By now, you probably know the irony of establishing credit.
In order to prove your ability to pay back debts, you have to enter into debt first. It’s a frustrating situation, to be sure, but one that actually makes some sense. In order to feel truly confident about loaning out money, you’d want to be able to see an established history of the receiver’s timely payments.
Still, it can be endlessly frustrating to establish and build a credit score up to the point where you can do much with it. Most experts say it takes about six months of various types of steady payments to establish and maintain a reliable credit score.
For those of you who don’t know how to take out lines of credit (in order to thereby prove that you can pay back debts), there are options for you. We’re going to cover your options for how to both establish and improve your credit score, even if you don’t have preexisting credit.
Side note: According to Credit Sesame, here are the proportional percentages for how your FICO credit score is determined: payment history (35%), credit utilization (debt vs. available credit; 30%), age of credit accounts (15%), number of recent new applications for credit (10%), and the mix of your types of credit (10%).
3 Ways to Establish Credit
1) Secured Credit Card
A secured credit card is like a normal credit card, except in order to obtain it you must deposit a certain amount of money (often the same as your credit limit) to be used as collateral if you do not make your payments. Your deposit is returned to you at the end of your account use.
This is perfect for those who do not have enough of a credit history to take out a traditional credit card account. It’s much easier to obtain, yet it affords you all the same opportunities to establish and build credit. You can use it, make timely payments, and keep your debt at or near to zero, and watch as your credit builds itself up.
Note: Make sure that your lender reports secured credit cards to credit reporting companies.
2) Become an Authorized User on a Credit Card
It’s possible to become an authorized user on another person’s credit card. This is a common way for parents to help their children establish credit, but the opportunity isn’t limited to family. In this scenario, the authorized user receives the credit benefits of timely payments but is not legally obligated to pay for charges.
It’s also possible to co-sign on a loan or unsecured credit card with someone who can user their own credit score on the frontend. But be cautious here: the other person must know that they are responsible for the full amount of the loan or other debt if you do not end up paying your part.
In other words, only go this route with someone who is a very, very established and secure relationship.
4 Ways to Improve Your Credit Score
1) Timely Payments
Opening various lines of credit will do your credit score no good unless you pay back what you owe—on time. If at all possible, pay 100% of your debts on time. This means you should pay utilities and other bills on or before their due dates, and for credit cards, it means paying off what charges you use it for very soon after your purchases.
2) Secured Loan
Since it’s so difficult to establish credit as a young adult or someone who has gotten into bad credit in the past, many banks offer secured loans, which are similar to secured credit cards. You deposit money into an account and borrow against it.
You forfeit your collateral if you fail to make payments. As the previously quoted Credit Sesame article states, “In general, the small scale of a secured loan to build credit should mean that if you fall behind, you can work with your lender to find a solution that doesn’t require a transfer of assets.”
3) Keep Your Balances Low
This refers to the “credit utilization” chunk of what makes up your credit score. If you remember, it’s 30% of your total score.
Much of your credit score is determined by how much debt you currently owe as compared to your credit limit. For example, if your card has a $600 limit, and you owe $300 after your purchases, you’re in a danger zone in regards to your credit. Most experts say not to let your debt rise about 30% of your credit limit, but of course the lower you keep it, the more you will improve your credit score.
4) Variety of Credit
There are all sorts of methods of establishing credit and paying back debts. These include student loans, credit cards, and utilities, and certainly car loans and mortgages if you can afford them.
Someone who make timely payments on student loans and utilities will be more easily scored by reporting companies than someone who only makes credit card payments.
These are some of your best options for establishing and improving your credit, but we would be remiss if we didn’t add a few words of warning about some of the pitfalls of credit.
Credit cards, by definition, help you afford purchases and lifestyle improvements otherwise out of reach. This is a nice, but potentially very dangerous ability, as you can easily reach your way far beyond not only what you can afford, but also what you can afford to pay back.
Credit, you might say, is a power to be wielded wisely.
2) Trying to Build Credit Too Fast
There is no magical way to jumpstart your credit score in a matter of weeks. Instead, improving your score should be a steady process, with you making timely payments each month, rather than hiking up your debt in a concerted effort to pay it off for (impossibly) fast credit building.
3) Opening Multiple Lines of Credit at One Time
Your credit score averages out the ages of your recent credit sources, so be aware of that every time you apply for a new type of credit. It will lower your average.\
On the flipside, keep credit accounts open as long as you can, even if you’re not using them, since that will positively affect the average age of your accounts.
May your credit-building be smart, happy, and expedient!
By: Ryan Drawdy
July 12, 2017