements being payment history and outstanding debts. The more punctually and consistently payments have been made and outstanding debts have been lowered, the higher a credit score is. Taking steps toward improving a credit score can be achieved by starting to pay bills on time and working down debt. The Credit Builder's Alliance, a nonprofit organization that aims to help moderate and low income individuals build good credit, reports that "a recent history of on-time repayments on diverse credit accounts reported to a major credit bureau is the best way toward a good credit score." In fact, a credit score can be increased by up to 100 points in half a year by making timely payments on a $100 loan.

Improving Credit Scores

When trying to improve a credit score, it's important to be wary of scams. Credit repair ads often promise to "erase" bad credit, to create a new credit "identity" or to remove evidence of slip-ups like bankruptcy from a person's file. The Federal Trade Commission (FTC) warns strongly against these companies. It is not possible to wipe away bad credit with the wave of a wand. If choosing to employ one of these companies, carefully research its credentials and the legality of its claims while making sure to run its practices through a checklist provided by the FTC.

Ordering a Credit Report

A person is entitled to know what is in his or her credit report and to annually order one free copy from each of the three nationwide consumer reporting companies -- Equifax, Experian and TransUnion. This can be done online by visiting the Web sites of each agency, or by visiting a Web site such as AnnualCreditReport.com. If there are inaccuracies believed to be negatively influencing a credit score, the report can be disputed by contacting the consumer reporting company and the information provider.

Remember that building good credit requires making mature and realistic financial decisions. This means not taking on an overwhelming amount of financial obligations, and knowing when to ask for help. If slipping into debt, talk to creditors to arrange manageable payment plans as soon as possible.

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