How to build good credit

Key takeaways

• You need borrowing experience to build good credit, and a credit card may help.
• When borrowing with a credit card, keep balances low or pay them off regularly.
• To keep your credit score as high as possible, always pay on time and keep unused accounts open.

Taking on too much debt is a bad thing, but the opposite can also be true: If you avoid all credit cards and loans, you may have little or no credit history. That could make you what's called a credit ghost.

Being a credit ghost makes you invisible to lenders. Recent college graduates and those who pay only with cash or debit cards are prime examples. When you go to apply for a car loan, for instance, you may not be approved if you have no credit history.

"That's why it is important to establish some sort of credit as soon as you can, and use it judiciously to help build and maintain a good credit history," says Stefan Ross, vice president of credit card products at Fidelity.

It's never too early to start. A teenager under age 18 won't be able to get a credit card in only their name, but even teenagers can start building up a history of good borrowing behavior.

1. Get credit

Having credit available to you is a major indication of whether you are a risk for lenders, and helps determine your credit score. Even opening a credit card you might not ever need or use could be seen as a good thing by lenders.

Having different types of debt may be good for your credit score too—for instance, having a car loan and a credit card. Having experience paying an installment loan on time as well as using revolving credit responsibly could also be viewed favorably.

If you don't have a credit history, it may be tough to get a credit card in some cases. Opening a secured credit card may help. Secured cards are credit cards that are secured with a deposit. Getting a secured card, and then making a few purchases, and paying the bill off every month could help build your credit history.

Another way to start building credit is with a cosigner or coapplicant. For instance, parents who want to help their children start off on the right foot credit-wise might cosign for a credit card or apply for the card as coapplicants. In that case, a lender would look at both parties' credit histories and income to decide if they feel comfortable extending credit. One thing to be aware of is that cosigners or joint applicants are equally liable for any debt incurred under the loan agreement.

Being added to someone's credit card as an authorized user may be an alternative as well. Being an authorized user means that the account owner has given you permission to use the line of credit, but you are not legally responsible for any debt in the account. It's not always a surefire way to build good credit. If the primary account holder has too much debt or pays bills late, your credit could be tarnished by the association. However, if a family member with sterling credit—and a card that reports authorized user activity—adds you to his or her account, it may help you start establishing a good history. (That's assuming the credit card issuer reports authorized users to the credit bureaus. Not all do.)

Shop around for the right card because each credit card issuer has different rules. You may be able to set spending limits or receive alerts when the authorized user makes a purchase.

2. Pay off your balance—or keep it low

Whenever possible, pay off your credit card balance every month. Using the card for 1 or 2 purchases each month and then paying it off shows that you can—and do—pay your bills on time.

Your credit utilization—the amount of available credit you actually use—is an important component of your credit score. Using all the credit available to you is typically viewed negatively by lenders and credit scoring models. Using just a little bit and paying it off regularly is better for your credit score than charging up to your credit limit and then paying it off over time.

If you do carry over monthly balances, pay more on the balances with the highest interest rate to eliminate them as quickly as possible. That way you won't need to pay a high rate of interest for a very long time—it may help reduce the total cost you pay to borrow.

3. Pay on time

As soon as your new credit card bill arrives, schedule the payment online. It may make sense to pay the bill on the date you get paid—as long as it is earlier than the date the minimum payment is due. That way, you don't need to worry about missing the date or not having the money available. Paying your monthly bill even one day late can cost you up to $35 or more in fees. Imagine if your bill was just $10 or $20; it would be painful to pay a fee higher than your statement balance.

Some credit card issuers will waive 1 or 2 late fees per year, but not all will. Read the fine print in your contract to know what you're agreeing to. If the due date is inconvenient for you, the issuer may be willing to switch it to the beginning, the middle, or the end of the month. With text alerts, emails, and online payments, there's no excuse for forgetting to make a payment.

4. Manage your spending

Resist the urge to overuse your newfound credit. Often, once a new credit card arrives, people tend to buy something they couldn't previously afford.

"While credit is wonderful to help pay unexpected bills, being mindful of what you can pay back is extremely important," notes Ross.

Read Viewpoints on Fidelity.com: How to save for an emergency

5. Don't close accounts

It may be tempting to say "good-bye" to a creditor once you've paid them off, but you may actually want to continue the relationship for the sake of your credit score. That's because a major component of your credit score is the age of your accounts. Rather than close accounts you don't owe anything on, simply put those cards in a safe place. The available balance on those "quiet" accounts will help your credit score too.

Credit is necessary

Too much debt can be an albatross around your neck, but there are times in life when your good credit may come in handy. For example, many employers scrutinize the credit history of job applicants, as do landlords when you're trying to rent an apartment. Your car insurance premium may even be based, in part, on the information in your credit file.

Plus, one day when you buy a home, having a great credit score may save you thousands of dollars over the course of a 15- or 30-year mortgage. That's because the best interest rates typically go to borrowers with the highest credit scores. Building a solid credit history while you’re young can pay off over decades. You never know when you may need to borrow money.