Having a good credit score is Personal Finance 101. Everyone knows you need one. But how do you go about it? If you want to know how to build credit with and without a credit card, we have you covered.
If you are even a casual reader of anything personal finance related, you see the words “credit score” a lot. But do you know what a credit score is, why you need one and how to build credit if you’re starting from zero?
Too many people just assume everyone knows all of that and just gloss over the fundamentals. But we like to get down and dirty with the basics. If you need a crash course or just a refresher how to build credit, here it is.
What is a Credit Score?
A credit score is a number that lenders use to determine the likelihood that a borrower will pay back their debts. The figure comes from a borrower’s credit history, which is a record of their credit accounts.
Credit scores range from 300 to 850. The higher the score, the more trustworthy a borrower is deemed to be. Credit accounts include revolving accounts like credit cards, installment accounts like an auto or student loan, and open accounts like utilities and cell phone accounts.
Your credit score is made up of six components. We did a detailed article explaining each part.
Who’s Keeping Score?
There are three main credit bureaus; TransUnion, Equifax, and Experian. These companies compile consumer credit information and sell it to lenders like banks and credit card companies in the form of a credit report.
Each company has their formula used to calculate your credit score and some creditors don’t report to all three bureaus so your credit score and report can vary between the three.
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I Don’t Need No Stinking Credit Score
Oh yes, you do. Having a good credit score is essential. The better your score, the better interest rates you will get when borrowing money for things like a home or car. That’s important because the lower your interest rate, the less the loan will cost you over its life.
A potential landlord will likely check your credit score before renting an apartment. A good score could give a leg up on your competition for the apartment. Utility providers may check your score too. If your score is weak, you may be required to pay a deposit before service is turned on.
“The lifetime cost of higher interest rates from bad or mediocre credit can exceed six figures.”
Employers can check your credit report with your permission. Of course, you can withhold consent, but you can imagine how that would look to a potential employer.
It’s Never Too Soon
It’s clear to see that you need a good credit score so when should you start working on it? The younger, the better but late teens is a good time to start. You have to be 18 or older to get approved for a credit card or a loan, but there are ways around that.
A parent can add a child to their credit card as an authorized user. An authorized user is not responsible for any charges they make, that falls to the person in whose name the card is in. A parent doesn’t have to let a child posses or use the card, just being an authorized user is enough to help establish credit.
Being an authorized user isn’t as helpful to building credit as having a card in your name, but it can help.
Remember, when a child is an authorized user, the parent’s use of the card affects the child’s score too giving parents a little extra incentive to use their cards wisely.
If your child has a part-time job, you could co-sign a small loan for them and help make sure they pay it off.
How to Build Credit From Scratch
If your parents didn’t help you to establish a credit history and you’re over 18, don’t worry, we can help you build your credit from scratch. It takes between three and six months to establish a credit score once you have your first line of credit.
Getting Your Foot in the Door
You want to establish a line of credit to help get your foot in the credit door. A credit builder loan is a small, short-term loan designed to help you, you guessed it, build credit. They are typically for small amounts, between $500-1,000 and have a term of one year.
These loans are easy to qualify for as they are for those who don’t have any credit and those who need to rebuild damaged credit. There are three types.
A Credit Builder Loan
With this kind of loan, the bank doesn’t give you any money. Instead, they put the funds into a savings account for the duration of the loan. When you’ve paid it back, the bank releases the money to you. You pay off the loan, and then you get the money.
The benefit to you is that this shows you to be a trustworthy borrower and helps establish your credit.
A Secured Loan
The money you already have in savings is what secures this kind of loan. You can’t access this money until you’ve paid back the money.
An Unsecured Loan
An unsecured loan is a traditional loan. You get the amount you borrow up front and pay the money back.
Big banks don’t often offer these loans so you’ll have better luck at a small community bank or a credit union. You will pay interest on these loans, and some of them have high rates so be sure to know what that percentage is before agreeing.
For many of us, student loans were our first lines of credit, and they’re not a terrible way to start building credit. Part of your credit score is determined by how long you’ve had credit, and since many of us take out the loans at 18, they will likely be your oldest line of credit.
Of course, the less money you have to borrow to pay for college the better, and we’ve discussed other ways to pay for school. And because the loans typically don’t come due until you graduate, no payments are being posted to your account in the meantime so while they can help your score in the future; they don’t make any difference in the short term.
No Credit Card? No Problem
When we think of a credit score, a credit card is what first comes to mind and for a good reason. Credit cards are an excellent way to help build your credit score. But credit cards are not as easy to get as they once were.
Credit card companies used to stalk college campuses like lions stalking the savannah offering all kinds of swag for signing up with them. Before 2009, there were few regulations on issuing credit cards to anyone who was at least 18 years old.
That has all changed. Congress passed the Credit CARD Act of 2009 that make it tougher for anyone under 21 to get a credit card. To do so, the borrower must have a co-signer or show they have the financial ability to pay at least the minimum amount due each month.
What that means exactly is up to the credit card companies to determine, but you have to provide proof of income or assets. So while it’s not as easy to get a credit card as it used to be, you can still do it.
As we discussed above, a parent can make you an authorized user on their card. Perhaps they already did but didn’t give you a card of your own. They may change their mind when you go off to college. It’s a good idea for students who are far from home to have a credit card in case of an emergency like a car repair or medical expense.
Because the card is in the parent’s name, they can see charges being made and cut the user off it it’s not being used responsibly, so they still have some control over the card.
Secured Credit Card
A secured credit card is like a pre-paid debit card. You deposit money with the issuer, and typically that amount becomes your credit limit. You pay off any balance accrued on or just before the due date just like you would a regular credit card.
