Credit can be a confusing and complicated concept. Building credit can be its own beast, especially if you have no credit history. Without a history, credit card companies, insurance providers, landlords, employers and lenders have a hard time determining your spending and repayment habits, making the process of getting a loan nearly impossible.
The quickest way to build good credit is by using a credit card, but you can’t get a credit card without good credit. While this can seem like a vicious circle, there are still a few ways you can establish credit history, and most of them you can take action on today.
We’ve listed four ways you can start establishing credit, as well as our tips for building and maintaining a good credit score.
4 Ways You Can Establish Credit
If you’re unable to get an unsecured credit card or apply for a loan, whether from bad credit, or a lack thereof, there are a few ways you can start to show a history of responsible repayment. Spoiler – some don’t even require a credit card!
Apply for a Secured Credit Card
A secured credit card is a great tool when you’re just starting to build your credit score. It functions just like any other credit card in the sense that when you use it to make a purchase, you’ll then make payments on that purchase on or before the due date, gathering interest if your balance is not paid in full.
The card requires a cash deposit that becomes the credit line for that account. The cash deposit, usually the same amount as your credit limit, backs the card. For example, if you put $300 into the account, your credit card limit becomes $300.
The cash deposit is used as collateral, making the risk to the issuer significantly lower than an unsecured credit card, because if you don’t pay your bill, the issuer can draw the money from your deposit. However, if you do pay your bill on time, you’ll get your deposit back after you upgrade to an unsecured credit card or close your secured card.
A secured credit card is a great tool to build credit and work your way up to an unsecured card (a card without a deposit). Before you apply for a secured card, make sure it reports to all three credit bureaus: Equifax, Experian and TransUnion.
Get a Co-Signer
While a secured credit card is a great way to build or repair your credit on your own, you can also apply for an unsecured credit card using a co-signer.
A co-signer is used when an individual can’t get approved for a loan or a credit card on their own accord due to a negative or lack of credit history. The co-signer agrees to pay back debt in the case that the borrower is unable. This may include any late fees and collection costs, on top of the full amount of debt.
However, this is not the most appealing way to build credit, as it poses a risk to the co-signer. Additionally, unlike secured credit cards, unsecured cards often charge higher fees and interest rates.
If you do plan on applying for an unsecured credit card by means of a co-signer, make sure you use it responsibly, paying your balance early or on time and never charging more than you can pay back.
We’ll dive into additional best practices throughout this post.
Become an Authorized User
Becoming an authorized user on a person’s credit card is another tool for building or repairing credit.
As an authorized user, you are added to someone else’s existing credit card, usually a family member or significant other, issued your own credit card that you are able to make purchases on, but not legally obligated to pay the debts on the account, even if they are from your charges. The repayment responsibility remains with the primary account holder.
Before you become an authorized user, consult the primary account holder and confirm that the card issuer reports authorized user activities to the three credit bureaus, or else you won’t receive the benefit of building your credit.
Build Credit While Paying Your Debt
You can build credit without even using a credit card by paying off your existing debts, like student loans or auto loans – even your rent.
If you’ve taken out a student loan, making on-time payments may be a great way to boost your credit.
When you pay your loan in full and on time each month, the three major credit bureaus will make note of your habits on a continuing, 30-day basis, demonstrating to future lenders that you handle your money responsibly.
Continue to maintain this history of responsible payment, and you’ll be able to qualify for an unsecured credit card and even a mortgage with reasonable interest rates and lower monthly payments.
Buying a car can also build your credit, if you make on-time payments on your auto loan.
Once you purchase the vehicle and get a new loan, the new debt is added to your credit report. As you begin to make payments on time and prove your responsibility, your credit score will increase.
Often, renters can build credit by making on-time payments and reporting those payments to the credit reporting agencies.
If your landlord doesn’t provide this service, you can pursue services that will report your rent payments to credit agencies to build or boost your credit, like Rental Kharma. However, there is often a fee for this service, so be aware of the costs before you sign up.
Keep in mind that while these are all great ways to build your credit, you should make payments on time, as missing payments can have an adverse effect on your credit score.
Building Your Credit Score – The Right Way
Building a good credit score requires time and responsibility. You must be able to prove at least six months of timely payments to start building your score. There are a few best practices to follow to prove your creditworthiness.
Make All of Your Payments on Time
Payment history makes up approximately 35% of your credit score, so it’s no surprise why our first tip is to make all of your payments on time. Even one late payment can result in a hefty late fee, additional interest charges and a ding on your credit report.
Be sure to pay your bill on or before the due date, because even if you pay on or after the due date, the late payment could remain on your report for seven years.
Don’t Reach Your Credit Limit
Just because your card has a $500 limit, doesn’t mean you should try to use all of it.
The more available credit you use, the worse it is for your credit score, a concept known as your credit utilization (your current credit card balance compared to your limit). Avoid using more than 30% of your credit card’s limit.
Don’t Open Too Many Accounts at Once
New accounts lower your average account age. You want depth in your credit report, because it shows that you have a long history of responsible payments.
Additionally, for every new account you open, the lender will pull your credit, which can lower your credit score by a few points.
Keep Your Existing Accounts Open
One of the most common credit card mistakes is closing a credit card. This shortens the length of your credit history and will most likely decrease your credit utilization ratio – both factors that will affect your credit score.
Check Your Credit Card Statements
Make sure you’re keeping up with your credit statements for oversights. This is not only good for checking on errors and discrepancies, but also identity theft. Be aware of any unfamiliar charges that might pop up so you can handle them accordingly.
Maintaining a Good Score and Credit Report
The best way to maintain a good credit score is by following the best practices of credit card management. In short, never spend more than you can pay back, and make sure you make all of your payments in full and on time.
Your credit report will show you a history of how you’ve used credit in the past and can estimate how you’ll handle it in the future. Sites like Rocket HQ, offer you the chance to check your credit score for free.
Your credit score is one of the key factors that mortgage lenders consider when you apply for a home loan. While FHA loans are available with credit scores as low as 580, Quicken Loans recommends striving for a score of 660 or higher, as it allows more mortgage options and determines your interest rate.
If your goal is preparing your credit for buying a first home, make sure you set yourself up for future success by following our tips today.
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