When you embark on your financial journey, you will learn how to manage your money through experiences, mistakes, and successes. You will receive income from your employer or customers and have to spread it across various expenses. While many effective money habits revolve around a firm grasp of income and expenses, it’s also important to consider your credit score. This three-digit number has significant financial ramifications, and having a good score can save you thousands of dollars over your lifetime.
Consumers can use several credit building tools and loans to improve their scores. This comprehensive guide will lay out the top choices.
What Are Credit Builder Tools and Loans?
Credit builder tools and loans are financial products specifically designed to improve your credit score. While any on-time loan payment will add points to your credit score, some loans are inaccessible to people with no credit or bad credit. These tools and loans are readily available for people who want to start or rebuild their credit.
These are starter products that make other loans easier to obtain. Once you have a mortgage, auto loan, unsecured credit card, and similar resources, you no longer need credit builder loans. Consumers with great credit scores do not need these products, but they can help people who want to get a fresh start or rebuild their credit.
Popular Credit Building Tools and Loans
The Current Build Card is a flexible secured charge card that lets you build credit, stay out of debt and access a ton of other perks.
Experian Boost is a free service that allows you to add eligible, on-time payments to your credit report, potentially increasing your credit score.
Learn how the Self credit builder account can help you improve your credit health or build credit while you also save money.
The Importance of Your Credit
Your credit determines how much money you can borrow from banks and what interest rate you receive. A higher credit score can help you borrow more money for a mortgage and reduce your monthly payments. Good credit gives you more opportunities and can help you save thousands of dollars.
Even if you never plan on taking out a loan or a line of credit (unlikely), a credit score still plays a major role in your life. Landlords will look at your credit score during the tenant application process, and a higher credit score can help you score lower utility bills. Credit scores open up more opportunities and lower your expenses. Building your credit score is a long-term journey, but mastering effective money habits along the way makes it relatively easy to maintain a good credit score.
What Affects Your Credit and By How Much?
The FICO credit scoring model uses five core components to assess your credit score. Knowing what goes into your score can help you gain points over time.
Payment History (35%)
Payment history is the largest component of your credit score. When you make on-time payments for your loans, credit cards, and other financial obligations from creditors, you will improve your credit score. Missing payments will hurt your score, and too many missed payments can result in bad credit.
Late payments will negatively affect other categories that impact your credit score and can result in extra interest and fees. Creating a list of your monthly payments and their due dates can minimize the likelihood of late payments. You can also set up auto-pay features so you don’t have to be in your bank account when payments are due. Creditors assess a borrower’s ability to repay loans, so it makes sense that payment history is the top category.
Amounts Owed (30%)
The amount of money you owe against your credit limit is called the credit utilization ratio. This ratio impacts 30% of your credit score and offers hints about a potential borrower’s financial stability. While this can sound complicated, it’s actually simple. The lower your credit card balance, the better it is for your credit score.
If you have a $10,000 credit limit and have borrowed $3,000 against it, you have a 30% credit utilization ratio. Any credit utilization below 30% can help your credit score, but getting this ratio below 10% is optimal. Aim for $1,000 or less on your credit balance if you have a $10,000 limit. It is ideal to pay off your entire credit card balance at the end of the month and avoid spending more than you earn.
While paying off your credit card balance each month results in a 0% credit utilization ratio, and consumers can also request higher credit limits. A higher credit limit does not reduce your total debt, but it does help your credit utilization ratio. In the earlier example, a $3,000 debt on a $10,000 credit line results in a 30% credit utilization ratio. If you negotiate with your credit card issuer to raise your credit limit to $20,000, you will only have a 15% credit utilization ratio. This ratio gets cut in half even though you have the same amount of debt.
You can request a credit limit increase, but this process will likely result in a hard credit check. The credit card issuer may grant your request, but it’s not a good idea to ask for a limit increase right before applying for a mortgage. Some credit card issuers automatically raise your credit limit based on your deposit history. If you receive more deposits each month (i.e., combined monetary value rather than the number of deposits), you may end up with a higher credit limit automatically. The automatic approach does not involve a hard credit check and will not impact your credit score. However, the higher credit limit can add a few points to your FICO score.
Length of Credit History (15%)
Older credit accounts indicate more experience and can help you qualify for better credit in the future. If you have any old, inactive credit cards open, do not close them. Keeping older accounts open will improve your credit score. You may want to consider using an old credit card for one of your monthly subscriptions. That way, the credit card issuer won’t close the card due to inactivity.
Creditors look at a potential borrower’s credit age to assess their experience. A borrower who has a 20-year-old credit account has more experience than a borrower with a 5-year-old credit account. More experience does not guarantee better financial performance or effective money management. However, many years of credit age increase the likelihood of the borrower being high-quality.
