Improving your credit score by building credit is one of the best ways to position yourself to beat long-term financial goals. For example, people with excellent credit can save tens, if not hundreds of thousands of dollars by securing the best mortgage rates.
But how do you build credit when first getting started, or after filing a bankruptcy?
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In the previously recorded Facebook Live video below, Motley Fool analysts Michael Douglass and Nathan Hamilton answer a user-submitted question about how people can set themselves up for future financial success by building their credit today.
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Michael Douglass: Gus asks: "How do I build credit?" Let's just talk through, really broadly speaking. Gus, I was in legitimately the same place. When I got my first auto loan, I had no credit score because I had never taken on debt. It was interesting because the loan officer said, "This makes you really risky." I said, "I think it makes me really safe."
Nathan Hamilton: I'm a good person.
Douglass: I don't take on debt. I only do it when I have to. Shouldn't that be a good thing? She said, "Except we don't really know what kind of borrower you are." I was like, "That's fair." I was like 20, 21, so I was new to all of this. Let's talk through building credit and what that looks like.
Hamilton: Looking at it here, you've essentially got an option with building credit if you are very brand new to getting credit cards. Typically, how people do so is apply for a secured credit card first, and a secured credit card is essentially -- you make a deposit to back the amount of money that you're borrowing, so there's very low risk to you, and many people use this as an opportunity to establish a credit history.
Then from there, as they establish a history of making payments on time, of being a low-risk borrower, not over-spending on credit, not surpassing their budget limits, all of those details, you will be rewarded with a higher FICO score over time, and from there, many people move from a secured credit card to maybe a rewards credit card, or move on up the spectrum. As you go over time, it's not going to be something that, two months down the road, your credit score goes from 600 to 800.
Hamilton: Maybe there are those scenarios out there, but in general, it does take some time to build credit. That's a good way to get in. One thing to add to that: Over time, FICO scoring models have adjusted their algorithms to account for people who have what they call a thin file, which is not much credit data to crunch to generate a credit score. Credit scoring models have become better over time for your exact situation to account for. How do I assess a credit score for this borrower that doesn't have much of a credit history?
Douglass: Right. Exactly. If only I had gotten that car loan later.
Hamilton: You just need to wait a couple years.