Finance

Why Establishing Credit Young is Important

April 19, 2024

Establishing credit at a young age sets a solid foundation for your financial future and can open up opportunities for better financial management and stability.

Building credit is one of the most important things for young people to do. Even though it might seem like an ordinary task, developing credit early on is really important. It can have an important effect on various aspects of a person’s life and provide the foundation for future financial ventures.

How to Establish Credit as a Young Person

Establishing credit as a young person may seem difficult, but there are several steps you can take to start building your credit history:

Open a Student Credit Card:

Many banks offer credit cards specifically designed for students with limited or no credit history. Look for a student credit card with low fees and a reasonable credit limit, and use it responsibly to make small purchases that you can pay off in full each month.

Become an Authorized User:

If your parents or guardians have a credit card with a positive payment history, ask them to add you as an authorized user. Being an authorized user allows you to benefit from their credit history and can help you establish your own credit history over time.

Apply for a Secured Credit Card:

A secured credit card requires a security deposit, which typically becomes your credit limit. Secured cards are easier to qualify for than traditional credit cards and can be a good option for building credit if you’re unable to qualify for an unsecured card.

Apply for a Credit Builder Loan:

Some banks and credit unions offer credit builder loans specifically designed to help individuals establish or improve their credit. With a credit builder loan, you make regular payments, and once the loan is paid off, you receive the funds along with a boost to your credit score.

Pay Bills on Time:

While certain bills, like rent and utilities, don’t typically appear on your credit report unless they go to collections, paying them on time demonstrates responsible financial behavior. Consistently paying bills on time can help you establish a positive payment history, which is a crucial factor in your credit score.

Monitor Your Credit Report:

Regularly check your credit report to ensure that all information is accurate and up to date. You’re entitled to a free credit report from each of the three major credit bureaus (Equifax, Experian, and TransUnion) once a year through AnnualCreditReport.com.

Keep Credit Utilization Low:

Try to keep your credit card balances low relative to your credit limit. High credit utilization can negatively impact your credit score, so aim to keep your balances well below your credit limit, ideally around 30% or lower.

By following these steps and practicing responsible credit management habits, you can start building your credit history and laying the foundation for a strong financial future.

Why You Should Start Building Credit Early

Establishing credit at a young age can provide several benefits:

Building a Credit History: Lenders use your credit history to evaluate your creditworthiness when you apply for loans or credit cards. Starting early allows you to establish a positive credit history, which is crucial for future financial transactions.
Access to Better Credit Opportunities: A good credit history opens doors to better credit opportunities, such as lower interest rates on loans and credit cards, higher credit limits, and more favorable terms. This can save you money in the long run and make it easier to achieve your financial goals.
Preparing for Major Financial Milestones: As you grow older, you may need credit for significant life events, such as buying a car, renting an apartment, or purchasing a home. Having a solid credit history in place early on can make these transitions smoother and more affordable.
Developing Financial Responsibility: Managing credit responsibly teaches valuable financial skills, such as budgeting, saving, and understanding interest rates. By learning how to use credit wisely and pay bills on time, you establish healthy financial habits that can benefit you throughout your life.
Improving Credit Score: Your credit score is influenced by various factors, including your payment history, credit utilization, and length of credit history. By starting to build credit early and maintaining good habits, you can gradually improve your credit score over time, which can have far-reaching implications for your financial well-being.

Starting to build credit early can lead to better financial opportunities, improved creditworthiness, and enhanced financial responsibility, all of which are essential for long-term financial success.

Mistakes Young People Make When Building Credit

While building credit is important, there are common mistakes young people often make during this process:

Applying for Too Many Credit Cards:

Applying for multiple credit cards within a short period can lower your credit score due to hard inquiries. Each application triggers a hard inquiry, and too many inquiries can signal to lenders that you’re desperate for credit, which can be seen as risky behavior.

Maxing Out Credit Cards:

Using up your entire credit limit can hurt your credit score, even if you pay off the balance each month. High credit utilization ratios can indicate financial strain and may negatively impact your creditworthiness.

