How to Build Credit So You Never Have to Worry About Getting Approved for a House, Car or Credit Card

This content is not provided or commissioned by the issuer. Opinions expressed here are author's alone, not those of the issuer, and have not been reviewed, approved or otherwise endorsed by the issuer. This site may be compensated through the issuer's Affiliate Program.

david.rodeck@gmail.com'/
howtobuildcredit1

By: Nathan Birt, David Rodeck and Gideon Sanford

Most of us come face-to-face with our credit at some point in our lives. Living purely on cash is possible but can be challenging. The biggest ticket item most Americans buy on credit is a home but even something as simple as opening a utility or cell phone account might require a credit check.

How’s your credit? Have you checked it recently? If you are searching for a way to start building your credit, or simply want to know more about it, you’ve come to the right place.

Here’s what you can expect in this guide to building your credit:

1. Understand the “Credit Formula”
2. Help! It’s My First Time Building Credit
3. Using Credit Cards to Build Credit
4. All About Credit Builder Loans

How to build credit fast

If you don’t have a good credit score – or any credit at all – prepare for harsh consequences if you haven’t encountered them already. Maybe that cell phone provider asked you for a cash deposit of several hundred dollars before they agreed to open a regular account for you. Maybe a landlord refused to rent you an apartment.

Credit spills into other areas of life, too. Some employers want to see that you’ve got a solid credit history before they’ll offer you a job.

Anyone, at any income level, can achieve great credit. All you need is knowledge. We’ve put together a roadmap detailing what you need to know to build credit quickly.

What is the process for building credit?

When you borrow money, the lender reports how you manage your payments to one or more of the three major U.S. consumer credit reporting agencies: Experian, Equifax, and TransUnion (“the credit bureau”). These companies keep track of all your information on your credit report. Future lenders are then able to look at your report to decide whether to lend to you.

It seems counterintuitive, but if you avoid credit products, you will not be viewed as a lower credit risk. In fact, the opposite is true. You have to have and use credit in order to build a credit history and score.

Building credit essentially boils down to borrowing money and then paying it back on schedule. This shows that you are a reliable borrower. If you pay late or stop paying, this negative information will also show up your credit report.

What your credit score is made of

The credit bureaus use the information in your credit history to calculate 3-digit credit score that represents your creditworthiness. The FICO score is the most common credit score. The credit score ranges from 300 to 850.

FICO scores are based on these factors, in the noted proportions:

  • Payment history (35%)
  • Debt utilization (the amount of debt you carry compared to your available credit) (30%)
  • File age (the average age of all of your accounts) (15%)
  • Inquiries (the number of recent new applications for credit) (10%)
  • Credit mix (such as student loan, personal loan, credit card, auto loan, mortgage) (10%)

Chart6

Although all three bureaus maintain a file on you, the information in those files can vary. Not all creditors report to all three bureaus. So the FICO scores generated by the three bureaus might not match. They should be close, though.

Is there a best way to build credit?

The credit bureaus use a few specific factors to calculate your credit score. Similar to the FICO formula, you need to understand why each factor is important, and what you need to do in order to help improve your credit score.

  • Keep balances low. For the best credit score, keep your balance under 30% of your card’s total limit. If your credit card has a $500 limit, don’t carry a balance of more than $150. If you use your card more than that, there’s a simple trick for having a lower balance reported. Just pay it down before the balance is reported to the credit bureaus (usually on the statement closing date, but check with your card issuer to be sure).
  • The most important factor is your payment history. Do you make your monthly payments on time? If you do, your score will slowly and steadily go up. At the same time, if you miss payments, your score will suffer.
  • Variety of different credit products in your file. Someone with a car loan, a mortgage and a credit card is easier to score that someone who only has a credit card.
  • The age of your credit history. You’ll reach a higher score with a long history of responsible credit use. Avoid closing old accounts because their age helps you, especially if you’ve also opened new accounts within the last few years.

VantageScore is another credit scoring model. VantageScore is very similar to FICO and uses the same criteria in similar proportions. VantageScore claims to more accurately score consumers who have a short or limited credit history.

Wondering how you stack up against other Americans when it comes to credit? Most people find the highest scores hard to reach. Only 19% of Credit Sesame members were in the highest credit score range (720 or higher), while 25% have good scores (640-719). About a third fall in the fair score range, between 550 and 639, and about a quarter of our members had credit scores below 549.  This is a chart that shows credit scores, taken from a subset of Credit Sesame’s 7 million members collected June 2016.

Chart7

How to start building credit for the first time

If you’re starting out building credit, you might need to get a little creative.

