A guide to credit for young adults

For a young adult who is just starting out on their independent financial journey, the world of credit can be complicated. The easier option is to ignore the topic altogether, but understanding the ways you can impact your credit score (both positively and negatively) will help you to feel in control of this vital aspect of money management.

Unfortunately, there’s no quick fix when it comes to establishing a healthy credit score. That’s why it’s so important to start thinking about your financial health early on, so you can develop good habits which help build a favourable score.

We’ve put together this guide with all you need to know about credit, so you can start to organise your finances as a young adult.

What is a credit score? 

A credit score calculates your credit risk and indicates how reliable you’ve been when borrowing money. Usually a three-digit figure, it represents your ‘creditworthiness’ (how responsible you are when repaying debts) and can be a determining factor in whether an application for credit gets approved or denied. If you’ve demonstrated responsible credit behaviour in the past, this will be reflected with a higher score. 

Each credit reference agency (CRA) uses different ranges and barometers to determine what’s considered a good score. It’s important to note that prospective lenders will have their own criteria for how they judge a credit score, so a rating that isn’t good enough for one lender could be approved by another. 

Credit scores are calculated by the three main CRAs: Equifax, Experian and Transunion. There are a range of factors that are taken into account by these institutions to determine your credit score. Some of the most important categories include: 

• Payment history. This is generally considered to be the most influential area since it analyses your history of repaying debts, and whether or not these payments were made on time.
• Amounts owed. This category primarily looks at your credit utilisation ratio. This number is determined by comparing your current balance with the limits set on your credit cards. If you’re using less than 30% of your available credit, this is generally considered to be a healthy utilisation ratio and will reflect favourably on your credit score.
• Credit history. Your score is also likely to be affected by the length of time you’ve been building your credit. The longer you’ve had access to credit and have demonstrated good financial discipline, the higher your score will be (with all else being equal).

The importance of building credit early 

If you haven’t started thinking about mortgage applications or applying for any other line of credit, you may be wondering why you need to concern yourself with credit scores at all. It’s true that in the short-term, young adults are unlikely to be affected too much by a poor credit score. But being proactive about money management from an early age can lay the foundations to help you build a more secure financial future.

Whenever we need to apply for credit, potential lenders will want to assess how reliable you are before approving your loan. One of the best ways for them to do this is to check your credit history and rating to see how you’ve managed money in the past. If you have built up a bad credit history, this will suggest to lenders that you are more of a risk and your application is less likely to be approved. If you don’t have any credit history at all, this will have a similar impact on your score, and lending institutions will be more reluctant to approve a loan.

On top of improving your chances of being approved for credit, people with a good credit score are more likely to be offered favourable terms on these agreements, meaning it essentially becomes cheaper to borrow money. What’s more, although it’s not a common practice, some companies may even check your credit history when you apply for a new job, so building a good financial reputation could help to boost your employability too.

That’s why it’s important to start building your credit from a young age. While you don’t want to take on too much financial risk, you equally don’t want to ignore this important aspect of your finances, since both will affect how reliable a borrower you appear to potential lenders.

How to monitor your credit

In most circumstances, young people won’t get a credit score until they turn 18 and start borrowing money – most commonly for a mobile phone contract. When your credit history starts being recorded, it’s important to regularly monitor your file, to help you track your reputation and to keep your accounts safe.

There are a number of different factors that could be impacting your credit score, and it can feel almost impossible to keep track of every little detail. However, there are some steps you can take to effectively monitor your credit and stay in control of your finances. 

Understanding what’s good and what’s bad for your credit score is the first step to keeping on top of things. This way, you can alter your behaviour and financial habits accordingly to help boost your credit rating. When it comes to physically tracking your credit status, there are several options to explore. You can either sign up to a free service that provides a broad overview of your credit health through monthly reports, or you can pay for a more comprehensive service through one of the credit reference agencies.

However, you choose to do it, monitoring your credit is a key part of looking after your general financial wellbeing. Not only does it give you a better understanding of your credit score, but you’ll also be able to spot if there are any unfamiliar inquiries, which could indicate that someone may be trying to use your account fraudulently.

How can young adults build credit? 

Fortunately, there are plenty of ways young adults can start to build a healthy credit score, giving you more financial freedom later in life. Building credit is all about doing more of the ‘good’ things while avoiding the ‘bad’ habits that’ll have an adverse effect on your long-term financial health. Here are some of the first steps young people should be looking to take as a way to start building their credit. 

Join the electoral register

Although it won’t have as big of an impact on your score as maintaining healthy financial habits, joining the electoral roll is one of the easiest ways for young people to quickly give their credit score a boost. Despite this, our research found that 72% of 18-24 year olds aren’t aware that being on the electoral roll has an impact on their credit rating. 

