How to Establish Credit for the First Time

Reader Question: I am saving up to buy a house next year, and I keep hearing how important it is to establish good credit when applying for a mortgage loan. I have not used credit cards in the past, but I have paid rent for many years. Is that enough to establish credit for myself, and if not what should I do?

We answered a similar question just a few days ago, so I would start by reading that response. In fact, now that I look at it, the previous question is identical to yours. Click the hyperlink to read that person's question.

Since we have covered this question before, I'll focus on what I feel is the most important part of this concept. I'll tell you how to establish credit the right way, without getting yourself into debt in the process.

But first, let me clear up some terminology for the benefit of other readers. When I refer to establishing credit in this context, I'm talking about building a history of good credit behavior. This behavior will show up in your credit reports and scores, and it's used one of the things mortgage lenders use when considering you for a loan. So it's not enough to establish a credit history in general -- in particular, you should focus on establishing a good credit history. That's the key to all of this, and it will unlock a lot of financial doors for you in the future.

So how do you do it?

If you have been paying rent for a while, as you've indicated, you are well on your way to establishing a good credit score ... especially if you've been responsible about paying your rent on time. The same goes for paying utilities (phone, electric, etc.) or anything else that requires regular payments.

Obtaining a credit card can also help you establish a history for yourself. If you refer to the FICO scoring chart we have on our website, you'll see that your payment history accounts for a large chunk of your overall credit score. In particular, this refers to your history of making credit card payments. When you make these payments on a regular basis over time, and you avoid missing payments, you can establish a good score for yourself. Of course, the other things mentioned above also play a role, but your payment history is a big slice of the pie.

Here's the most important thing you should take away from this lesson. The key is to use your credit card responsibly and sparingly. The last thing you want to do is rack up a huge balance on your card, because that can lead to debt problems (among other things).

So the best way to establish credit for the first time through the use of a credit card is to (A) make small purchases from time to time and (B) pay the balance off each month. Do this over time, and you will eventually have a history of being financially responsible. This is exactly what lenders like to see. It shows them that you can use credit responsibly, and that you can manage your debt.

Hope that helps. Good luck.