Missing Payments:

Late payments can have a significant negative impact on your credit score. Consistently missing payments or paying bills late can signal to lenders that you’re unreliable and may lead to higher interest rates or difficulty obtaining credit in the future.

Ignoring Credit Reports:

Failing to monitor your credit report regularly can lead to missed errors or fraudulent activity that could harm your credit score. Reviewing your credit report at least once a year allows you to identify and address any inaccuracies promptly.

Closing Old Accounts:

Closing old credit card accounts can shorten your credit history, which may negatively affect your credit score. Even if you’re not using a card anymore, keeping it open and occasionally making small purchases can help maintain your credit history and utilization ratio.

Cosigning Loans for Others:

Cosigning a loan for a friend or family member can be risky. If the primary borrower misses payments or defaults on the loan, it can damage your credit and strain your relationship with the borrower.

Ignoring Interest Rates and Fees:

Failing to understand the interest rates, fees, and terms associated with credit cards and loans can lead to high debt and financial stress. It’s essential to choose credit products with favorable terms and to make informed borrowing decisions.

Not Having an Emergency Fund:

Relying too heavily on credit without having sufficient savings can lead to financial instability. Building an emergency fund to cover unexpected expenses can help you avoid relying on credit cards in times of need.

Avoiding these common mistakes and practicing responsible credit management habits can help you build a solid credit history and achieve your financial goals.

How Long Does It Take to Establish Credit?

On the other hand, building a credit score may require up to six months of payment history. Additionally, lenders and credit scoring models might not have enough data to determine your creditworthiness at this time if you have fewer than five credit accounts, a situation known as having a thin file.

Establishing credit can vary in terms of the timeline depending on various factors such as your financial habits, the type of credit you’re seeking, and the policies of the financial institutions you’re dealing with. Here are some general guidelines:

Credit Cards:

If you’re starting with a secured credit card (where you provide a deposit as collateral), you can typically establish some credit within a few months of responsible use. After about six months to a year of timely payments and responsible credit behavior, you may start to see improvements in your credit score.

Loans:

Installment loans like auto loans or personal loans can also help build credit. Regular, on-time payments over the course of the loan term can positively impact your credit score. This process typically takes about six months to a year to start seeing significant improvements in your credit history.

Authorized User:

If you’re added as an authorized user on someone else’s credit card account, you may benefit from their positive credit history. However, not all credit bureaus will report authorized user activity, and the impact on your credit score might be less significant compared to having your own credit accounts.

Credit Builder Loans:

Some financial institutions offer credit builder loans specifically designed to help people establish credit. These loans work by having you make payments into a locked savings account, and once the loan is paid off, you receive the funds plus any interest earned. This can typically take six months to a year to complete.

Rent Payments:

Some credit bureaus allow rent payments to be reported on your credit report. This can help establish a positive payment history if you consistently pay your rent on time. However, not all landlords report rent payments, so this method may not always impact your credit score.

Regardless of the method you choose, the key is to demonstrate responsible credit behavior consistently over time.

Frequently Asked Questions

What are the benefits of establishing credit young?

The benefits of establishing credit young include easier access to loans and credit cards, better interest rates and terms, preparation for major life milestones such as buying a home or starting a business, and the ability to navigate emergencies and unexpected expenses with financial flexibility.

How early should I start establishing credit?

It’s never too early to start establishing credit. As soon as individuals become eligible for credit cards or loans, they can begin building their credit history. Many financial experts recommend starting as soon as possible to reap the long-term benefits of a strong credit profile.

Can parents help their children establish credit?

Parents can help their children establish credit by adding them as authorized users on their credit cards, teaching them about responsible credit management, and encouraging them to start building credit as soon as they’re eligible. Additionally, parents can cosign loans or provide guidance on obtaining a secured credit card to help their children establish credit responsibly.

Conclusion

To sum up, building credit early in life is essential to achieving financial freedom and empowerment. It establishes the foundation for a sound financial future by giving them access to opportunities, better credit terms, and a safety net in case of emergency. Early financial education helps young people establish good credit habits that will benefit them for the rest of their lives. As a result, young people must prioritize building credit and take early action to manage their financial well-being.

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