A Guide to Credit for Twenty-somethings

In your twenties? If you’re like most twentysomethings, you’re probably working hard to finish your education, get your career started on the right foot, and launch your life in the “real world.”  Whatever stage of the game you’re in, don’t forget about credit!

Although you may not be thinking about credit — that little file that can help or hinder your ability to borrow money — the sooner you start to build and maintain good credit, the more easily you can take important steps like financing a new car or buying your first home.

Why Credit Matters

Let’s face it: cash is king. When you pay for things you want and need with cash, you don’t go into debt. With cash, you never buy anything you can’t afford. If you already spend money this way: congratulations! You’re smarter with your money than most Americans.

But fast forward five, ten, or fifteen years from now. Will you want to buy a home? Do you think you’ll have saved enough cash to buy a property that costs hundreds of thousands of dollars? Today, most people simply can’t pay cash for their first home. Even if you never want to borrow money for any other reason, you’ll probably want to borrow for a home.

Trouble is, you’ll have a difficult time getting a mortgage if you’ve never borrowed money before.

And that’s why it’s so important to build credit early in life…even if you don’t think you need it yet.

How Credit Works

In a nutshell, your credit report is nothing more than a record of all your debts and how you repay them. From that seemingly basic information, credit bureaus (the companies that collect, store, and distribute your credit report) make calculations (like credit scores) that tell lenders how risky it would be to lend you money.

You get points for borrowing money responsibly and paying it back on time. Take out a credit card and a loan or two and pay each loan on time (every time) for a year or two to build good credit. If, however, you miss a payment or two or take on more credit that you can afford to pay back, your credit score won’t look so hot.

Where Do You Start?

Often, the hardest part to building credit is taking out that first loan or credit card. That’s because banks don’t want to lend money to somebody that doesn’t have a credit file yet.

If you’re a student, credit card companies offer student credit cards that may approve you even if you don’t have any credit history. Trick is, you must be a full-time undergrad. Also, the pending CARD Act will also restrict people under 21 from getting a credit card without a co-signer or proof that you’re financially independent.

If you’re not a student, you can always apply for a loan or a credit card with a co-signer (like a parent) who has good credit. Your co-signer will be responsible for any debt you incur if you don’t pay. Ask your bank if they will issue you a loan or a credit card with a cosigner and then release the cosigner from liability after you make a year or two of on-time payments.

If these options don’t work, ask your bank about getting a secured credit card. With a secured card, you’ll have to deposit money into a savings account (the security deposit) and will get a credit card with a credit line equal to your security deposit. You make purchases with the card just like a regular credit card and pay your bill every month. Unlike a debit card or prepaid card, however, the bank will report your timely payments to the credit bureaus (which builds your credit). After a year or two of on-time payments, most banks will upgrade your secured credit card into a regular unsecured card.

Credit Building Myths

Once you’ve gotten your credit report started with your first account, you’ll be able to apply for a couple more credit lines to help you build credit good enough to qualify you for a mortgage when you’re ready. As you build credit, avoid these two common credit myths:

• You have to carry a balance (and pay interest) to build credit. Not true! If you make a few purchases (even just a tank of gas a month) on your credit card and pay the balance in full, on-time, you’ll still build good credit.
• You need a ton of credit accounts to have good credit. It’s true that having a "mix" of credit accounts is a good thing. For example, at least one revolving credit line like a credit card and at least one fixed-installment loan like a student loan or car loan. That does not mean you need twenty credit accounts to have good credit. After a certain point, extra credit accounts will actually hurt your credit rather than help.

Building good credit is an important step in building your own life and financial independence. As you go, just remember to be patient and that paying your bills on time is the single most important thing you can do to ensure you’ll always have a good credit profile that can help you reach your financial goals!

This guest post comes from David Weliver. David is publisher of Money Under 30, the personal finance blog for the young and ambitious, featuring advice for twentysomethings on getting out of debt, mastering money, and getting on with life. You can learn more about David and his blog or follow David on Twitter @MoneyUnder30.