How to Get Credit if You're
20-Something

It’s the eternal question…how do I get credit if I don’t have credit? We’ve all been there - applying for that first credit card, that first auto loan and eventually that first home loan. We’ve all learned that getting the credit isn’t as difficult as expected. What is difficult is ensuring that you are not getting saddled with interest rates and loan terms that are less attractive than what our older, more credit experienced brethren receive.

In order to fully leverage the credit environment right out of the gate it’s important to understand why lenders treat newer credit users differently. There are four primary reasons why this is the case. They are:

You’ve been pegged as high risk

Consumers who do not have credit are, as a whole, higher credit risks than consumers who do have credit. This not only makes common sense but is also empirically sound. Because of this, creditors will tend to only offer new credit candidates products and services that are designed for higher risk customers. These products will carry with them higher interest rates, lower credit limits, higher deposits and overall poorer treatment from lenders. It’s not that they don’t want your business. They just want your business under terms that are heavily in their favor. It’s their way of hedging against the increased credit losses they know they are going to take from the consumers who are new to the system.

Your first credit product is probably unsecured

It’s highly likely that your first credit “vehicle” will be a credit card or a retail store card. Both of these are what are referred to as “unsecured.” Unsecured means that the creditor has no collateral insuring their investment in the consumer. An example of secured credit would be a loan for a car or a house. If you stopped paying those loans the bank would simply repossess your car or foreclose on your home. Unsecured credit is a higher risk proposition so the issuing lender is going to be more cautious when reviewing the applicant’s credit history or lack thereof.

It’s more difficult to process your application

Believe it or not, a lender’s ability to process a consumer’s credit application via their automated processing systems plays a role in whether or not you will be approved for credit. Consumers who do not have a credit history are also not going to have a credit score. And those are two components that are key in extending credit using centralized lending policies, which are managed by automated processing systems. Some creditors choose to decline credit applications versus having to process them manually without credit histories or credit scores.

You probably don’t have a sufficient credit history or credit scores

For better or worse, today’s creditors depend almost exclusively on the use of credit reports and credit scores to determine whether or not you will get credit and at what rates and terms. Credit scores, which are based on the data in your credit reports, are essentially a numeric representation of your future credit risk. Lenders use these scores to rank applications and extend credit with rates and terms that are proportional to their level of credit risk. The problem for younger consumers is that without a solid credit history their scores will not be as high or as stable as needed to get credit at competitive rates. And in some cases the lack of a credit history will even result in a “no score” being generated.

So exactly how do you go about building a solid credit foundation, one that is strong enough to earn you higher credit scores and, as such, better interest rates and terms? There are several ways that younger consumers can establish credit. Here are some tips and the pros and cons of each.

Start with secured credit cards

Secured cards, offered by almost all reputable banks and credit unions, are very popular with consumers who are building or re-building their credit histories. The consumer makes a deposit with the creditor who then issues a credit card with a credit limit equal to the amount deposited. So, for example, if Monica deposits $2,500 then the bank will issue her a secured credit card with a credit limit of $2,500. The bank is guaranteed that Monica will not miss a payment because she has essentially already pre-paid for any amount she charges.

• Pros – The consumer is building a credit history and will eventually earn a high enough credit score that lenders will be willing to extend more attractive unsecured credit cards that do not require a deposit.
• Cons – Your cash deposit is essentially off limits while you have the secured card and is not earning interest.

Entertain retail store cards

Retail cards are credit cards issued for use at specific retail stores. Some examples are Saks, Macy’s, Bloomingdales and The Gap. Retail cards are generally much easier to obtain even if your credit history and credit scores aren’t in the best shape.

• Pros – Again, you are building your credit history.
• Cons – You are limited in where you can use the card and the interest rates are generally very high. Also, credit limits on retail cards are typically very low.

Become an authorized user of someone else’s credit card

This used to be the most common way young consumers built their credit histories and scores. The credit scoring company, FICO, decided in June 2007 to no longer count authorized user records in their scores and put an end to this practice. 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 – You get use of an established credit card without the risk of being the primary account holder. This is a good way for parents to "share" their credit while still maintaining some control.
• Cons – The authorized user account will not help to establish your credit and will not be counted in your credit score.

Apply for high interest cards

This is the most risky of all strategies. High interest credit cards are very easy to qualify for and the reality is that the interest rate really only matters if you revolve a balance to the next month. If you pay off your balance each month then you will never have to pay interest so the rate really doesn’t matter.

• Pros – Again, you are building a credit history and will eventually be able to qualify for lower interest cards.
• Cons – You must be disciplined NOT to run up such a high balance that you start making only the minimum payment.

Take advantage of student card programs

Most reputable credit card issuers offer student card programs that require little or no credit history. These cards are generally offered through a program with a college or university. The credit card issuers who participate in student card programs are betting that if they can get “in your wallet” first that you will remain loyal to them as you go from student to wage earning employee.

• Pros – These cards are generally very easy to qualify for and you are building a credit history.
• Cons – These cards generally have very low credit limits and, therefore, cannot be used for any major purchases.

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