Being part of the register allows potential lenders to confirm your identity, reducing the risk of fraud whenever you make an application for credit. As an added bonus, signing on can save you time when sending your application, since potential lenders might be able to access some of your details through the electoral roll. 

If you’re unsure whether or not you’re already part of the register, get in touch with your local Electoral Registration Office through the government website.

Use a secured or low-limit credit card

Another way you could build or improve your credit score is through a credit card which, when used responsibly, can demonstrate to lenders that you can be trusted to repay your debts each month. 

For young people just starting out on their credit journey, there are a range of options available, including student, low-limit and secured credit cards. Before making any applications, it’s important to understand the differences between each type of account so you can make best use of it. Depending on your financial situation and lifestyle, one card may be more suitable than another. Here is what each type looks like:

• Secured – this type of credit card requires a cash deposit which acts as a form of insurance. The deposit is usually equal to the credit limit set on your card and can be used by the card issuer in the event the user defaults on their balance. Because there’s less risk attached to this type of card, applications are more likely to be approved.
• Low-limit – as the name suggests, a low-limit card only lets users borrow a small amount of money each month. There isn’t a blanket limit that’s imposed on all low-limit cards – each account will be different depending on the holder’s circumstances and financial wellbeing. These cards are designed to help you avoid overspending while also gradually building up your credit score.
• Student – a student credit card encourages students to spend within their means each month, by having higher interest rates and lower spending limits than standard credit cards. While you’re studying, it’ll generally be easier to attain a student credit card than it would a standard credit card. In addition, there are often rewards and benefits to be had from owning a student credit card, so make sure you research your options carefully before making any applications. 

Become an authorised user on a parent’s card

If you don’t feel ready to take on the responsibility of managing your own credit card just yet, another option is to become an authorised user on someone else's account. Usually, this will be a parent or guardian – providing they have a healthy credit score. As an authorised user, you can benefit from the account holder’s responsible use of a credit card without having the financial obligation to manage the monthly payments yourself. 

If you don’t have any credit history and aren’t well positioned to apply for your own credit card, this is a good way to start building up your credit score to prepare you for future applications.

Common mistakes to avoid

There are plenty of common mistakes that people of any age make when using credit, but they can be harder to avoid or notice as you take your first steps into the world of credit. Here are some of the typical mistakes people make when looking to build their credit score. 

• Setting the limit too high – whenever you pay for something with a credit card, you’re essentially using money that isn’t yet yours. And when a credit limit is set too high, this can encourage people to spend beyond their means, leaving them with an expensive problem at the end of each month. Being a responsible credit card user from a young age will help to boost your creditworthiness and support your financial wellbeing.
  
  Typically, if you use a credit card designed for young people like a student or low-limit card, these will come with a preset limit that will encourage you to use it more responsibly. But bear in mind that even though you may have a low limit, regularly reaching close to that figure will harm your credit score. It’s recommended that you should only spend within 30% of your credit limit each month; maintaining a low credit utilisation ratio demonstrates that you’re a responsible borrower.
• Making late payments – you should aim to pay off your balance at the end of each month in full. Missing a payment could increase the amount you owe due to interest charges and penalty fees, whilst also impacting your credit score.
  
  When a late payment gets recorded on your credit report, it will remain there for six years. However, it typically takes around 30 days for a missed payment to show up on your report. If you do miss a payment, the first thing you should do is get in touch with your provider to discuss the next steps. This way, you may be able to minimise the impact of a late payment on your credit file.
  
  One way to ensure you never miss a payment is to set up a direct debit with your bank. However, this relies on you having the necessary funds available in another account to be transferred across. Make sure you know when your payment is due each month and organise your accounts, so you aren’t penalised. 

• Making minimum payments – at the end of each month, banks will give you the option of making a minimum payment on your credit card bill. This could either be a percentage of your total debt or a fixed fee – it can vary depending on your provider’s policies and the amount you owe. This information will always be on your monthly statement. If you only make the minimum payment each month, it’ll take longer to clear your balance as the debt will continue to grow with interest over time.
  
  In the short-term, paying back the minimum amount is unlikely to drastically affect your credit rating – missing the payment or making a late payment will be more damaging. However, getting into the habit of only paying off a small proportion of your credit card debt each month can ultimately be detrimental to your financial standing. To prevent this, try to pay off what you can afford each month, even if it doesn’t completely clear the debt. Doing so will limit the amount of interest on what you owe, helping to save you money in the long run. 

It can feel daunting as a young adult to take responsibility for managing your credit. But discussed in this guide, there are several things everyone can do to start building up a healthy credit score. Any positive steps you take now to improve your credit history, however large or small, will benefit you and your finances for years to come.