Whether it’s renting your first apartment, buying your first car or even just paying for a hotel room while traveling, the importance of good credit is inescapable.
But the advice around how to build credit is often too little, too late.
Good credit doesn’t happen by accident, and poor credit isn’t carved in stone. In fact, the best time to learn how to build your credit is now, and Kudzu can help.
In this article, we’ll cover the foundations of credit and how it can help you achieve your financial goals. We’ll also lay out the basic steps you should take to build and maintain healthy credit.
What Is Credit?
At its most basic level, credit is about trust. Similar to relational trust, there are practices that help you build credit and behaviors that can erode your credit.
A person’s credit is an approximate measure of how much they can be trusted to repay a financial debt. It’s currently measured on a spectrum from low to high, but it’s an ancient concept that reaches back to some of the oldest written records we have.
Most systems of credit were established in small communities between individuals and local business owners. A farmer could buy groceries “on credit” until their harvest sold—as long as the grocer trusted their verbal commitment to repay.
This system of trust was vital for economic progress: for most of human history, access to cash and banking services has been severely limited.
The first formal credit reporting system was invented by an American entrepreneur named Lewis Tappan. Tappan kept credit files on his customers, using his judgment to assess each person’s character and creditworthiness (i.e., their ability to pay back credit).
Eventually, other business owners began asking Tappan to share the information he collected to help with their businesses.
The word “credit” can mean a lot of different things, and some people use it interchangeably with terms like “credit history,” “credit score” and “credit report.” It’s even used synonymously with borrowing, but where all loans are a form of credit, not all credit is considered to be a loan.
We’ll define some of these terms and give you pointers for how to keep each concept separate so you can fully understand how to build your credit.
1. Credit History
This is the most simple and straightforward term.
It’s a chronological record of how you’ve managed your credit across all the various sources of credit that you use. That includes how much you’ve borrowed and the timeliness of your repayments.
Your credit history constitutes a major piece of your credit report, which is the next item we’ll explain.
2. Credit Report
A credit report contains your credit history as well as your credit-related activity, including personal identification information, credit accounts, payment history, public records (such as bankruptcies and tax liens) and credit inquiries (i.e., requests you’ve made to receive new credit).
Your credit report may not include your credit score, unless you request it.
3. Credit Score
A credit score is a three-digit number that serves as a summary of your creditworthiness. There are multiple types of credit scores, but the FICO score is one of the most well-known and popular scores.
A FICO score is weighted across five primary factors, each drawn from your credit report:
- Your payment history accounts for 35%.
- Your amounts owed account for 30%.
- The length of your credit history accounts for 15%.
- The mix of your credit types accounts for 10%.
- New credit accounts for 10%.
Each of these factors is part of what affects your credit score positively or negatively, depending on the information in your credit report. And the importance of each category can differ for each person.
A credit score provides lenders and creditors with a standardized way to quickly assess potential borrowers and their risk of default.
An alternative to the FICO score, for example, is VantageScore. While gaining traction, it still has a much lower degree of adoption among creditors.
Types of Credit
You’re probably familiar with credit cards and loans, but you may not realize all the different types of credit that exist.
Human beings are endlessly creative when it comes to business and finance: if there is enough demand for credit, rest assured that somebody will find a way to supply the funding.
That said, here are some of the most common types of credit available today.
Revolving Credit
The most popular type of credit in the U.S. is the credit card, which is also a form of revolving credit. Revolving credit allows the borrower to use up to a pre-approved amount (i.e. credit limit), pay it off in whole or part and use that credit repeatedly.
As of 2023, 82% of American adults had at least one credit card in their wallet, but the total number of credit card accounts is more than 600 million—that’s nearly two accounts for every U.S. citizen!
A personal line of credit is another type of revolving credit. As in credit cards, you have a set limit of money that you can borrow, but you only pay interest on the amount you actually borrow. As they generally have lower interest rates than credit cards, they can be useful if you have a big expense.
Installment Credit
Most loans are forms of installment credit, where you’re given a lump sum of money in advance and required to pay it back in smaller installments. Installment credit usually includes an interest rate and various fees, which increase your repayment over the original value borrowed.
Mortgages, auto loans, student loans, personal loans and business loans are all forms of installment credit.
Housing debt is the largest category of installment debt (or any type of debt period) in the U.S. by volume, totaling $12.98 trillion in Q3 of 2024.
Service Credit
When a company agrees to allow you to pay for a service after you’ve used it, that’s a form of service credit.
This applies to most utility bills, internet bills and wireless phone plans.
While service credit isn’t automatically considered a factor in your credit history, you can request credit bureaus to include them as a way to boost your score (if your payment history is clean).
Open Credit
Open credit accounts require the borrowers to repay the amount in full at the end of the billing cycle.
This applies to charge cards, certain utility bills and some types of membership services.
American Express is an example of a company that offers charge cards with no spending limit, but requires the borrowed amount to be paid in full each cycle. They also offer revolving credit in the form of credit cards.
Why Is Building Good Credit Important?
While it’s nice to imagine that with enough fiscal responsibility you can pay for everything upfront in cash, that’s not true (and hasn’t ever been; remember those ancient Sumerian debt records?).
The ability to borrow and repay money is a powerful tool that can accelerate your journey towards financial freedom.
As part of a thoughtful and responsible financial strategy, credit can open doors, relieve stress and help you build wealth, by:
- Giving you access to better financial products and services.
- Allowing you to save money through lower interest rates.
- Building your reputation with lenders.
- Helping you get approved for better apartment or home rentals.
- Making it more affordable to buy a home.
- Unlocking funding for starting a business.
Even if your credit history is short or your credit score is low, there’s plenty of hope!