Credit Mix (10%)
Credit mix makes up 10% of your score. The more types of debt you pay off, the better it is for your credit score. It indicates you can juggle multiple financial obligations with creditors. If you have a mortgage, auto loan, credit card, and other commitments, you are strengthening your credit mix.
You shouldn’t incur all types of debt just for the sake of maintaining a good credit mix. However, most people end up with good credit mixes as they borrow more money for various financial commitments.
New Credit (10%)
New credit makes up 10% of your credit score. When you apply for new credit, you may endure a hard credit check. This hard credit check makes a lender feel more confident about giving you money, but it also hurts your score in the short run. Limiting your new credit applications can improve your score.
If you need new credit, wait until you don’t plan on applying for important loans. You shouldn’t apply for any new credit leading up to an auto loan or mortgage application. You want as high of a credit score as possible to capitalize on lower interest rates and larger loan amounts.
What Doesn’t Affect Your Credit
Anything that isn’t a part of those five FICO scoring categories will not impact your score. It’s also important that the payment history is trackable. Payments conducted in cash or debit card will not impact your score. A high net worth will not change your credit score. Borrowing money from a friend off the books and paying them back will not help you build credit, even though you repay the financial obligation.
How Credit Builder Tools and Loans Help Your Credit
Credit builder tools and loans make it easier to access financial products that build your credit score. Some loans and credit cards have stringent credit scores and income requirements, making them less accessible for beginners. Credit builder tools and loans remove many of the obstacles associated with building credit.
Types of Credit Building Tools and Loans
Consumers can select from several financial products designed to raise their credit scores.
Credit Builder Loans
Credit builder loans allow low-credit or no-credit consumers to build credit. These loans are small, typically $500 or $1,000, spread across a 6-24 month term. Most credit builder lenders will ask for a security deposit that you will receive back after repaying the loan. Since the lender requests a security deposit, many of these loans do not have credit score requirements. The lender will report all of your payments to the credit bureaus.
Credit Builder Cards
Credit builder cards are more accessible for people who want to rebuild their credit. These cards, also known as secured credit cards, require a security deposit. This security deposit becomes your credit limit. For instance, if you make a $500 security deposit, you have a $500 credit limit. A $1,000 deposit grants you a $1,000 credit limit. You will receive the security deposit back if you close the card or get it upgraded to an unsecured credit card.
Most of these cards are not as glamorous as unsecured credit cards. Many of these cards do not have any rewards programs, and you may have to pay an annual fee. However, credit builder cards give you a good starting point that can help you build credit over time.
Debit cards will not improve your credit score since their activity does not get reported to the major credit bureaus. However, some credit building apps let you link your debit card to a line of credit. Essentially, the line of credit covers your debit card purchases, and then the money from your bank account goes toward the line of credit. This approach allows debit cardholders to improve their credit scores without relying on credit cards.
Credit Builder Apps
Credit builder apps have resources that help consumers raise their credit. Some of these apps offer loans, but you can also find educational material that teaches you strategies to build credit. You can also track and monitor your credit score on these tools, and some of them have budgeting features.
Other Credit Building Tools
Credit builder loans, secured credit cards, and credit builder apps are great resources for building credit. However, you can also explore educational resources and other credit building tools that can raise your score over time.
Credit Builder Tools and Loans
Consumers can choose from several credit builder tools and loans. Here are some of the available options, but this list only scratches the surface:
Popular Credit Building Tools and Loans
The Current Build Card is a flexible secured charge card that lets you build credit, stay out of debt and access a ton of other perks.
Experian Boost is a free service that allows you to add eligible, on-time payments to your credit report, potentially increasing your credit score.
Learn how the Self credit builder account can help you improve your credit health or build credit while you also save money.
Things to Consider When Choosing the Best Credit Builder Tools and Loans
You can choose from many financial products and resources to build your credit. Before you embark on the journey and select a credit builder tool or loan, you should consider the following factors.
Your Current Credit Score
Your current credit score dictates the opportunities you have for building credit. Anyone can read educational resources, and loans without credit score requirements are easily accessible. However, if you don’t have the best credit score but not a bad one, you might qualify for credit builder loans and secured credit cards that have lower interest rates.
How Much It Can Improve Your Score
Some financial products do a better job of improving your score than others. A steady stream of on-time payments and a low credit utilization ratio are the two best ways to raise your credit score. Those two components make up 65% of your FICO score. Other strategies can give you marginal improvements, but pick approaches that focus on on-time payments that get reported to the major credit bureaus.
