How to Build Credit from Scratch
A strong credit history opens up a wide range of opportunities. You can get prime interest rates on major purchases like a home or car and can also become a prime candidate for apartments and jobs.
But if you’re just starting out with your own finances, you may be confused over the best way to begin building your credit. Not only have we gathered the best credit building products available to those without a substantial credit history, we’ll also teach you powerful habits to successfully build your credit from scratch.
In just a short amount of time, you’ll notice your credit history becoming more substantial, your credit score increasing, and your access to credit becoming less expensive. The longer and more positive your credit history is, the better rate offers you’ll receive, meaning you’ll pay less interest and earn better rewards when you do decide to use a credit product.
5 Products to Help You Establish Credit
In order to build your credit, you have to actually use credit. The catch-22, though, is that most lenders and credit card companies don’t want to extend an offer to someone with no credit history.
The reason for this is because there is no indication of how able and willing you are to repay what you owe. Luckily, there are a few different products you can use to overcome this issue while taking baby steps into the world of credit.
Credit Cards for Beginners
Opening a credit card gives you the chance to show that you can charge money in an appropriate amount and make regular payments of at least the required minimum (or ideally, in full).
There are a few different kinds of credit cards available for building your credit from scratch. The first is a secured credit card. In order to use this card, you’ll make a cash deposit to the creditor, which will be the same amount as your credit limit.
However, your monthly balance isn’t paid off by the deposit; instead, it’s your responsibility to make the payments so your credit can build. If you don’t pay off the balance in full, you’ll accrue interest, and if you fail to pay altogether, your deposit is used as collateral.
Next is a student credit card, which is geared towards younger adults who are still in school. You’ll probably have a relatively low credit limit and higher interest rates, but you could qualify for rewards or a promotional offer. If you don’t want a co-signer, you’ll likely need some sort of income (even part-time) to get approved.
Another option to build your credit is to get a retail credit card. Like student credit cards, these usually have higher interest rates. You can only use them at a specific retail chain, but often receive perks like store discounts and coupons. They’re also quick and easy to get — the application process takes just minutes right at the sales counter.
Co-signer Loans and Credit Cards
Whether you’re looking for a loan or a credit card to build your credit, you can use a co-signer to increase your chances for access to credit. In fact, if you’re a student and don’t have any income, you might be required to find someone who is over the age of 21 to serve as your co-signer. But don’t make this decision lightly.
Co-signers are legally obligated to pay your debt if you default. Not only that, your actions affect their credit; for example, just as late payments hurt your credit score, they hurt your co-signer’s score just as much.
It can also be difficult to remove a co-signer once he or she is on your credit card or loan. In fact, you may have to transfer your balance or pay it in full for removal from a credit card, and you might even have to refinance for removal from a loan.
These loans aren’t incredibly common and you’ll probably have to go to a credit union or small community bank to get one. But the good thing is that it’s a low-risk way to build your credit from scratch, or even rebuild a poor credit score. The way a credit-builder loan works is that you essentially repay the loan in advance of receiving any money.
When you’re approved for the loan, the money is transferred into a savings account — but you can’t access it yet. You then begin making monthly payments on your loan and once it’s paid off, you get the funds.
Yes, you could simply put away your own money into a savings account and then use it, but that doesn’t help your credit score. Your financial institution reports your on-time payments to the consumer reporting agencies, lengthening your payment history and boosting your score.
Becoming an authorized user on someone else’s credit card is a relatively simple way to build your credit. You simply ask a close family member to be added to an existing credit card. However, it does not come without risk, particularly for your family member. While you’re able to make charges on the credit card, you are not legally obligated to make any payments.
That means the actual cardholder is on the hook for any charges you rack up. But if you do use the card responsibly, the positive payment history is typically reported to the bureaus for you as well.
Rent Reporting Services
Services such as Rental Kharma and Rent Reporter offer to report your rent history to the credit bureaus. These services allow you to build your credit history by paying rent on time. Rent reporting services generally cost between $50-$100 upfront and then charge a month service fee of $10-$15.
4 Habits to Help You Build Your Credit
It takes more than getting a credit card or loan to build your credit. You also have to steward those accounts responsibly. A few routine habits will help keep your credit healthy, ensuring that your credit history is a positive one.
These steps strengthen your credit score and demonstrate that you are trustworthy with a creditor’s money. That way, they’ll be more willing to lend you more money if you need it, and at better rates.
Make Payments On Time
Your payment history accounts for 35% of your credit score — the most heavily weighted category there is — which means it’s crucial to make all of your payments on time each and every month in order to build a healthy credit history.
This doesn’t just apply to credit cards: student loans, cell phone bills, and utility bills all report late and delinquent payments if you fail to pay. Making full, on-time payments is the fastest way to either build or trash your credit, so it’s up to you which one you want to do. (But it’s pretty obvious, right?)
Carry Small Credit Card Balances (or none at all!)
When you get a credit card to build your credit history, the ideal scenario is to charge a little bit each month, and then pay off your balance in full by the due date. Having a credit card isn’t a license to spend frivolously; instead, it’s giving you the chance to prove yourself as a creditworthy individual.
If you do need to carry a balance for some reason, try to keep it under 30% of your credit limit. So, if you’re allowed to charge up to $1,000, you wouldn’t want to have a balance of more than $300 at any given time. Clearly, the lower balance the better because you don’t want to spend outside your means and accrue outrageous interest that you’ll have to pay back over time.
Limit Your Number of New Accounts
While you might qualify for any number of the credit products we talked about above, don’t overextend yourself by opening up each and every account you’re approved for. Account age is considered in determining your credit score, so new accounts bring down the average age of your overall credit accounts.
Not only that, your credit score is temporarily dinged a few points for every hard inquiry on your report, a step that is necessary to get approved for a loan or credit card. Plus, from a lender’s point of view, lots of open accounts might indicate that you’re desperate for credit and might not have steady finances.
Don’t Overuse Your Credit Cards
When you do have a strategic number of credit cards, be sure not to max them out. Again, this makes you look like you’re reliant on credit just to get by. Your amount owed also accounts for 30% of your FICO score — the second largest category after payment history. The amount you owe compared to the amount of credit you have access to is called your credit utilization ratio.
If you have a high credit utilization ratio, it means you’re close to maxing out your accounts and could indicate that you might have trouble making your payments in the future. This is generally a bad sign and can hurt your credit score. Stay on top of your monthly payments right from the start to avoid getting bogged down later down the road.
As long as you’re strategic with your credit products and don’t become reliant upon them for everyday purchases, you’ll remain on track for building a fantastic credit history right from the start. Start off by selecting one or two products that work for you, then make small purchases that are easy to repay each month. You’ll love watching your credit history expand over time.