A secured credit card, described above, is a good choice because you can usually qualify regardless of your credit history. Once you use the card responsibly for six to twelve months, you can apply for a traditional card, which usually comes with better terms, and continue to build credit.

If you have a friend or family member with a credit card, that person can make you an authorized user on their account. You receive a card with your name on it that you can use to make purchases on their account. The payment history and utilization for the account are transferred to your credit file. If payments are late or the card is maxed out, your credit score will suffer along with the primary account holder’s.

Another strategy is to ask someone with good credit to co-sign for you. This means they take full responsibility for the debt in the event you fail to pay it back. Having a co-signer can help you qualify for a credit product that would otherwise be out of reach. Make all of the payments on time or you could do serious damage to your co-signer’s credit.

karicredit

Credit Sesame staffer Kari, moved to the U.S. from Canada.

If you moved to the United States from another country, your past credit history might help you here. International credit data does not transfer over, but some multinational companies communicate between branches.

For example, one of Credit Sesame’s staff moved to the U.S. from Canada. She set up an American bank account with TD Bank, which also handled her banking in Canada. TD Bank was willing to approve her credit card application even though she did not have any American credit history, because they already had a good financial relationship with her.

Note that accounts are not removed from your credit report when they are closed. They can continue to help or hurt your credit for quite some time. Closed accounts in good standing remain in your file for another ten years. Closed derogatory accounts remain for seven years.

Each time you apply for credit, the creditor checks your file. That’s called a hard inquiry. Applying for new loans and credit cards hurts your score in the short-term. Only apply for new credit when you really need it.

When you check your own credit, that’s a soft inquiry and it doesn’t hurt your score at all. Other soft inquiries that don’t hurt you include prescreened credit card offers that you receive in the mail, and the free credit score generated by Credit Sesame.

How to read your credit report

Credit Report_640

You can order a copy of your credit report, the exact same document that lenders check. Every 12 months, you can request a free copy from each of the three major credit reporting agencies from AnnualCreditReport.com. If you want to check your report more frequently, you can sign up for a paid service or you can use Credit Sesame, which updates your free credit report and free credit score monthly.

Your credit report starts with your personal information like your name, Social Security number, addresses, and work history.

Your report also shows a summary of all your loans and credit cards. Here’s what you can expect to see when you receive your credit report.

Type of AccountWhat You'll SeeIs the Account in Good Standing?Negative Items (Sent to Collections)
Public Records
Loans- Amount borrowed
- Monthly payments
- Date account was opened
Any late payments will be noted- What is the problem
- Was it solved?
- When negative info will be removed
Highlights any legal problems like bankruptcies or foreclosures
Credit Cards- Date the account was opened
- Credit limit
- Average monthly balance
- Monthly payments
Any late payments will be noted- What is the problem
- Was it solved?
- When negative info will be removed
Highlights any legal problems like bankruptcies or foreclosures

Your credit report also has a section for public records, which shows whether you ran into any legal problems like bankruptcies or foreclosures.

Finally, you’ll see inquiries. Soft inquiries, including self-checks, are visible to you but not to creditors. If you’ve applied for new credit and the issuer requested a copy of your credit report, this is a hard inquiry. Hard inquiries remain on your report for two years.

Your free credit report does not include a credit score. To get your score from the credit bureaus, you’ll pay a fee. You can get it for free, updated monthly, on Credit Sesame. Credit Sesame provides VantageScores generated by TransUnion.

Popular ways to build credit

  • Credit cards
  • Secured credit cards
  • Personal loans
  • Student loans
  • Utility bills
  • Rent

Using credit cards to build credit

One of the most important elements of your credit report is your use of revolving credit, which for most credit users takes the form of credit cards.

Credit cards can affect your credit score in three simple ways. First, each credit card account reports your outstanding balance and payment history to the three major credit bureaus, and each month that you pay at least the minimum amount due counts as a positive mark in your credit record. A history of consistent on-time payments is one of the foundations of a good credit score.

Learn More: What Affects Your Credit Score

Second, creditors like to see that you have credit but don’t use it much. If you keep your credit card balances low compared with their credit limits, you’ll help your score.

Third, besides establishing a record of on-time payments, credit cards are also factored into the average age of all your credit accounts. So even a credit card with which you don’t make any purchases at all will, over the long term, gradually increase the average age of your accounts and exert upward pressure on your credit score.

