How to Build Credit Without Going Into Debt

Unless you were born in some remote location and lived off the grid your entire life, it’s not news to you that good credit is needed to function in today’s society. Your credit history is what indicates your trustworthiness to lenders, stores, and even employers and landlords. Bad credit or no credit is a major barrier preventing some from attaining good interest rates or securing a new lease agreement, among other things. There’s really no point in me stressing the utter importance of having a good credit score. That’s a given. But for those of you who fear having outstanding loans, balances on credit cards, or debt of any kind, how does one achieve good credit?

Reasons to Avoid Debt

You may be new to the credit system. Thus far you’ve paid cash for everything you’ve purchased (not a bad idea in and of itself, by the way). In this instance, you may be nervous about getting tied to a payment. Your entry-level income is limited and you’d rather pay your unavoidable living expenses with money already in your banking account and save whatever is left over.

Or maybe you’re on the other end of the spectrum, having lived some and learned plenty the hard way. Maybe you’re coming back from a bankruptcy and see opening a loan or credit card as a slippery slope. It can quickly lead you back down the over-limit, fee-riddled, owing-more-than-you-can-afford pit you just paid legal fees to dig yourself out of … but I digress. The point is that an uncomplicated and unencumbered financial position helps to alleviate stress and keeps peace in the financial sector of our lives.

Whatever your particular position and perspective, debt, if not managed well, can be a huge burden. Here’s how to build or re-build your credit without going into debt.

1. Secured Credit Cards

Credit cards can have high interest rates and even higher penalty rates on missed or late payments, but managed well, they are one of the easiest ways to build a good credit standing. While you may be new to credit cards and wary of running up a big balance that you may not be able to ultimately afford, a number of banks allow you to open a secured credit card without having a stellar credit score. Secured credit cards require the borrower to provide cash up front that serves as their credit line. Then, as a credit card, the borrower builds payment history by making consistent on-time monthly payments. After a period of consistent payments, you may be able to upgrade to a traditional line of credit. Just be sure to check that your secured credit card issuer reports to the three major credit reporting agencies, as some may not. (And, in those cases, you won’t be building credit.)

2. Housing & Utility Payments

Most traditional credit scores don’t consider non-loan-related payments — like rent or utilities — when calculating your creditworthiness. However, the Equal Opportunity Credit Act requires creditors consider additional information about an applicant’s creditworthiness at that person’s request. There are several agencies that will generate alternative credit reports, citing payments for things like utilities, rent and mobile phone service, that you can furnish to a prospective lender. The benefits can lead to you qualifying for a new loan/credit card by showing you as a timely payer of obligations. Keep in mind, some of these agencies may charge a fee for their services.

3. Credit-Builder Loans

Installment loans require a fixed monthly payment over a set period of time. (Think of a mortgage or auto loan.) They can add diversification to your credit profile, but can also add a large monthly payment that you have to budget for. Fixed monthly payments can be the biggest income eaters. It is understandable to want to avoid a fixed payment, but having a mix of credit in your profile can help to boost your score faster.

Credit-builder loans are an option to add that diversification if you don’t have established credit. These loans work in the same way as a secured credit card, in that you provide the cash collateral and perform by making monthly payments before gaining the benefit of the loan. Some credit unions offer credit-builder loans to help credit union members (shareholders) rebuild/establish their credit with limited liability to the credit union. Monthly payments and reporting to the credit bureaus help to build a good payment history.

Whether you want to establish credit or improve a low credit score, it takes a personal finance management system that works for you individually. For many of us that requires courage to make major changes in our lives and to persevere. Hit the ground running by practicing good credit behavior from the start. Practice makes perfect. You can start by knowing whether you have a credit score, and if you do, what that credit score is. You can get two free credit scores, updated every 14 days, on Credit.com. And you can request your free annual credit reports at AnnualCreditReport.com.