How Fast It Can Improve Your Score
It takes a while to build up to a great credit score, but a good credit score is more manageable. Some credit builder tools and loans can improve your score faster. Quicker improvements can be critical if you plan on applying for a mortgage or personal loan soon.
Your Lifestyle and Spending Habits
Credit builder loans and secured credit cards require initial security deposits. You cannot access this money until you pay back the loan or get a new credit card. Not everyone has the financial flexibility to make a $500 or $1,000 security deposit.
While some people with less-than-perfect credit can still receive unsecured credit cards, these cards can lead to bad spending habits. Financial products can have significant long-term ramifications, and it’s important to assess your lifestyle and seek to strengthen your money habits before getting started.
The Fees and Costs
Some credit building loans and credit builder cards have higher interest rates and fees than conventional products. These higher costs come from the increased risk of working with low or no-credit borrowers. Even though you are providing a security deposit for most of these products, most lenders will still charge higher rates and fees. You should compare costs across various financial products before committing to a creditor.
Other Ways to Improve Your Credit
You don’t have to take out a credit builder loan or secured credit card. You don’t even have to explore various credit building apps. While these resources can help, it’s possible to improve your credit score by implementing these tips.
Monitor Your Credit Score
Checking your credit score from time to time helps you see your status. Staying on top of your score can serve as an inspiration and help you track which activities have an impact on your score. Consumers can set benchmarks for their credit scores based on the types of loans they want. For instance, you can get an FHA loan with a 3.5% down payment if you have a 580 credit score. However, a conventional mortgage requires a 620 credit score.
Dispute Errors on Your Credit Report
The three major credit bureaus — Experian, Equifax, and TransUnion — can give you a free copy of your credit report each year. This report contains items that are impacting your credit score, and some of them may be inaccurate. Checking your credit report for errors and disputing them can add extra points to your credit score. It’s a quick fix, but this strategy only works if there are errors. If you have been making late payments, those items will remain on your credit score.
Make Payments On Time
Making on-time payments is the best way to improve your credit score and is the foundation for effective money habits. Listing your expenses can help you stay on top of monthly costs and more effectively manage your money. If you feel nervous about your ability to cover payments, you should reduce your expenses, seek career advancement, or pick up a side hustle until you have enough money to cover your bills.
Settle Your Debts and Balances
Don’t let any debt linger for too long. Settling your debt and balances can provide a fresh start and put you back on the path to a good credit score. You can pay these balances to reach a debt settlement agreement if necessary.
Limit Opening New Accounts
Your credit score will take a hit each time a hard credit inquiry gets placed on your report. These hard credit inquiries often take place each time you apply for new credit. While some creditors only conduct soft credit pulls, you may have to go through a hard credit check. Hard credit checks are more prevalent for mortgages, personal loans, credit cards, and similar financial products.
While opening new credit accounts can give you access to more money and strengthen your credit score, it’s not a good idea to create too many accounts. Opening new credit lines can also make you more reliant on debt to cover expenses, which can hurt your long-term financial goals. Only use the credit and capital that you need. You should be especially attentive to opening new accounts if you are applying for a mortgage or another significant financial product in a few months.
Reduce Your Credit Utilization
Your credit utilization ratio is the second largest component of your FICO score, making up 30% of the total. Paying off your credit card debt results in a lower credit utilization ratio, improving your credit score.
Instead of stopping at the minimum monthly payment, seek to pay off as much of your balance as possible. Making more than the minimum monthly payment can reduce the amount of interest you pay on your credit card and reduce financial stress. If possible, you should pay off your entire credit card balance at the end of the month. Trimming discretionary spending can help you achieve this objective.
Add to Your Credit Mix
Taking on different types of loans will give you a better credit mix. This FICO scoring component makes up 10% of your score. While you shouldn’t take on additional debt just for the sake of a credit mix, this process happens naturally for many people. Most people cannot buy homes at the full asking price and opt for mortgages instead. Mortgages improve your credit mix while giving you the opportunity to own a home and make on-time loan payments.
Become an Authorized User
Authorized users get to piggyback on someone else’s money management skills. When the primary credit cardholder makes on-time payments for their credit card, the authorized users also get that information added to their credit histories. It’s possible to rebuild your credit by becoming an authorized user on a trustworthy person’s credit card. Consumers should set up this arrangement with people who pay their bills on time because late payments from the primary cardholder also hurt authorized users.
Authorized users can spend money on the credit card but are not legally obligated to pay off the credit card balance. Some primary cardholders set up authorized users, but make sure the authorized users do not use the primary credit card.
Once you build enough credit as an authorized user, you can apply for financial products, such as personal loans and your own credit card. These financial products can lead to a higher credit score and make you less reliant on being an authorized user.