Best Credit Cards to Build Credit

If you’re starting new to credit with a thin or nonexistent credit file, the first challenge is getting approved for a credit card at all. And indeed, young people without a history of income and of servicing debt may struggle to qualify for the best rewards-earning credit cards out there. But plenty of credit card options exist that will help you establish a history of on-time payments and increase the average age of your credit accounts. Here are the best credit cards recommended by Credit Sesame.

Secured Credit Cards

For many consumers, the fastest way to build credit from scratch is to apply for a secured credit card. If you want to open a secured credit card, you need to put down a deposit — which means you’re essentially using your own money to front your credit line. If you’d like a secured credit card with a $1,000 credit limit, you need to give the bank $1,000. However, the upside is that it can help you build your credit because just like a regular credit card, when you manage your credit responsibly, the payments are reported to the credit bureaus.

After you’ve developed a history of using your secured credit card responsibly you can either ask to be moved to an unsecured credit card or apply for a new unsecured credit card and close the secured card. In either case, you’ll receive your deposit back.

Discover it® Secured Card – No Annual Fee

Although there is no single best credit card to build credit, several good options are available. In our opinion one of the best credit-building cards currently available is the Discover it® Secured Card – No Annual Fee card which allows you to establish a credit line by depositing $200 and up to $2,500 with Discover. After you’re approved your minimum security deposit amount of $200 or more will establish your credit line up to the amount Discover can approve.

The amount you deposit will be the amount of your credit line. Beginning at 12 months of card membership, Discover will evaluate your account on a monthly basis to see if you qualify to get your security deposit back and these reviews are based on responsible credit management across all of your credit cards and loans.

The Discover it® Secured Card – No Annual Fee has two additional advantages over other secured credit cards. First, like all Discover cards, it has no foreign transaction fees, so you won’t pay a 3-5% premium when you use your credit card for purchases outside of the United States (including Mexico and Canada).

Second, it offers a cash back rewards program on purchases made with the card (rare for secured cards), so you’ll earn 2% cash back at restaurants and gas stations on up to $1,000 in combined purchases each quarter and earn 1% cash back on all other purchases.

Remember that to take full advantage of any rewards program it’s important to pay off your entire balance on-time every billing cycle. Credit card debt incurs interest charges, and the rate you pay will always be more than the rate you earn in rewards.

Capital One® Secured MasterCard®

Another good secured credit card option is the Capital One® Secured MasterCard®, which has no annual fee, but a required security deposit of $49, $99 or $200 refundable deposit based on your creditworthiness. Make the minimum required security deposit and you’ll get an initial credit line of $200. Plus, deposit more money before your account opens to get a higher credit line, up to $3,000. The Capital One® Secured MasterCard® also has no foreign transaction fees, but doesn’t offer any cash back rewards program.

For that reason, the cash back rewards program, I believe the Discover it® Secured Card – No Annual Fee card is a slightly better value, despite the somewhat more limited acceptance of Discover cards compared to MasterCard.

Besides Discover and Capital One, most large banks offer secured credit cards for building credit, like the Wells Fargo Secured Visa Card, BankAmericard® Secured credit card, and the Citi® Secured MasterCard®. Those cards all have annual fees ranging between $25 and $39. They also charge foreign transaction fees so should not be used internationally if it can be at all avoided.

Finally, many credit unions offer secured credit cards to build credit, some of which have very friendly terms.

Student Credit Cards

student-cards-img

Many banks offer student credit cards. These are designed for young people or others who have yet to build a credit history. Student credit cards are credit cards for building credit, but before you apply, know that the rules for student cards are slightly different from the rules for traditional credit cards.

Student cards require proof that the cardholder can repay the debt (evidence of employment, for example) or a co-signer (usually a parent), who becomes equally liable with the student for any charges made with the card. In that case, the card will appear on both the student’s and the co-signer’s credit report, so if it’s not handled responsibly, both credit scores will suffer.

If it’s consistently paid off on time, however, a student credit card can give the student’s credit a leg up when he or she enters the workforce and starts borrowing for larger purchases.

Store cards

store-cards-img

Store cards are like credit cards in the sense that you borrow money in order to make a purchase, and then have the option to pay off your balance later. If you choose not to pay your balance in full, you’ll also be charged interest on the amount of your purchase.

The difference between a store card and a traditional credit card is that the store card can only be used at the issuing store (or, in some cases, a family of stores).

Store cards are reported to the credit bureaus, and a history of on-time payments will tend to increase your credit score over time.

Some store cards are popular because they allow you to accumulate a store’s loyalty or reward points faster than you would if you paid with cash. For example, the Banana Republic card earns 5 Rewards points for every dollar spent at Banana Republic brands, so if you do a lot of shopping at GAP, Athleta, Banana Republic, or Old Navy you can get a $5 reward for every $100 you spend.

