How to build your credit score from scratch

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Without a credit history, it's difficult to be approved for a loan when you purchase a house, car or other big-ticket item. And if you do get approved, you'll be stuck paying a higher interest rate.

Lenders want to see that you have a proven track record when it comes to borrowing money. One of the ways that they do that is with your credit score.

Here's why you might be lacking a score - and how to start building one.

Why you might not have a score
There are many reasons you may not have a credit score.

"You may be a millennial spooked by the financial crisis who refuses to touch a credit card," Laurie Campbell, CEO of Credit Canada Debt Solutions, said in an emailed response to questions. "You may also be a new Canadian, who has never borrowed money in this country."

Or, you may simply have never had a credit product under your name. For example, for women in older generations, it was quite common to put everything under the husband's name. However, if the couple were to divorce or the husband dies, the wife could have problems getting credit in her own name.

Alternatively, you could be an older Canadian who has simply always used cash or even debit.

Best ways to begin building a credit score

There are several ways you can establish a credit score from scratch, but perhaps the easiest is to apply for a secured credit card.

With a secured card, you give the bank a certain amount of money as a deposit, often $500 or more, and that becomes your credit limit. You use the card as you would a regular credit card: make charges, receive a bill, then pay the balance. The deposit you made is simply collateral in case you become unable to make payments.

Secured credit card behaviour is reported to the credit bureaus, TransUnion and Equifax, allowing lenders to see how good or bad your repayment behaviour is. The higher your score, the better you look in the eyes of lenders.

"By using your secured credit card responsibly over time by paying off your balance in full and keeping your credit utilization under 35 percent, you can help build a good credit score, before eventually being able to qualify for a regular credit card," said Campbell.

A good way to build credit score if you're a young Canadian is a student credit card. Usually, the best time to sign up is the beginning of the school year. That's when the best perks are typically available.

"Not only is a student card a good way to build your credit, it also comes with perks, such as cash-back, zero fraud liability and discounts on school-related items," Noel D'Souza, money coach at Money Coaches Canada, said in an emailed response to questions.

"Just make sure the credit card is used responsibly. Although it typically comes with a low limit, carrying a large balance on your credit card can negate any good you were hoping to achieve by signing up in the first place."

If you're not a student and you have a decent income, you may be able to qualify for a low limit fee-free credit card.

"A fee-free credit card offers the best of both worlds," said D'Souza. "It offers you all the perks of a regular credit card and helps build your credit score.

Avoiding the common pitfalls of credit
When you're new to credit, it's easy to make mistakes.

Some common mistakes include:

1. Applying for too many products at once.
When you apply for credit products, it counts as a "hard inquiry" on your credit report.

"Too many hard inquiries on your credit report within a short period can lower your credit score," said Campbell. "By only making credit applications you're serious about, you can avoid lenders pulling your credit report too often."

Sometimes, similar applications are grouped together, such as when you are searching for a home or car. When you're applying for many different credit cards, however, you may be perceived as desperate for credit.

2. Making minimum payments.
Making payments late and only paying the minimum are common credit pitfalls to avoid. Not only can this cost you more interest (late payments often result in a higher interest rate), you'll be hurting your credit score instead of helping it.

"By using credit responsibly and only making purchases you can afford to pay in full once your credit card statement comes due, you can avoid getting yourself into the trap of only paying the minimum," said Campbell.

3. Keeping a high balance.
Your credit score is made up of several factors, including repayment history, credit utilization, new inquiries, credit mix and your total credit history (how long you've been using credit). The two biggest factors, by far, are repayment history and credit utilization; that is, how much you owe compared to how much credit you have available.

Generally, it's best to keep your credit utilization under 30 to 35 per cent. So, if you have a credit limit of $1,000, it's best to keep the balance around $300-$350 at any given time. The lower your utilization ratio, the better.

There are some other common credit score mistakes to keep in mind, but these are the biggest concerns. With smart use of your credit cards, you can be on your way to a good or great score in no time.

See related: Application denied: 6 reasons for credit rejection, How to improve your financial literacy, The credit card application process explained

Published September 6, 2017

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