by Carrie Schwab-Pomerantz, CFP®, President, Charles Schwab Foundation
July 29, 2009

Dear Carrie,
What is the best way for a graduate with a new job to build a good credit rating? I have no credit at the present.
—A Reader

Dear Reader,
Credit is ubiquitous in modern life, but the realities of it, particularly the details of your credit rating or credit score, as it is more commonly known, are not well understood. But you’re smart to think about it now as you’re starting out because it’s not just your ability to borrow money that is at stake. Some companies use credit scores in making hiring decisions, landlords can use credit scores to screen rental applicants, and some insurance companies may even use your credit score to help determine your premium.

You’ll probably be able to get a credit card now, but without a credit history, the terms may not be very attractive. That's actually OK: Your goal should not be to use the card too much, but just enough to build your credit rating. That way, when you really need credit, like for a car or a house, you’ll get the benefit of lower rates and more attractive terms.

Your credit history, essentially, is translated into a number: your credit score (also known as your FICO® score, after its creator, the Fair Isaac Corporation). It’s a numerical assessment of your creditworthiness, and credit card companies, mortgage lenders, and other lenders use it to determine not only if they’ll give you credit but at what terms. When it comes to your credit score, higher is better! The top score is 850; the median is 725, and 760 or higher will typically qualify you for the best deals.

How can you boost your rating? Here are five things you can do to ensure your credit score is as high as possible:

1. Pay your bills on time. Credit card bills should, obviously, be paid on time (it’s ridiculously expensive to be late with a credit card bill these days), but you should strive to pay all your bills on time, including telephone, cell phone, and utilities along with student loans. Your payment history counts for about 35 percent of your overall credit score.
2. Build a credit history. Lenders like people with long records of on-time payments. Your score will be higher if you keep cards for awhile instead of jumping around from card to card. Your history accounts for 15 percent of your credit score.
3. Keep your balances low. Try not to use too much of your available credit in any account– preferably no more than 25 percent. Even if you pay off your entire balance every month, still limit your usage. For example, if your credit limit on a particular card is $5,000, try to keep that balance at $1,250 or lower. This accounts for 30 percent of your credit score.
4. Don’t make a lot of new credit requests. Every time you sign up for a new card or new credit account, your credit score is updated. If you’re thinking of a big loan, like a mortgage, don’t open new accounts in the months leading up to it. Credit requests account for 10 percent of your credit score.
5. Use installment and revolving debt. The mix of credit also impacts your score, with credit cards (revolving debt) having more weight than car loans and mortgages (installment debt). This final component accounts for 10 percent of your credit score.

Once you start using credit, you’ll want to stay on top of your credit score, which is also easy (and free). The three main credit reporting agencies are Experian, Equifax, and TransUnion; each is required to give you a free copy of your credit report once every 12 months (go to AnnualCreditReport.com for instructions). You can see how your credit history is progressing and—very important!—catch mistakes before an important credit decision is made.

A good credit score is important; it can save you very real money in interest charges and, occasionally, can spell the difference between getting credit or not. But just as important is learning to use credit effectively. That’s a topic for another day, but in general, try to live within your means and use credit sparingly! Good luck.