The issuer reports your payment history to at least one of the three reporting bureaus, and this establishes your credit history.
Each card has different terms. Some let you make a deposit smaller than your credit limit, some charge a fee, some will increase your limit without requiring an increase in your deposit after a few months of on-time payments, and some will upgrade you to an unsecured card after making a certain number of on-time payments. Some cards even give cash back rewards! Discover offers secured credit cards with favorable terms.
Student Credit Card
Students can get an unsecured student credit card with no co-signor if they have proof of independent income or assets that are enough to cover at least the minimum payment due each month.
Because student cards don’t come with very high credit limits, usually around $1,500 the issuer considers just $10 a month sufficient income. Discover answers the call again; they offer student credit cards.
In some stores, the sales clerk will ask if you’d like to “save X% today.” If you say you would, they will offer you a store credit card. Store cards have a lower bar for approval than a traditional credit card because the credit limit is usually relatively small and the interest rate is typically high.
Some store cards are co-branded with Visa, MasterCard, and American Express and you can use them anywhere you would use a traditional credit card, and some store cards can only be used in-store although at any location.
Store cards, even those that can only use in store, do report to the three credit bureaus so they can help you and show you how to build credit.
If you want a credit card but don’t meet the requirements, some cards allow a co-signer, usually a parent. The card is in your name, and you are responsible for making the payments, but if you fail to do so, your co-signer is on the hook.
Typically the co-signer can’t make charges on the card. Not all credit cards allow co-signors, and if they do, it’s not always easy to end the agreement. You must close the account, and each person then applies for credit in their name using their credit history if they wish.
If there is a balance on the card, the issuer may not allow the agreement to be canceled until the balance paid in full.
Credit Cards are Not Evil
Some people just have an aversion to using credit cards. We don’t think that is necessary. Credit cards are not inherently dangerous. They’re a tool and like any tool, can be used well or used poorly.
If you have had problems using credit wisely in the past though, we understand. There are still ways to build credit even without credit cards.
Credit Builder Loans
We discussed these above. They are meant to help you establish enough credit to get a credit card, but they help build your credit whether you later choose to get a credit card or not.
Rent is the most significant monthly expense for most of us, and even if we are sometimes late on other payments, we make an effort to pay our rent on time. So it seems a shame that your rent doesn’t help build your credit score. But there may be a way it can.
Some landlords and management companies are taking rent payment online. Some of these companies including eRentPayment, RentTrack, and Rentller send payment information to the three credit reporting companies.
If your landlord still requires a check, you can still have your rent payments reported on your credit report. Rent Reporters charges a fee of $94.95. They will contact your landlord and verify rent payments going forward and even going back for two years.
If you’ve rented at multiple addresses over the past 24 months, for an additional $50, Rent Reporters can do the same for those prior addresses.
You can take out a small loan from a peer-to-peer lender like Lending Club. The requirements for approval are less stringent than traditional banks. Lending Club offers loans as small as $1,000 and are unsecured.
The loan can be paid back over two to three years and Lending Club reports your payments to the credit bureaus.
Buy a Car
When you finance a car, those payments will be reported to the credit bureaus. Of course, you wouldn’t buy a car you didn’t need just to build credit. And we know any of our readers would never buy more car than they could afford.
But if you need a car, making those monthly payments is an excellent way to build credit.
Utility companies typically only report delinquent payments, but there is a growing interest in having these companies report monthly payments. And why not? Why is paying your cell phone or electric bill every month any different to paying your credit card or student loan payment each month?
It isn’t, and while most don’t, it can’t hurt to call your providers and ask if they report the information.
Now that you have the ball rolling on building a credit score, you want to keep track of it. Your credit score comes from information on your credit report. You can get a free copy of your report once a year from each of the bureaus at annualcreditreport.com.
It’s a good idea to do so once a year because there can be mistakes that negatively impact your score. If you find an error, all three bureaus allow you to dispute it online.
Some credit cards including Discover and Capital One now offer a free credit score on your statement every month.
Don’t obsess over your score. If you are doing everything right, it will increase, but it doesn’t happen overnight. Checking your score once a month is plenty.
You’ve worked hard to establish your credit, and you don’t want to undo your work with bad behaviors. The most important thing you can do is always to make your payments on time!
On time payments makeup 35% of your credit score, and there is no in between. If you’ve made all of your payments on time, you have a 100%. If you’ve missed even a few, that drops you down to 97%. That’s not bad right, 97%? A 97 on a test is great!
Bzzt! No, 97% puts you in the red category, and that’s bad. It takes one to two years for those late payments to stop affecting your score. Make every payment on time. Don’t bother doing things like making multiple payments a month on one account. It’s a myth that doing so increases your score. Just make your payments a day or two before the due date each month.
It takes time to build your credit score up, but there are some things you can do to make it happen faster.
No One Likes an Over Achiever
Fine-tuning your credit score should not turn into a hobby. Some people obsess over it and try all sorts of weird hacks to boost their score higher and faster. But it’s not necessary.
Overachievers don't think reasonably, sensibly, or rationally.Tweet This
Yes, having a good credit score is essential, very important. It makes life substantially less expensive. But it’s only imperative when you are planning to do something like buy a home or a car.
The highest credit score you can achieve is the vaunted 850. All you need for the best interest rates on loans is 740. By all means, work to get to that 740. Work harder to get there when you start thinking about buying a home or a car. But the rest of the time, pay your bills on time, keep your utilization below 30%, and your credit score will take care of itself.