The Need to Build Credit
If you do not have a credit history, lenders do not know whether or not they should give you money. Without any credit history to rely on, they have no idea what to expect: will you pay off your loan, or will you walk away (leaving them with a loss)? You need to build credit in order to prove your creditworthiness.
Who Needs to Build Credit?
Anybody without a history of using credit needs to build credit. You never know when the need for a loan will arise, and it is a lot easier to get money with a solid credit history. Young adults who are just setting off on their own typically need to build credit, and new arrivals to the U.S. are also unlikely to have a credit history. Sometimes people have built credit in the past, but they lose it because they stop using it.
Ways to Build Credit
There are several ways to build credit. Unfortunately, they all take time. There are some things you can do for a quick bump up, but real, significant improvements in credit do not come quickly. The approaches below will help you build a solid credit history that will last for the rest of your life.
As you build your credit, you’ll find that some of the steps below are easier to pull off than others. That’s fine – just do what you are able to do, whenever you are able to do it. The suggestions below are listed more or less in the order that you will likely progress; items at the beginning of the list are easier to accomplish, and they allow you to build up towards items farther down the list.
Whichever method you use, it is essential that your lender reports your activity to the credit bureaus. If they don’t, you won’t build credit. Ask your lender if they report to credit bureaus before borrowing, and then verify by checking your credit reports after at least 30 days.
Get a secured credit card from your bank or credit union. These cards are easier to qualify for because you deposit money with the bank before using the card, and your limit will be the same as your deposit. As a result, any spending you do with the card is “secured” by the money you’re letting them hold onto – if you don’t pay off the card, they can take your deposit. For example, you might deposit $500, and you’d get a secured credit card with a limit of $500. Note that a secured credit card is not the same thing as a prepaid debit card.
Use a co-signer (who has good credit) to help you qualify for a loan. Lenders will consider the co-signer’s existing credit. The co-signer essentially ‘vouches’ for you while you build credit. Note that this is a big responsibility – you can cause major headaches for the co-signer if you don’t pay as agreed (see How Co-Signing Works for details).
Become an authorized user on somebody else’s credit card (a parent or spouse, for example). This practice adds the account to your credit files, and helps you build credit. But it only works if there is a legitimate relationship – you can no longer pay a stranger to “piggyback” on their good credit.
Use retailer programs for modestly large purchases like furniture. For example, you might buy a sofa on the “$40/Month Payment Plan”. Gas station cards can help as well. These programs can be easier to qualify for than traditional credit cards, and they certainly help you build credit. But these loans should only be used sparingly – relying on these loans too much may make it harder to get other loans (so keep it to one or two loans or cards at a time).
Apply for a personal loan at your bank or credit union. Using an unsecured loan helps you move beyond credit cards and loans from retailers. Instead of paying as you charge, you’ll make a regular monthly payment (which the credit scoring programs like to see).
Use different types of loans. As you build credit, use several different types of loans to create a rich mix of loans in your credit files. Don’t borrow for the sake of borrowing, but add in a student loan or auto loan where appropriate (don’t just use credit cards to pay for school or your next car). This shows that you know how to use different types of loans for different situations.
Keys to Building Credit
This process is about more than just taking on loans. It’s true that the best way to build credit is to borrow and repay on time, but there are other things to consider. First, make sure that your credit history is free of any errors (or worse – problems from identity theft). Then monitor your credit reports regularly. The US Government requires the credit bureaus to provide a free credit report to you annually, and you should take advantage of that right.
If you use any kind of credit card, be sure not to spend anywhere near the limit on the card. Even if you pay the card off in full each month, it’s possible that the card company will take a “snapshot” of your balance and report it to the credit bureaus when you have a high balance. Try to stay below 30% of your limit (for example, if your limit is $100, don’t spend more than $30 without paying off the balance).
If you’re having an especially hard time building credit, just start doing things that may eventually be used on “alternative” credit reports: get utility accounts (gas and electric) in your name, and be sure to pay your mortgage or rent on time. It might even help to open a checking account at a small bank or credit union. Using those accounts responsibly may improve your chances. There’s no guarantee that a lender will take this information into consideration, but it’s better than nothing.