It’s the ultimate catch 22 — you can’t get credit without credit history, but you can’t get credit history without credit! What’s a consumer to do?
If you ever plan on borrowing money in your lifetime, you’ll need to establish good credit. It takes several years to establish good credit, and 10 or more years to establish excellent credit. A good credit score also ensure you will receive the lowest interest rate possible on any loan. So here’s the skinny on how to get started.
Credit Bureau Basics
Your credit history is maintained by three credit bureaus — Equifax, Experian and TransUnion. With your permission, any perspective employer, landlord or creditor will contact the credit bureaus to see how you manage your finances. All three bureaus should have basically the same information regarding your bill-paying history, the number and types of accounts you have, late payments, collection actions, and the age of your accounts. Each credit agency has their own statistical formula to calculate your FICO credit score. Your FICO score helps creditors predict your creditworthiness. Perfect credit is 850; anything above 750 is above average.
Credit bureaus only track credit. The definition of credit means a borrower receives something of value now, and agrees to pay the lender at some date in the future (generally with interest). Therefore, the credit bureaus DO NOT track:
- Debit cards tied to your checking account
- Prepaid credit cards
- Utility and Phone bills
If you want to establish credit and you have no credit history, here are some suggestions.
Get a Co-Signer
Having someone with good credit history co-sign a credit application will go far in helping you to establish credit. A co-signer simply agrees to make payments on the signer’s debt should that person default. You’ll need to find someone with an excellent credit history willing to gamble that you’ll make your payments on time. If you fail to make payments on time or default on the loan, it will negatively impact your co-signer’s credit score.
Get a Secured Credit Card
Secured credit cards require you to make a security deposit against a credit limit to obtain a credit card. This is different from a prepaid credit card in that a prepaid card only allows you to spend the amount you’ve deposited on the card. The secured credit card allows you to spend more than your initial deposit, but the deposit remains with the lender until your card is converted to an unsecured credit card or the account is closed.
Get a Starter Card
These cards are specifically designed for people new to credit. Starter cards have low limits (generally $300-$500), an annual fee, and higher interest rates for unpaid balances.
Retail and Gas Cards
Oftentimes it is easier to obtain credit with cards that don’t have the Visa, MasterCard, American Express or Discover logos. This simply means that the card can only be used at the issuing retailer. If you obtain one of these cards, make sure they don’t have open terms. Open terms simply means the balance is required to be paid in full each month, thus not meeting the definition of credit. Open term cards are not reported to the credit bureaus and will not give you the benefit of establishing credit.
Once you’ve established credit, the key to success is to use the card occasionally and pay the balance every month on time. If you miss a payment in the beginning stages of establishing credit, it can have a detrimental impact on your credit score. Be sure to keep up payments for at least a year before you can expect anything positive on your credit history.