How to Build Your Credit From Scratch
Welcome to the Catch-22 of the credit world - you need credit to get credit, but you can't get credit without credit. It's a confusing and frustrating cycle, but fear not - there are ways to break free and establish that all-important credit history. Read on for tips and tricks to jumpstart your credit journey.
What is a Credit History?
A credit history is a record of your past borrowing and repayment behavior, including information about your credit accounts, credit usage, payment history, credit inquiries, and public records such as bankruptcies and liens.
Credit card companies, lenders, and other financial institutions report your borrowing and repayment activities to credit bureaus, which are companies that collect and maintain credit data on consumers. Credit bureaus use this information to generate credit reports, which are detailed records of your credit history.
Lenders use it to assess your creditworthiness, or how likely you are to repay a loan, to determine your eligibility for credit products such as credit cards and loans.
Lenders also use your credit score to decide if they should give you a loan or credit card, and what interest rate they should charge you. Your credit score is based on your credit history and is a much quicker and more efficient way to estimate your creditworthiness. Think of it as a grade you got for your credit history.
Why Should You Establish Credit?
First, let's look at why you might want to establish credit. One of the most notable benefits of maintaining a good credit history is the potential for significant savings on interest rates for large loans. Lenders view people with good credit scores as a lower risk and, therefore, are more likely to offer them lower interest rates on loans. Good credit can result in significant savings over the life of the loan. Even a little difference in interest rates can add up to thousands or tens of thousands of dollars in interest payments.
A good credit score can also help you qualify for the best credit card offers, which may come with lower interest rates, better rewards, and other benefits. But credit history can impact you in other ways beyond borrowing money.
One of the ways that credit history can impact people is during a job search. Some employers check an applicant's credit history as part of their screening process to assess an applicant's financial responsibility and reliability. Insurance companies often use credit scores to determine rates and coverage for auto and homeowners policies. Utility companies may require a deposit or charge additional fees for individuals with poor credit history for opening a new utility account.
How to Build Credit With a Credit Card
If you have no credit or poor credit, you may find that your credit card options are limited. However, there still are a few ways to build credit with a credit card.
Get a Secured Credit Card
A secured card is nearly identical to a regular credit card, except you need to deposit money upfront in your account with the card issuer. This security deposit acts as collateral for the credit card and helps the card issuer cover unpaid balances or defaulted payments. In other words, with a secured card, you borrow your own money without any risk to the card issuer. For that reason, secured credit cards are easier to get than regular credit cards, and can be an excellent option for building or rebuilding credit.
As with the regular credit card, your secured card payment history is added to your credit report and factored into your credit scores. Once you establish credit with a secured card, it will become much easier to get approved for traditional unsecured credit cards. Using just a few credit cards responsibly is all you need to build good credit.
Keep in mind a secured card is different from a prepaid card. A prepaid card allows you to load the card with cash ahead of time to spend it later. Prepaid cards are great for people who don't want to carry cash for purchases, but prepaid cards won't help establish credit.
Become an Authorized User
A credit card-authorized user is someone who is allowed to use someone else's credit card account. To become an authorized user, the primary cardholder must add you to their account.
As an authorized user, you will receive a credit card with your name on it, but it will be associated with the primary cardholder's credit line. As an authorized user, you can use the primary cardholder's account to make purchases and pay off the balance, which will be reported to the credit bureaus and help you build a positive credit history.
But because authorized users are not responsible for paying the bills, credit bureaus don't give authorized user accounts as much weight.
And although being an authorized user won't allow you to build credit as fast as you could with your own credit card account - it's still a viable option if you have a limited credit history or a low credit score, as it can help you establish a track record of responsible credit usage and improve your creditworthiness.
Another good thing about this option is that most credit card companies don't have a minimum age requirement for authorized users. To get your own credit card account, you must be at least 18 years old. So becoming an authorized user is a great way to build credit before you can get your own credit account.
As an authorized user on a credit card account, be aware that if the primary cardholder doesn't pay their bills on time, it can negatively affect your credit. However, if this happens, you can protect your credit by removing yourself as an authorized user from the account in question and filing a dispute with the credit bureaus to have the account removed from your credit reports.
How to Build Credit Without a Credit Card
Building credit with credit cards is an easy and free way to build your credit history if you pay off your credit card balance in full before the due date. However, there are other options that don't involve applying for a credit card. Any type of borrowing money where the lender reports the information about your loan to the credit bureaus is included in your credit reports and therefore builds your credit history.
Generally, borrowing money and paying fees and interest is not the best way to build your credit history. But in some cases, it may be what you want. If you already plan to take a loan for your education or to finance a major expense, taking a loan can be a good option.
Find a Co-Signer for Your Loan
If you don't have an established credit history, lenders will be hesitant to lend you money, and you will need to find someone to co-sign a loan with you. This person, often a parent or a relative, has good credit and is willing to use their credit history to help you get approved for a loan. When you co-sign a loan, you get the benefit of the other person's good credit history, which may help you get approved for a loan you might not have been able to get on your own. Once you have the loan, you can then build your own credit history by making regular, on-time payments.
Co-signing a loan may help you qualify, but it puts the co-signer in a vulnerable position. If you, as the primary borrower, are unable to make the payments - the co-signer takes on the responsibility for repaying the entire loan amount. This situation can damage both your and the co-signer's credit score and put a strain on your relationships. There are other risks to consider. Carefully consider the risks of co-signing before taking a loan.
Get a Credit-Builder Loan
A credit-builder loan is a type of loan designed to help individuals build or improve their credit history. Some banks and credit unions offer these loans, which are generally small and have low-interest rates.
An interesting feature of credit-builder loans is that the lender doesn't give you the money you've agreed to borrow until you've paid the loan in full. The lender creates an account for you to make monthly principal and interest payments for a term specified in the loan agreement. These terms are usually short, around six to 24 months. The lender reports all your payments to credit bureaus, which builds your credit history. The money in your account is available to you once you've paid the loan in full.
The benefits of a credit-builder loan are twofold - it forces you to save money while also building credit. Credit-builder loans may be a good option if you want to save money while establishing or rebuilding your credit.
Because credit-builder loans are designed to help individuals build or improve their credit history, it's usually easy to qualify for this type of loans, even for people without credit history or who have had credit problems in the past and are looking to rebuild their credit. There is no risk for lenders with credit-builder loans because they don't part with their money.
Credit history can impact you in many ways beyond borrowing money. It can affect your ability to get a job, rent a home or apartment, obtain insurance, and open new utility accounts. Maintaining a good credit history is essential for maximizing your financial opportunities.
Remember, there is no secret sauce to building and maintaining good credit. The key to building strong credit is to avoid missing payments and maxing out credit accounts. After all, credit history is just your track record of credit usage. Being responsible with your credit will lead to good credit history.
Furthermore, keep an eye on your credit reports and ensure there are no errors or inaccuracies, as these can unjustly impact your credit score.