Other store cards are popular because of periodic promotional deferred interest rates on large purchases. For example, the Sears store card frequently offers a 12-month zero percent deferred interest rate promotion on purchases over a certain amount. But beware: deferred interest rate offers can be dangerous, since if the purchase isn’t paid off in full and on time, the entire amount of accrued interest is added to your balance at the end of the offer period.

What should my first credit card be?

For those who are new to credit (a thin credit file – limited or nonexistent credit history), roughly 1.3% of active Credit Sesame members, secured credit cards like the Discover it® Secured Card – No Annual Fee or Capital One® Secured MasterCard® are choices that you may want to consider. A history of responsible use by you will build up your credit score until you can graduate to an unsecured card.

If you don’t want to deposit cash to secure a credit line, you might consider applying for a store card from a store where you regularly shop. Since store cards can only be used at the issuing store, eligibility requirements can be less stringent.

Store cards are a great way to build your credit, as long as you pay off your balances in full and use the card responsibly.Click To Tweet

As the old saying goes, banks are in the business of lending money to people who can prove they don’t need it. The best way to build credit and prove you don’t need it are to apply for credit, use it responsibly over time, and gradually apply for more.

Student loans

Like other forms of debt, student loans appear on a student’s credit report and, if consistently paid on time, will gradually increase the student’s credit score over time. Student loans issued by the federal government don’t require a co-signer, so present no risk to a parent’s credit when a student decides to borrow to pay for their education.

How a credit builder loan works and why it can help build credit

 

credit-builder-loan

If you’re wondering how to build credit without a credit card, one option is a credit builder loan. In some ways, a credit builder loan serves as a resume of your financial merits. The acts of applying for, obtaining and successfully paying down a small loan demonstrates your ability to make timely payments, meet a financial objective and manage debt without falling behind.

Broadly speaking, a lending product that does not require credit to be issued can be considered a credit builder loan, explains Carlos Colón, an Accredited Financial Counselor®, bilingual personal finance coach and financial education program manager with mpowered in Lakewood, Colo. Some credit cards fall into this category.

A credit builder loan is one such product. In its most traditional form, the loaned funds are deposited into a restricted savings account that the borrower cannot access until after making the final payment. In another type of credit builder loan, the collateral is money that is already in the bank. The funds are frozen and then released gradually as the borrower makes payments against the loan.

Consumers of all credit scores may seek to build credit for various reasons, but some in particular might see measurable benefits. According to Credit Sesame data, approximately 55 percent of active Credit Sesame members identify their credit score as fair (550 to 639) or lower, which means there is plenty of room for credit improvement.

In addition, about 1.3% of our active members are new to credit (a thin credit file – limited or nonexistent credit history). Depending on their circumstances, some of those borrowers could benefit from a credit builder loan because a positive payment history could add to the depth of their credit portfolio.

Credit cards are the top form of credit sought by consumers, followed by car loans and student loans, according to a May 2015 report by the Federal Reserve. The report surveys the economic well-being of U.S. households based on a survey of nearly 5,900 respondents.

Credit builder loans help consumers improve their credit score in two ways.

“One, the product does not require any credit, thereby allowing people who would otherwise be effectively barred from participating of the credit system to start building a file,” Colón says. “Two, the lender reports the payment activity to the credit bureaus thereby building credit by starting a credit file, or by adding a new and presumably positive active line of credit to an already existing file.”

In most cases, a credit builder loan has a balance below $1,000 and the payments period is from six to 24 months, depending on the borrower and the circumstances of his or her credit, he says.

Shopping For Credit-Building Loans

Consumers need to do a little advance legwork before deciding to apply for credit building loans.

“First, meet with a credit counselor or financial coach to review your credit and determine if it might be the best course of action,” Colón says. “This is useful because some people may not require a credit builder loan and could apply instead for a traditional credit card, or other product, with a low balance.”

In cases where that course of action isn’t possible, credit building loans are an option to consider. That kind of situation “usually involves other actions for rebuilding credit,” he says. “In other words, it becomes one part within a larger strategy.”

What You Need to Be Aware of When Using Small Loans to Build Credit

There are several pitfalls to avoid when exploring small loans to build credit, in addition to the risk that you might fall behind on payments. Among them is signing onto a loan without a holistic approach to rebuilding credit.

“These loans are not a one-size-fits-all type of product,” Colón cautions. “Another common mistake is to assume that the creditor is reporting to all three credit bureaus. It’s important to know ahead of time if the creditor will report to one, two or all three, and generally speaking we would choose a product that reports to at least two credit bureaus.”

