Tips for Building Credit for the First Time
So you’re excited about making a splurge on a new car or a vacation, but you don’t have the credit card to pay for them. You wanted to open a credit account, but the credit issuer is asking for your credit score. But, you don’t have a credit score. You don’t even have a credit history. And now, the dreams for new wheels or a grand vacation are starting to ebb away, simply because you didn’t have credit.
And the vicious cycle goes on and on.
How does anyone build credit anyway, without a credit card or a loan? And how does anyone get a loan credit card without credit history? Well, the thing is, we all started with zero credit. The people who have established credit history took the first basic steps in credit-building. Over time, their credit grew and now they can finance cars, get loans and even buy a house.
When Should You Start Building Credit?
Credit history is established over time, so the sooner you’re able to build yours, the better. Some parents start establishing their kids’ credit at an early age by designating the child as an authorized credit card user. However, most people start to build credit when they enter college (especially when taking student loans) and when they’re able to sign up for student credit cards.
The thing is, you should start building credit when you can, immediately. Credit scores don’t climb up overnight – it’s a cumulative effort over time. As you transition towards adulthood when you face bigger financial decisions and having substantial credit can be a huge help.
Why is Credit Score Important?
The credit score is an essential aspect of credit building. The credit score is a three-digit figure that determines how you manage your finances. The credit score is also used by most financing institutions to decide whether or not it’s right to grant you a credit card, personal loan, and other financing instruments. Many employers, service providers, and even landlords will take a look at your credit score to check if you’re eligible for the position, products/services or rental apartment.
With that said, it is important to work on your credit score and keep it in good shape to the best of your ability. To do this, you need to keep your credit utilization rate low (at most 30%), pay your bills and debts in full and on time, and avoid opening and closing accounts in short span of time. It also pays to have a good mix of credit (personal loans, home equity credit, credit cards etc), but you have to make sure that you’re able to manage them properly simultaneously.
6 Best Ways to Jump-start Credit Building
Fortunately, having a credit card is not the only way to build credit for the first time. There are several ways to start building credit from scratch. Here are the best and smartest ways to begin with now.
Open a Secured Credit Card
Credit issuers typically ask for credit history before they process your credit card application. Without credit history, it is very likely that you will not get approved. An ideal alternative is to apply for one or two secured credit cards.
Secured credit cards work pretty much the same way as the regular credit cards. The only difference is that you need to provide a cash deposit or security, which also often equates to the credit limit. For instance, if you deposited $1000 as security, you will also have $1000 credit limit. The security deposit works as collateral should you fail to pay your bill.
However, don’t think that a secured credit card is similar to a debit card. You still have to pay your credit bill despite having a security deposit, unlike in the case of a debit card where the payment is pulled out from your account. Hence, you should still treat your secured credit card as you would any plastic money: purchase only what you know you can afford, pay your bill on time and keep utilization rate low.
The main advantage about using a secured credit card is that you defer your risk through the security deposit, increasing your chances for approval despite zero to little credit history. And if you use your secured credit cards wisely and responsibly, your credit score climbs up, consequently making you eligible for unsecured credit cards with better rates and limits.
Apply for a Student Credit Card
A student credit card is a type of credit card designed and marketed primarily for college students. It works so much like any other traditional unsecured credit card, but typically with lower credit limits. A student credit card can be your very first real credit card. Owning and using a student credit card responsibly in your younger years could help beef up your credit score in the succeeding years, making you more qualified for better financing tools in the future.
Although student credit cards are nearly as convenient as the next conventional credit card, it offers fewer perks. For one, you cannot always command the lowest interest rate. Credit issuers typically assign an APR depending on your credit history (if you have any) and source of income. You may also have to ask a parent to co-sign the credit card.
You may earn some cash back for purchases made with the card, but they’re not as grand as the regular credit card. However, if you’re after to initially build your credit, a student credit card can prove to be most accessible. And just like any other credit line or loan, you want to make sure that you can manage your student credit card well so you don’t end up purchasing more than you can afford.
Ask to Become an Authorized Credit User
Another excellent and easy way to build credit is becoming an authorized credit user under someone else’s account. If your parents, siblings or close relative allow you to become an authorized credit user, any activity made on that account are reported and recorded with the credit bureaus. Therefore, if you opt to be under a credit owner who already has good credit history and can handle his finances responsibly, the positive impact rubs into your own credit history as well.
The advantage of becoming an authorized credit card user is that you don’t have to go through the hoops and loops of applying for a credit card. You simply get the card and use it as any primary credit holder would. Also, the purchases made with the said card go towards the primary owner’s bill, making him or her responsible for settling the debt promptly.
It’s important to remember that when you’re added as an authorized user into someone else’s credit card, both of you share the same credit limit. Sharing reduces the credit limit between the two of you, so you need to make sure that you’re not going beyond the recommended utilization ratio for the said account. Also, if the credit issuer reports to the credit bureaus, any activity made on that account reflects on both your credit scores. So if the primary credit owner observes proper credit card use, you get to share on his credit score as well.
