Learn how to do anything: How to Establish Credit

To people without much financial experience, credit can seem a lot like a Catch-22: to get it, you must already have it. While it's true that having a credit history is a prerequisite for many of life's major financial transactions (like, for instance, buying a house), with the right approach, you can establish healthy credit from almost nothing over a few years. By starting small and gradually increasing your credit (all while making responsible financial decisions), you can establish a good credit history that will be able to serve as a strong financial foundation for years to come.

Steps

Starting Your Credit History

If you have no credit history, start by signing up for a secured card. For someone who's looking to establish credit from an absolute blank slate (or start repairing a bad credit history), a "secured" credit card is generally the best bet. These credit cards (which should be available from most local banks and credit unions) work basically the same way as a collateral-secured loan — you give the credit issuer a certain amount of money, and in turn the credit issuer gives you a line of credit that you can spend as you please. Because these sorts of credit cards essentially come with a "security deposit," they're often some of the easiest credit cards to get — the credit issuer isn't worried that it won't get its money back because you've already given it collateral.
- However, your credit issuer may still ask for evidence of your financial history when you apply for a secured card. Even if you've never had a line of credit before, you can still make a case for yourself as a responsible candidate by presenting evidence that you've been prompt about paying off your major expenses. For example, if you've been making utility, rent, or car payments, showing the bank your receipts or cancelled checks used to make the payments can show that you've been meeting your responsibilities.^[1]
Make small, manageable purchases with your line of credit. To get a good credit history, you need to use your credit! Once you have your new credit card, start using it to make small purchases, like groceries, meals, movie tickets, and so on. Track your spending carefully and never let it get out of hand. A good rule of thumb is not to spend any more than about half of your credit line at any one time — however, most financial commentators will agree that less than 30% is even better.^[2] Having lots of outstanding debt can impact your credit score, even if you're eventually able to pay it back.
- Once you start getting the bills for your credit card, pay each one off in full as soon as you can. By doing this, you're establishing a history of prompt repayment. Future credit issuers love this — it proves that you're reliable about paying your bills back and that you don't typically spend more than you can afford.
When you're ready, make the jump to an unsecured credit card. After a while of responsibly spending and paying back your bills with a secured line of credit, you should be able to qualify for an unsecured (ordinary) credit card. Sign up for one of these cards at the same bank that issued your secured card and start using it to make small, responsible purchases just as you've been doing with your other card.
- These credit cards are slightly more risky for banks to loan because they don't require you to put down collateral, which means that there's a chance that they won't get their money back. Thus, it's in their interest to give these cards only to people who they trust to be smart with their money. Since you now have a demonstrated history of paying back your debt, it should be easier for you to get an unsecured card.
Consider getting one or two store credit cards from local businesses. Banks aren't the only entities that can issue credit. A wide variety of businesses (like, for instance, department stores, airlines, gas/petrol companies, and many more) issue their own credit cards. Often, these "store" cards come with a special one-time signing bonus (like 10% off your purchase) or the ability to earn "rewards points" towards in-store credit. If a business that you frequently use issues credit cards, consider signing up for one when you make a major purchase, as these cards count towards your credit history just like bank-issued cards.
- You'll generally want to avoid signing up for more than just a few store credit cards, however. Having many different credit card bills to pay raises the risk that you'll eventually forget one. Plus (as we'll see below), opening many lines of credit can sometimes damage your credit reputation.^[3]
Pay down all debts as quickly as possible. Once you have multiple lines of credit, you'll want to continue with your habit of paying off your debts as quickly as possible. If you can, pay off your credit card bills as soon as you get them. If, for any reason, however, you can't afford to completely pay off your debt one month, pay as much as you reasonably can. This will help you avoid the long-term expenses of interest payments on credit card debt (which, compared to basic personal loans, are usually high.)^[4]
- Try to avoid the dangerous situation of amassing so much credit debt that you can only afford to make the minimum payment each month. This will cost you lots of money in interest payments in the long term (and will usually hurt your credit score.) In this case, you may be in need of credit counseling services (see below for more information.)
If you can, make a big purchase with store/dealer financing. Being able to make a major purchase like a car or a refrigerator with one lump payment up-front is very convenient, but doing this can rob yourself of a great opportunity to boost your credit score. Instead, try opting for a store financing plan (most stores that sell high-priced products will allow you the option to pay them off over time rather than pay the entire cost up-front.) Keep the money you would have used to make the lump-sum purchase separate from your normal funds so that you'll still have enough to make the entire purchase when the time comes. When you get the first monthly bill, pay off the entire cost of the product. Since this sort of financing plan is technically a loan, paying it off immediately looks great on your credit history.^[5]
- Paying off your purchase immediately also keeps you safe from interest — many sellers will have a special "interest free" repayment window at the start of the loan (often 90 days.)

