How to Build Your Credit
Credit is very important for your financial life. If you want a loan, your credit will be examined. If you want a credit card, you need a good credit. Even cell phone companies look at your credit profile before approving any phone plan. Almost every important service requires a good credit score from your end.
But there is a catch 22 situation here. You cannot get a credit card if you don’t have credit. But, if you don’t have a credit card, then how will you build a credit history? Which one comes first? The first step to building your credit is to first establish the credit.
Ways in which you can build credit from scratch
You can establish credit in a few ways. Following are some options that you could look at:
Credit builder loan
Sometimes, you face the problem of bad credit rather than no credit. A credit builder loan is often a great way to rebuild your credit. You can also use a credit builder loan to start from scratch if you do not have any credit history. A credit builder loan is basically a loan which a smaller bank or a credit union will offer you. The loan money sits in your account for a few years. You cannot use the amount right away. You basically pay the monthly EMIs for the tenure of the loan. Once you are done paying all the EMIs, the lender will release the credit builder loan amount to you for any use that you want. It is an arrangement where the loan is paid off first, and the money is released at the end. You might be amused as to why you should get into something which is the total opposite of a regular loan. After all, taking a loan means money now and pay later. But the whole point of a credit builder loan is to build your credit. It is not about money. When you start making EMI payments, you start building a credit history. Once you pay off the credit builder loan, you will have built decent enough credit to avail other financial services such as a regular loan or credit cards.
Secured credit card
If you are not able to get a credit card from any bank or financial institution, then ask for a secured credit card. This is a special kind of credit card that requires you to make an upfront cash payment. This cash payment/deposit is used as a collateral against the credit card issued to you. You use the secured credit card just like any other credit card and make payments at the end of the monthly cycle. If you do not pay the outstanding dues, you are charged interest – just like a normal credit card. In case of a default, the cash payment that you deposited originally is used to recover the dues. Remember that this cash deposit is refundable and you will get it back when you close the secured credit card account. While this type of a credit card is not a long-term solution, it is a great short-term option that allows you to build enough credit history to then apply for a regular credit card.
Join an existing user or leverage their credit
If someone in your family is a credit card holder, you may be able to join the account as an additional authorized user, subject to the rules of the bank or card issuing authority. The person who is the original cardholder should be willing to add you as an authorized user. If you are successful, you can use this credit card and start building a credit history. However, one important step that you need to take is to first ensure whether the card issuer will report your usage activity to the credit bureaus. The whole exercise only makes sense if your activity gets reported. If that is not the case, no matter how much you use the credit card, your credit history will remain at zero. Another thing to keep in mind is that you are legally not bound to pay your part of the credit card payments since the primary or original cardholder is responsible for the bill payments. So, you need to figure out the arrangement with your family/loved-one about how you will pay your share of the credit card transactions.
Another option that you have if you want to use a credit card to build your credit is applying for an unsecured credit card with another person as a co-signer. The co-signer can be someone who has good credit. So, even if you do not have any credit history, you can leverage the co-signers creditworthiness and still get a credit card to start building your history. The co-signer becomes legally liable to pay off any credit card bills that are unpaid, so make sure you choose the right person and act responsibly. Your actions could affect the financial situation of someone else.
Get your rent payments on your credit report
There are certain companies that will put the record of your rent bill payments onto credit reports. This will help you build a history of making timely payments and that in turn will build up your credit score. Note that not all credit bureaus may be willing to accept rent payments as credit report items. But some will probably accept it, and that might just be enough for you to get a credit card or a loan, which in turn will help you build up more credit in the future.
As you go about building your credit using the above methods, there are some best practices that you should follow in order for the above tips to work effectively. You should keep the following in mind:
- Always make timely payments. The whole idea of getting credit builder loans and secured or unsecured credit cards is to build good credit. You do not want to do something which can jeopardize that process. So, be prompt and do not delay credit card or any payments. Even rent and utility payments count as credit bureaus keep track of them. Any payment that is due must be paid on time.
- Stay conservatively below the credit limit on your credit card. If you are too close to the limit, then that is a negative factor as far as credit score is concerned. Credit bureaus like to see conservative credit utilization where you are far from the credit limit. If you are straying too close to the limit, then either cut down on card expenses or request for a limit increase.
- Keep your credit card accounts for as long as possible. This ensures more data, more credit history for the bureaus and more creditworthiness for your profile. There are many credit cards which do not charge an annual fee. Go for such cards if possible and if paying annual fees for a longer time is a concern.
- Do not open too many credit card or loan accounts at once. Build your credit gradually and keep things simple. The lesser accounts you have, the simpler the payment process and the lesser the monthly outgo. More accounts mean more EMIs and monthly payments. Once you build a good credit score, then you can have more accounts as is necessary. But resist the urge of opening new accounts just for the sake of it or just because the credit card companies are aggressively marketing their products to you.
- Lastly, always check your credit scores from time-to-time. You should order your free annual credit report from Experian, Equifax, and TransUnion. Once you get the reports, read it carefully and check if there are any errors. A mistake on a credit report can affect your credit detrimentally. It can limit your ability to get loans or other services in the future. So, if something is wrong, bring it up and dispute it. Credit bureaus have well-established dispute processes.
With the information and guidance listed above, you should be able to begin building your credit score right away. Follow the tips and best practices and your chances of success will increase.