How to Establish Credit

Most major financial landmarks in life, such as buying a car or a house, will require the use of credit, but when you have little or no credit, there are often more “no’s” than there are “yeses” from lenders. Starting to build your credit is not the easiest thing to do when there are more rejections than approvals, it is difficult to know where to start.

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When starting out, it is important to ensure that you are starting out clean. There have been several cases over the years that I have seen when someone who thought that they had no credit actually had some credit from a joint account they held with a parent or from years of student loans they have been paying. There have been those that have very bad credit riddled with collections from utilities or rent that went unpaid. The first thing you need to do is check your credit. There are several ways to do this but the easiest is to head over to www.annualcreditreport.com, which provides a free credit report from each of the three major credit reporting agencies once per year. You should verify that the information you find on your credit report is correct and accurate. If it is not, for instance, if you have fraudulent charges on your report, you will need to dispute the charges, most likely with both the creditor and the credit reporting agency.

Once you have an idea of what your credit looks like there are several ways to go about building credit.

Retail Cards

Retail cards, such as credit cards for department stores and gas companies, are often the easiest credit cards to obtain as they are limited to the retailer that you choose and usually come with lower spending limits, hence less risk for the issuer. However, these cards often come with high interest rates if you are not paying them off every month and carrying balances month over month, and they can have you paying much more for a product or service than it is actually worth.

Secured Credit Cards

One of the best ways to build or rebuild your credit is to start with a secured credit card. Secured credit cards are safeguarded by money you provide to the lender, usually in amounts of $300 or greater. This money is placed in a savings account and locked until the card is closed. The lender issues you a credit card with limits equal to the amount of money you provided. When charges are made to the card, monthly payments are still required and interest accruing. The initial secured payment that you provided the company is to be used only in the event that you default on making your payments, which would show negatively on your credit report, as well.

Many of the companies that issue secured credit cards have programs where they will evaluate your payment history on a regular basis and consider graduating you to an unsecured card when you meet their specific guidelines. The great thing here is that you are building credit and should not have to pay fees or undue interest provided you make the payments in full each month.

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Secured Loans

A secured loan can have several advantages, including helping you build your credit faster than you could with credit cards alone. The process is very similar to that of a secured credit card, where you provide the lender with cash in advance. For a secured loan, the security amount is usually $3,000 or greater. This amount is placed in a savings account that you cannot access until the loan is paid in full. In the meantime, the lender gives you a percentage of the held amount, usually around 90%, and you establish a set payment plan of a few years to pay the loan back in regular monthly intervals. One of the greatest advantages of this type of loan is that it will show as an installment loan, a loan for a fixed amount of money repaid over a set time period, when reported to the credit agencies. This will add to your overall credit mix and help you increase your credit score.

Going the way of a secured loan is in essence paying for the privilege to establish your credit. These loans also often come with a hefty interest rate or loan origination fees.

Become an authorized user

Another option and often one of the simplest ways to build credit, is to be added as an authorized user to a friend or family member’s credit card account. This allows you to associate your name and information with that of the credit your friend or family member is using. However, not all lenders report authorized users to the credit reporting agencies, so there is a chance that being an authorized user may not be helping you build your credit.  Before taking this approach, make sure the credit card company reports all authorized users to the credit reporting agencies.

This option may be risky, so use extreme caution if you choose to become an authorized user. In becoming an authorized user, ensure that you friend or family member uses their credit responsibly and always makes their payments on time. Should their account become delinquent or go to collection, that negative action will also reflect on your credit.  On the other hand, you need to practice responsible credit behaviors as well. Having a clear plan in place to inform the card holder of the purchases made and how you will reimburse your friend or family member for purchases is also important so that you don’t hurt someone else’s credit.

Have a Co-signer

If you’re having a hard time accessing credit for a purchase, you can ask a friend or family member to co-sign a loan. Similar to the authorized user option, you are using your friend or family member’s good credit standing to help you get approval for a loan; however, in this case, their credit now counters the risk to a lender on your behalf. In essence you are requesting this person to put their credit reputation on the line for you. Should you default on the loan, this person is now responsible for the full repayment of any outstanding balances and fees that may accrue. Any missteps on the repayment of this loan by you can negatively affect your co-signer’s ability to obtain financing in the future and can cause irreparable damage to their credit history and your relationship.

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Once you have a few types of credit under your belt, it’s important to carefully monitor your credit reports for changes, understand what is on your credit report, and know how your credit score comes together. This is a good way to monitor your credit-building efforts and see how these efforts are paying off in terms of building your credit while actively protecting yourself from fraudulent activity.

When starting out, it is imperative to begin making your payments on time as agreed from the beginning. Reports of late payments and other missteps will stay on your credit reports for up to seven years. A few late payments or an account that becomes a collection account when building your credit can cause you years of work and frustration trying to clean it up.

As you make payments you’ll progressively build your credit and it is possible to make significant progress on establishing your credit quickly. As building your credit is not quick project, incremental improvements month by month will provide you better financial options in the future.

Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.

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