Additionally, be aware some products and services come with strings such as fees. The collateral funds will earn just a small fraction of a percent in interest, while the interest you pay on the loan will be higher at least ten times that amount and possibly more.

So even though the money is in the bank, the loan will cost more than it earns. In some cases, paying the loan off early could result in a penalty. Colón recommends asking the lender whether hit provides an exit strategy as credit improves.

Where to Apply for Loans to Build Credit

Many credit building loans are offered by financial institutions such as credit unions, brick-and-mortar banks and online banks.

The best loans to build credit may be found right in your neighborhood. “I like to recommend credit unions because they are a nonprofit institution, tend to be local and thereby tend to offer better service,” Colón says. “Nonetheless, the borrower should shop around and choose the products that best serve their goals as well as their bottom line.”

It’s always smart to seek out the best interest rate on loans to build credit, but be cautious about how you do this. That’s because in some cases, you can’t find out the rate you qualify for until the lender checks your credit. That’s a hard credit inquiry and it will result in the loss of a few points from your credit score. Unlike mortgages, student loans and auto loans, there is no rate-shopping window for personal loans.

A soft approach is best for the initial research. Place phone calls or check online to inquire about lenders’ rates. Know your credit score in advance so you can share it with a prospective lender, who should be able to easily report back on typical rates for someone in your score category. If you are uncomfortable with making contact in this way, you can try out peer-to-peer online lenders like Prosper or Lending Club. In response to your request for a rate quote, these lenders make a soft inquiry that won’t affect your score.

Remember that loans to build credit are meant to demonstrate responsible interaction with debt over time, not your ability to speed through the process quickly. Pay your monthly balance in full and on time. Don’t accelerate the payoff. This is how you’ll develop a solid history of responsible credit use.

As you search for a lender and the right financial product, work with a free or low-cost credit counselor or financial coach to nail down and follow through with the proper credit-building strategy.

Secured Credit Builder Loan Versus Unsecured Loan

Credit building loans are available both as a secured loan to build credit and as an unsecured loan. The term “secured” refers to the fact that if you don’t make your payments, you forfeit your collateral. The lender can repossess or place a lien on your assets if you fail to repay the loan.

An unsecured loan means the financial institution doesn’t have the right to act on your assets in that way, though your interest rate generally will be higher as a result.

In general, the small scale of a secured loan to build credit should mean that if you fall behind, you can work with your lender to find a solution that doesn’t require a transfer of assets.

How to Buy Your First Home with Help From a Credit Builder Loan

first-home-credit-builder-loan

It’s possible to buy your first home with support from a credit builder loan, but there’s no direct correlation between the two. You must have a broad financial strategy and work with knowledgeable financial professionals to achieve your dream of home ownership when the time is right, Colón says. A financial coach or counselor can assist you in building credit, while a housing counselor can help you understand the ins and outs of a real estate purchase.

“Credit builder loans can help to the extent that they help improve our credit and credit scores, and typically, the better our score, the better the terms on a mortgage,” he explains. “However, it is important to realize that credit scores are just one factor that lenders and mortgage underwriters use to assess risk. In other words, I can have very good scores and still get denied on a mortgage.”

Credit builder loans are a piece of the puzzle, ‘not a silver bullet’

Although useful in some cases, credit builder loans are not a silver bullet. Colón encourages borrowers to work on their overall financial goals with help of financial professionals accredited by the Association for Financial Counseling and Planning Education (AFCPE). Impartial experts who are not associated with any particular financial product can help you set and achieve the smartest objectives for your family.


Disclosure: Credit Sesame is an independent comparison service provider. Reasonable efforts have been made to maintain accurate information throughout our website, mobile apps, and communication methods; however, all information is presented without warranty or guarantee. The editorial content on this page is not provided by any credit card issuer. Any opinions, analysis, reviews, or recommendations expressed here are author’s alone, not those of any credit card issuer, and have not been reviewed, approved or otherwise endorsed by any credit card issuer. The credit card offers that appear on this site are from credit card companies from which we may receive compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). This site does not include all credit card companies or all available credit card offers. All images and trademarks are the property of their respective owners.

Responses are not provided or commissioned by the bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by the bank advertiser. It is not the bank advertiser’s responsibility to ensure all posts and/or questions are answered.

Save

You can trust that we maintain strict editorial integrity in our writing and assessments; however, we receive compensation when you click on links to products from our partners and get approved.
Published June 29, 2016 Updated: September 21, 2016
Related Links

Leave a Reply