8 Tips to build great credit scores

By Laura Adams | MBA and Host of Money Girl | Sponsored Content

Why you need good credit scores

One of the best reasons for building credit is that you qualify for a lower interest rate when you borrow money, which can save a bundle.  

Here are more ways having good credit improves your financial life: 

• Insurance companies charge higher premiums (in most states) for home and auto policies when you have poor credit.
• Utility companies such as wireless, internet, power, and gas providers charge higher security deposits or may not extend you promotional offers based on your credit. 
• Landlords and property managers may require good credit to approve you for a lease.
• Employers that check credit may not hire you with negative marks on your credit reports.

8 tips to build excellent credit

So if building credit is one of your financial goals, keep reading for eight essential tips.

1. Understand how credit scores work

You must understand how the credit system and credit scores work to improve your credit. Your data gets maintained by three leading nationwide credit agencies, Equifax, Experian, and TransUnion. Your creditors (such as credit card companies and lenders) may report your account and payment information to one or all of them. 

The data in your credit reports is used to create various credit scores, such as the well-known FICO® score. However, there are hundreds of different models with their own credit score algorithm, which is why your scores can vary. 

Credit scores typically factor into your payment history, amount of outstanding debt, types of credit accounts, age of accounts, and recent credit inquiries. When calculating your scores, credit models don't use demographic information, such as your race, marital status, gender, or income.

2. Use credit accounts to build credit

It's a common misconception that being debt-free gives you good credit scores. If your credit reports have too little or no data, they can even be too "thin" to generate scores. You must have credit accounts and use them responsibly to build excellent credit. 

3. Make payments on time

Since your payment history is the most significant factor in your credit scores, it's critical to pay your bills on time every month. Even if you can only send your credit card's minimum, paying it on time helps build a history of positive data in your credit reports. Making even one late payment can significantly hurt your scores.

4. Don't close credit accounts

If you pay off a revolving credit account such as a credit card or line of credit, keeping it open is better for your credit than closing it. That's because your credit utilization ratio is a significant factor in your credit scores. 

Having more available credit relative to your debt balances indicates you use credit responsibly. But closing an account cuts your available credit instantly, causing your credit utilization to spike and your scores to dip. 

5. Keep account balances low

It's a common myth that you must carry debt to improve your credit scores. An excellent credit-building strategy is to make credit card charges that you pay off each month. Not only will you avoid interest, but you'll maintain a low credit utilization ratio, which boosts your scores.

6. Use a secured credit card

If you can't get approved for a regular credit card, consider using a secured credit card for building credit. Secured cards work like standard cards but require an upfront refundable deposit that becomes your credit limit. After making on-time payments for a period, you typically qualify for a regular, unsecured card. Just be sure the card you choose reports payment data to the nationwide credit agencies. 

7. Become an authorized user

A common question is whether being a credit card authorized user builds credit. The answer depends on the cardholder's financial behavior and whether the issuer reports it to an authorized user's credit reports. 

If positive payment data gets reported to an authorized user's credit history, it's a great way to boost credit. However, if the card owner doesn't manage their card responsibly, it could hurt an authorized user's credit. 

8. Be patient 

So how long does it take to build credit? If you're starting from scratch, you can see significant increases in your credit scores after six months or a year. It may take longer if you're rebuilding your credit after having accounts in collections or bankruptcy. However, scores typically give more weight to recent account activity.

How often your credit scores update depends on when creditors report information to the credit agencies. In general, account data gets updated monthly, so your scores can change from month to month. To review your credit reports, visit AnnualCreditReport.com.