Keeping Your Credit Score High

Make all payments on your credit on-time. Perhaps the single most important thing you can do to establish good credit is also the most mundane. Simply making a point to pay back all your credit card bills by their due dates is a great way to build your credit in the long term. On the other hand, missing payments or frequently opting to make only the minimum payment on your debt makes it appear as if you can't afford to maintain your current level of debt, which will make it difficult to get more credit in the future.
Don't let any of your regular bills go delinquent. It's important to remember that it's not just your credit card bills that you'll need to pay on time — ordinary expenses like rent, utilities, car payments, and so on are also important to your credit score. Usually, the sorts of agencies that you'll pay for these expenses don't regularly report your credit activity to credit agencies. However, if one of your bills becomes delinquent, they usually do report this.^[6]
- Thus, while paying your monthly expenses on time won't usually be useful for credit purposes after getting your first secured credit card, failing to meet these expenses will have negative consequences for your credit.
Know your rights as a consumer. When it comes to your credit, knowledge is power. Consumers have a wide range of legal rights and protections when it comes to navigating the world of credit. As just one example, consumers are legally protected from being discriminated against based on their race, sex, religion, and much more — in addition, consumers also have legal protections against credit card companies that attempt to mislead them or hide information from them.^[7] Knowing your legal protections can make it much easier to build healthy credit and avoid common pitfalls, so visit FederalReserve.gov or FDIC.gov to find complete information on this subject.^[8]
- One of the most important pieces of knowledge you have in your arsenal as a consumer is that you can legally request one free credit report per year from each of the major credit reporting agencies. These reports can help you keep track of long-term trends in your credit and can alert you to any negative factors you may be unaware of. See our article on the subject for more information (or visit AnnualCreditReport.com.)
Keep in contact with your credit issuer. Your relationship with your credit issuer is an important one. If you're on good terms with each other, you may get preferable interest rates and forgiveness policies in the event of minor mistakes. If you ever have any questions or concerns regarding your credit, don't hesitate to contact your credit issuer — nearly all will be more than happy to assist you. You may also want to contact your credit issuer to request line of credit increases or to re-negotiate the terms of your repayment plan.
- Contrary to many people's first instincts, your credit issuer is actually one of the first people you'll want to get in contact with if you anticipate that you'll have a hard time paying back an upcoming bill. Credit issuers want to keep you as a paying customer, so if you've been responsible so far, many will be willing to work out alternate repayment plans in the event of hardships. If you have an especially good history, this one-time anomaly may not even impact your credit.
Consider credit counseling services if you run into trouble. The best possible course of action for your personal credit is to never get into a situation where you have more debt than you can reasonably pay back. If, however, this does happen, you may want to enlist the services of a credit counselor. Credit counseling agencies are organizations that can help you manage out-of-control debt, work with your debtor to re-organize your payment schedules, and get your finances back in order. While working with a credit counselor can damage your credit, the damage is likely to be much less than if you default on your bills or declare bankruptcy, so it's almost always preferable to these alternatives.
- Depending on your situation, this sort of help may be free or there may be a small fee attached.
- For information on reputable credit counseling agencies near you, consult the website of the National Foundation for Credit Counseling (NFCC), a non-profit organization set up to offer free-and low cost services to help with credit problems.^[9]
- Unfortunately, some credit counseling agencies are known to take advantage of troubled debt holders in their vulnerable state. Only work with reputable credit counselors accredited by major national organizations like the NFCC. See the "avoiding scams" step below for more information.

