It’s the ultimate catch-22. You need good credit to be approved for a loan or a credit card, but you can’t get good credit without first having a loan or a credit card. This is a frustrating and common problem: one in ten Americans doesn’t have a credit score. I often talk to people who want to get a mortgage but haven’t had a chance to build a credit history. They are often young people who haven’t established themselves yet or people who hate the thought of having any debt.
So what’s a person to do? After all, you’ll probably need credit at some point in your life, since the financial world revolves around credit scores. The strength of your credit history is the deciding factor in car loans, mortgages, and qualifying for a credit card. I have a few ideas that I share with my own clients to help you as you start to build a good credit score.
I generally advise people without any credit history to go out and open three accounts. These will probably be credit cards and maybe a small loan. It’ll take about six months for information to show up on your credit history. And there are some things you can do to make it more likely that your applications will be approved, even without a credit history.
Checking Your Credit File
Before you apply for your first credit card or loan, you should check with the three major reporting agencies (TransUnion, Experian, and Equifax) to make sure that your identity hasn’t been stolen and used to apply for credit. If your identity has been stolen, you’ll want to clear this up with the credit reporting agencies before applying for more credit, especially if your score has been damaged by the thief. (An important note: when a problem is fixed, the lender must report the correction to all three credit agencies, so you shouldn’t have fix the same problems three times.) The best way to get started on this step is to go to annualcreditreport.com, which gives you a free credit report from each of the three reporting agencies.
Other Financial History
Even though bank account history isn’t part of a credit report, having a solid bank account can show that you are financially responsible. A record of regular withdrawals and deposits can help. Checking or savings account history can be particularly helpful if you apply for a credit card through your bank. But beware that even though positive bank account information won’t show up on a credit report, negative information can affect a loan application.
The main credit score that mortgage lenders use is the FICO score, but sometimes lenders pull from other sources as well. In fact, some scoring models rely heavily on utility bill payment history. So make sure that you always pay all of your bills on time.
Getting Some Help
There are a few ways other people may be able to help you establish credit history. One option is to get a close friend or a family member to co-sign on a loan with you. That way, the lender can look at that person’s established credit history to make a decision (rather than making a decision about risk based on your history alone). But make sure that your co-signer has good credit, and remember that both of your scores will be harmed if you have problems making loan payments.
Most credit cards are unsecured (that is, there’s no collateral to back them up), but you can sometimes get a secured credit card (through your credit union, for instance). Your spending limit will be whatever you have in the bank to back up what you’re spending, but the money doesn’t come out of your account like it does with a debit card. If the secured card isn’t through a bank you have an account with, you will have to deposit money equal to the amount of your credit line. Just make sure that the lender reports to the credit agencies, or you won’t be building your credit at all. After using a secured card responsibly, you can ask to be upgraded to a traditional card.
Last, a word on bank loans: credit cards are usually an easier and less expensive way to build credit than personal loans. Loans require you to pay interest, which you don’t have to do if you pay your credit card balance in full every month. But some credit unions do offer small personal loans at lower interest rates than traditional banks, which may be beneficial if you can’t establish credit in another way. Another option is a secured loan, for which you would use a savings account or a certificate of deposit for collateral (since this is minimally risky to the lender, you are likely to be approved for such a loan).
The Road to Good Credit
Establishing good credit isn’t as hard as you might think. It does take some patience and responsibility. But if you make timely payments, have a variety of accounts, and don’t charge too much to your credit cards, it won’t be long before you reap the benefits of a good, solid credit history.