Building credit in your 20s
By Jenesy Gabrielle Burkett Fox
Most young adults don’t have the money to make big-ticket purchases independently. As if our generation’s historically low wages weren’t enough, the COVID-19 pandemic has negatively impacted our financial prospects as a generation. Because of this, many Gen Z and millennials rely on loans to fund larger investments like our education, cars and homes. We all know we need good credit scores to get these loans but how do we build good credit?
The primary factors that impact your credit score are your payment history, the ratio of your debt to available credit (credit utilization ratio), the length of your credit history, new credits and the diversity in types of credit you hold (credit mix). To get a better understanding of what a credit score is and how they’re calculated, read “What exactly is a credit score.”
Credit cards are the easiest way for younger people to build credit. Particularly store credit cards and airline credit cards because they are more lenient with approval as they come with lower credit limits and high-interest rates. There are many types of credit cards that come with different benefits. For example, store credit cards often come with discounts or points at your favorite stores. Airline credit cards earn miles as you shop which transfers to free airline tickets. There are also gas credit cards that earn you cash back or points toward future fuel purchases.
Pay off your credit card in full every month
Choosing a credit card to use for purchases you know you’ll spend cash on (such as gas or airline tickets) can be a good approach if you pay off your credit card balance when it is due. If you have a credit card, it is important you make regular payments and keep your balance as close to $0 as possible. This is because your history of making regular bill payments and the amount of available credit you spend are used to calculate your credit score.
Keep your credit utilization low
Charging your credit card and paying off your balance on time will keep your credit utilization ratio low and positively impact your credit score.
A good rule of thumb is to use up to 15% of your available credit every month. So, if you have a $5,000 limit on your credit card, try to keep your balance below $750 every month. If you find yourself spending more than 15% of your available credit, you can ask your credit card company for a higher credit limit increase or apply for a second credit card. This will increase the amount of credit available to you, leading to a lower credit utilization ratio and improving your diversity in lines of credit.
Sign up for automatic bill payments
Your credit score does take into account your history of making payments to bills such as utilities, rent, insurance, phone, credit and other loans. Setting up automatic bill payments ensures these bills are paid consistently and on time.
Credit cards are not the only way to build credit in your 20s
After about 9-12 months of beginning to build your credit score with a credit card and regular bill payments, you can apply for a small personal loan. These loans are typically larger than credit card limits and provide you with a lump sum toward bigger purchases. This type of loan is a great step toward approval for larger loans like mortgages. Taking out a small personal loan improves your diversity in types of loans and provides an opportunity to make regular payments to that loan.
Building credit is intimidating and can be scary when you’re concerned about racking up debt (as most of us are). But building credit is essential to building a strong financial foundation so lenders will view you as financially trustworthy. By slowly taking on different forms of debt and making regular payments on time, you can build a strong credit score which will open up different investment options for you in the future.
Cover photo by Liza Summer