Knowing What to Avoid

Don't confuse credit cards with debit cards. Though they look almost identical and can both be issued by banks, credit cards and debit cards are two entirely different things. Debit cards don't operate on credit. In other words, when you make a purchase with a debit card, the money comes directly out of your checking account as if you've written a check for the purchase. No credit issuer is loaning you the money — you're paying with money that you already have.
- For this reason, you can't usually use a debit card to build credit (unless your card has the optional feature to be used as a credit card.)
Don't take out a bank loan to establish credit. If you stay on top of your credit card bills, credit cards are usually an easier and smarter way to build credit than personal loans. While paying off a loan on-time is good for your credit, it's usually a waste of money to use it solely for this purpose. Loans require you to pay interest — on the other hand, it's usually possible to pay credit cards off in full without incurring interest if you use the earliest available repayment schedule.^[10] Thus, as long as you keep up your habit of paying off your credit card bills as quickly as possible, there's no real incentive to take out a loan for the purpose of building credit.
- For major purchases however (like homes and cars), loans are unavoidable, as you can't typically charge these sorts of purchases to credit cards. In these cases, simply pay back your loan as quickly as possible to minimize the amount of interest you pay.
Don't open more lines of credit than you need. Having a few manageable lines of credit is a good thing. Having many lines of credit can be a very bad thing. As noted above, the more lines of credit you have, the harder it is to keep track of your payments. Worse still, if you get behind on your payments and get into the deadly habit of using one card to pay off another, you may quickly find yourself in a financial "death spiral" that's very hard to get out of. For these reasons, many credit agencies consider opening many lines of credit to be a "warning" sign for risky financial behavior, so this may cause a dip in your credit scores.^[11]
Don't get hooked into a credit repair scam. While there are an abundance of fair, ethical credit counseling agencies available, some "bad apples" exist to take advantage of customers who are in dire financial straits. These agencies may promise a "clean slate" or an easy way out of credit troubles, but instead use exploitative and even illegal practices to profit from your situation, all while pushing you even deeper into debt. As a very general rule, if any sort of credit service seems "miraculous" or "too good to be true," it's probably best not to trust it. Below are a few common "danger signs" to be on the lookout for — consult the website of the Federal Trade Commission (FTC) for more information:^[12]
- Agencies that make you pay them before they do any work for you
- Agencies that tell you to dispute parts of your credit report that you know are correct
- Agencies that tell you not to contact your creditors directly
- Agencies that tell you to lie to creditors or lenders or misrepresent your Social Security Number (note that these are federal crimes.)
- Agencies that can't prove their affiliation with the NFCC or another similar national organization

Video

Tips

After 6 months your credit history will start to build up and your score will continue to climb also.
Start at something small and work your way up, don't worry, as long as you have a little bit of good credit, you'll be fine.

Warnings

You will need to make successful payments on all the accounts. In most cases this is just the interest. At any time though you can work your way backwards though to close the accounts once you have built up your credit.
Don't go overboard on the credit cards and loans, they can help with your credit history, but only if you pay them on time!
If you do not want to keep the secured cards, change to credit cards you like and get rid of the secured ones as soon as possible. Getting rid of a long-standing account will do damage to your credit. (Or ask the bank if it is possible to convert your current secured card(s) to unsecured.)

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Sources and Citations

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Learn how to do anything

Thursday, August 20, 2015

How to Establish Credit