Just like relational trust can be rebuilt through consistency and commitment, credit health can be rebuilt the same way, even after a crisis such as bankruptcy.
After all, everyone deserves the chance to develop smart habits and achieve financial freedom.
How to Build Credit (and Rebuild It)
Nobody is born with good credit or the knowledge of how to build it. That’s why it’s important to study the best strategies around building credit and choose the ones that fit your situation best.
While it can be helpful if your parents have good credit and are willing to support you in building credit, it’s definitely not a necessity. You may choose to build your credit on your own or request the help of family members. There’s nothing wrong with asking for their help and being gracious if they say “no.”
Get a Credit Card
As we mentioned earlier, more than 80% of American adults have at least one credit card. And every year, millions of people turn 18 and become eligible for their first credit card.
The world of credit cards is complex and can feel overwhelming. There are two main types of credit cards: secured and unsecured. A secured card requires the holder to deposit a certain amount of money upfront. An unsecured credit card allows the holder to use it without paying a deposit.
If you’re at the beginning of your credit-building journey and have a “thin” credit file (meaning no or minimal credit history), using a secured credit card to build credit may be your best option.
Whichever type of card you end up with, the golden rule of smart credit card usage is to pay off the balance every month—this approach ensures that you pay no interest on your purchases.
Become an Authorized User
If you’re struggling to get your first credit card, you can look for ways to become an authorized user on someone else’s credit card account. You could ask a parent, family member or spouse who has a well-established credit history.
If they agree, they will contact their credit card company and add you as an authorized user. You may even receive a card with your name on it!
As an authorized user, you can make purchases and benefit from the primary account holders’ timely payments. Be careful who you ask though—if they miss payments or engage in irresponsible credit card behavior, it will hurt your credit instead of helping.
Apply for a Credit-Builder Loan
Banks and credit unions have created products to help people struggling to start building good credit. One such product is the credit-builder loan (secured credit cards are another).
When you take out a credit-building loan, the lender holds the money from your loan in a certificate of deposit or a high-yield savings account (HYSA), and you start making payments. Once you’ve paid off the full amount of the loan, you receive the money minus interest charges and fees.
While a credit builder loan isn’t a good option if you need access to the borrowed money immediately, it’s a great way to build your credit history. Companies such as Self Financial, Credit Strong and Fig Loans offer credit-building products online, but it’s wise to check with small banks or credit unions as well, as they may offer attractive terms or rates.
Use Rent-Reporting Services
By using a company such as Self Financial, Esusu Rent or RentTrack, you can leverage your rent payment history as part of your credit history.
Be sure to compare the various services to find the one that fits your budget, works with your landlord and your credit goals.
Best Practices to Improve Your Credit
If you’ve established a credit history and would like to boost your credit score, there are several things you can do. These also apply if you’re learning how to build credit for the first time.
The most important steps you can take are to advocate for yourself and be willing to make sacrifices in pursuit of your goal.
Check Your Current Credit
The credit bureaus make mistakes, and fraud happens.
Both of these factors can result in negative marks on your credit report. You should check your credit report regularly and dispute anything that looks out of place. This can include incorrect balances, fraudulent activity and other reporting mistakes.
You might even consider using a credit monitoring service that alerts you when something changes, or suspicious activity happens.
Tip: You can get a free copy of your credit report every 12 months from each credit reporting bureau through Annual Credit Report.
As a final note, beware of companies offering to repair your credit for a fee. Usually, you can achieve the same results for free by calling the credit bureaus or visiting them online and disputing errors yourself.
Address Unpaid Commitments
Missing a payment or struggling to repay your debts isn’t a reason to give up! Not all creditors are gracious or flexible, but most of them want to help you repay the debt successfully.
Your best bet is to communicate early and often, ask what options are available to help you get back on track, and agree on a plan. This can even include negotiating settlements for some debts.
There are two primary strategies for paying off debt, known as the snowball and avalanche methods. The snowball method focuses on the smallest debts first, while the avalanche method focuses on the highest-interest debt first. Both methods can be effective if you stay committed.
In some cases, debt consolidation (i.e., combining multiple debts into a single, new debt with potentially better terms) may be the best option for eliminating high-interest debt and simplifying your monthly payments. Debt consolidation will affect your credit report, but for many people, it’s the fastest and most reliable way to get back on track.
Establish Positive Habits
The first and most obvious habit to create is paying your bills on time, every time. Most creditors, utilities and other companies make it easy to set up automatic payments so you don’t have to remember on your own. If your income varies from month to month, this might feel like a scary thing to do, but it’s a goal worth striving for—you can set calendar reminders to make it easier for you.
The other top habit for building healthy credit is to bring your credit utilization rate below 30%. That means that if you have a credit card with a $3,000 limit, try to keep your balance below $1,000. Credit scoring models will assess your utilization at the aggregate and individual account levels. That means that it’s best to keep all your accounts below 30% usage if possible.
If you’re struggling to make payments or see your credit balances creeping up, then it’s time to take stock of your expenses and see what you can cut. You’ll never borrow your way out of debt, that’s for sure.
Celebrate Every Step as You Learn How to Build Credit
Building your credit or achieving financial freedom can feel very lonely and difficult. While you create healthy financial habits, your friends might be going out almost every night or making impulse purchases. Feel empowered to stay on track—your future self will thank you.
Not every company that offers you credit has your best interest at heart, and not every financial institution will take your needs seriously. You need all the allies you can get.
That’s why Kudzu has created tools to help people make smart money decisions, such as SpendSense Alerts to set spending limits and Saving Habits to automate your savings goals—like a coach to help you achieve your financial dreams.
With Kudzu in your corner, it’s time to start growing places.
