How to Build Your Credit Score
The problem, in this case, is as old as money itself – how can you arrange to get credit when you have no credit to speak of?
If you're young and/or just starting out in your financial life, the good news is that there is a way to do just that – if you have a little knowledge and the right plan.
Let's start by examining the issue – specially, what is credit? The word 'credit' comes from Latin, meaning "trust." Credit is a way we can buy
or sell goods and services without exchanging actual cash currency. For example, today's ubiquitous credit cards are only an automated means of offering credit to a consumer – "trusting" that they will eventually pay it all back (and of course, charging a hefty rate of interest in exchange for that trust).
If you need to earn some credit to get some credit, it's not the puzzle you might think. In fact, it's highly doable, if you take the right course of action.
Here are some tips and the pros and cons of each.
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Start with secured credit cards. Secured credit cards are a good way to earn credit when you're just starting out, favored by consumers, banks and credit card companies. The formula is simple. The bank approves your card application with one or two caveats – you fork out the cash upfront in the form of a deposit, and you must agree to a credit card with a credit limit equal to the amount deposited. For example, if you deposit $1,500 then the bank will issue you a secured credit card with a credit limit of $1,500. The bank is covered by the money deposited on the account. And you get a credit card, which you can use to establish and build that much-needed credit.
- Pros– You start building a credit history and can eventually earn a high enough credit score that lenders will be willing to extend more traditional credit cards without the "caveats" that come with unsecured cards.
- Cons– You need to come up with the cash upfront. Secured credit card limits are typically very low ($200-$500 depending on your security deposit) so you can't charge too much at once or you'll max out your card and hurt your scores in the process. The goal is to charge very small amounts and pay off the balance each month. You want the proportion of your balance to your limit to be as low as possible – 10 percent or less is ideal here. This means if you have a $500 limit, you'd need to keep that balance at $50 or less. See? It's very easy to overuse on a secured card because the balance is so low. Just remember, it's a stepping-stone to a more traditional account.
Note: When choosing a secured credit card, choose one that reports to all three of the major credit reporting agencies. You want the account to be reported in all three of your credit reports.
Entertain retail/gasoline store cards. Store and gas station credit cards are another option for those new to credit. Such cards are easier to get than traditional credit cards and, used judiciously, they can set you on the fast path to establishing a good credit score.
- Pros– You are building your good credit history – as long as you pay your bills on time and keep your balances relatively low.
- Cons– Usage of store or gasoline credit cards are limited to those places. Also, the interest rates can be higher than traditional credit cards. Your goal should be to only charge what you can comfortably afford to pay off each month. Not only will this eliminate those higher interest charges, it'll also keep you from falling into debt.
Become an authorized user of someone else's credit card. If you can get someone who has already established a good credit history, like a parent or older sibling, to add you as an authorized user you can essentially piggyback on their good credit. An "authorized user" is someone who has a credit card issued to them with their name on it but has no financial liability. Another person known as the "primary account holder" generally pays for the account.
- Pros– An "authorized user" status gives you a pathway to good credit, without the responsibilities of having to qualify for a credit card.
- Cons– Your use of the card may be limited, and even though you're not responsible for the bill, the primary cardholder is liable for your actions on the account.
Take advantage of student card programs. Many credit card providers offer "student" credit cards for college-aged consumers with no credit history. By and large, such cards are funneled through a program with a college or university. Credit card companies really like student card programs – it gives them "first crack" at young consumers who presumably will use the same credit card company once they're out in the working world.
- Pros– Student credit cards aren't tough to get and you can use them to get started at establishing a solid credit history.
- Cons– Some come with high interest rates and usually come with low balance limits.
The takeaway? Getting credit without having any credit is no mean trick. But if you start slowly and build credit with the tools that actually are available to you, and use the "staircase" approach to reaching your credit goals, you'll be well on your way to building solid credit reports and credit scores.