Get a Co-Guarantor
Sometimes, all we need is a helping hand to help establish credit for the first time. If someone, say a parent, with good credit standing, vouches and co-signs a credit line for you, then you’re off to owning your first credit card easily.
Unlike being an authorized credit card user where you’re not responsible to pay the credit bill, getting a co-signer is a different story. You are the primary card owner, so you need to be the one to pay the debt. In case you fail to pay the debts timely or entirely defaulted on the credit card of loan, the co-signer takes responsibility. Not only will bad finance habits hurt your credit score, but that of the guarantor as well.
You need to convince someone with a good credit score to co-sign for you. Just remember though that you’re no longer “riding” this person’s credit standing, but you’re now trying to build your own. Use the credit card wisely to nurture better credit standing and avoid staining the relationship with your guarantor.
Use Store Credit Cards
You can take advantage of your brand loyalty in a more meaningful way, namely, to build your credit score through their store cards.
How many times has a sales clerk asked if you’d like to sign up for one of their store credit cards and get 10-20% off on your purchase that same day? If you frequently shop in that establishment, getting a store credit card is indeed a good deal. Not only will you receive some exclusive promos and discounts, but you can also even use it to build your credit.
In fact, most people started building their credit with store credit cards. Such credit cards are easier to qualify for than the regular credit cards. You may apply and get approved with zero, little or even bad credit. Although it is typical for store credit cards to have lower limits and higher interest rates, they can very much become a stepping stone for better credit deals in several months or few years.
Apply for a Credit-Builder Loan
Some banks and financial institutions offer loans designed for newbies in credit and those who have poor and little credit history.
A credit-building loan is a typically a small amount of personal loan. The credit issuer needs to report to the three credit bureaus so you can use it to build credit, or else, you defeat the purpose. While most issuers would be keen on lending you some money, you must be able to show proof of income. For this reason, the credit-builder loan can be beneficial for fresh college graduates who have already landed jobs.
Now, it is important to understand how credit-builder loans work because they’re a little different than other types of personal loans. First, when you get approved for the credit-builder loan, you won’t get the funds right away. The loan is kept in a savings account. You keep paying off the loan, the issuer reports your activity to the credit bureaus, and then the funds would be released to you by the end of the loan term.
Therefore, you shouldn’t need that loan when you’re taking a credit-builder loan. The primary purpose for that loan is to establish credit, so if you need it for a vacation or other expenses, they certainly won’t be that handy. Second, remember that you’ll still be making payments month after month until the loan term ends. These payments can make a dent in your finances, so figure them out in your budget. Focus on providing timely payments and soon enough, your balance should drop and credit score would rise.
Should You Take On Debt To Build Credit?
In a nutshell, you need some form of debt or financial obligation to build credit, but should you take on debt just for this cause?
The general advice is never to take on debt unnecessarily. Debts can take a toll on your financial well-being, and if you let debts blow out of proportion, you’d suffer not just the financial, but the emotional stress as well.
A student credit card, some store credit cards and perhaps a co-signed loan should already give you a good start in building credit in your early years. If you do get into debt for something, perhaps to replace your damaged laptop or get your first couch, then getting into debt does become necessary. Not only will you be able to fill a need, responsible payments will also help build your credit score – it’s a win-win!
How to Manage Your First-Time Credit and Loans
You might consider getting a house, buying a brand new car or applying for a more lucrative credit card in the next few years. Ideally, you’ve started building credit early enough to make you more eligible for these “adult” purchases. Otherwise, you might find it difficult to obtain the best financing tool due to lack of credit history.
When you get your first lines of credit or loans, you must use them properly and treat them with respect. First thing that you need to remember is that you can never build credit in a rush. It takes time to generate a credit score (typically 6 months), so you need to use your existing credit cards wisely.
Moreover, don’t open too many accounts all at once. Even too many inquiries made to banks can hurt your credit score. Only apply for a new line of credit when you really need it and don’t do it for the sake of getting a better mix of credit. Applying for a number of accounts in a short span of time projects desperation, which lenders conceive as irresponsible management of finances.
Also, don’t close your old accounts even if you’re no longer using them. The longer your name stays on the account, the better it would be for your credit history.
Lastly, remember to keep your credit utilization rate low, ideally below the 30% rate. Wipe off your balances entirely, if not, keep them low. Sometimes it’s tempting to carry balance especially in tight financial times, but do your best to pay them off as soon as you can. Most people get into trouble because they let a small balance neglected, allowing it to balloon into unmanageable debt.
Building credit doesn’t have to be a gruesome process if you focus on responsibly handling your finances. You want to start building credit today even if you don’t need it yet because when you need one in the future, you’d aleady be all set. The small, little steps you make today cumulatively impact your credit standing, so make them count!
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