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How to Build Credit for the First Time

How do you get a loan or credit card?

By showing the bank a good credit history that shows you’re responsible paying loans and credit cards on time.

Wait, what?

How are you supposed to get approved for a loan or credit card if you’ve never had one before?

It’s the ultimate catch 22:

  • No credit card? No credit history.
  • No credit history? No credit card.

If you’re panicking because you don’t know how you’ll get that student or auto loan you need because you don’t have prior credit history, relax: it can be done. Everybody has to build credit from scratch. I’ll show you how to do it.

WHY BUILD CREDIT?

I know a bunch of people who went through most of their twenties without credit. They had no student loans, no credit cards, not even a car loan. They paid in all cash and alright with it. On the one hand, they never had to worry about getting into debt over their head. On the other hand, as they got older and started to think about buy a first home (or they just wanted a credit card to take on a business trip), they were years behind others who started building credit in their early twenties…or even younger!

If you ever plan on borrowing money in life (for a car, home, or even a business), you should build good credit. Over a lifetime, people with the best credit scores pay over $100,000 less in interest than people with average scores. And people with poor credit pay even more.

Here’s the thing: It takes several years to build “good” credit. And it takes 10 or more years to build “excellent” credit. So even if you don’t need credit today, if you want to get the best rate on a mortgage in 10 years, you should start to build credit now!

Last but not least, your credit history may be used for other things like

  • Calculating car insurance premiums
  • On apartment rental applications
  • For employment screening

I’m not saying this stuff to scare you. Personally I think it’s crappy that some people get passed over for jobs because they paid a couple of bills late. But such is the world we live in.

WAYS TO BUILD CREDIT

It will take about two years to build a “decent” credit score. (If you’re curious, here’s a big guide to what credit scores are, what they mean, etc.) The first step to building credit is to open an account that reports your payment history to the credit bureaus.

About Credit Bureaus: There are three credit bureaus—Equifax, Experian, and TransUnion. The bureaus maintain databases of everybody’s credit history and package this information as reports and scores to sell to banks, landlords, employers, etc. For the most part they collect similar information, although each may track this information differently, and there may be discrepancies on your credit history with each. This is why it’s important to check your credit reports at least once a year. 

Examples of accounts that report to credit bureaus include:

  • Major credit cards (Visa, Amex)
  • Store credit cards (Target, GAP)
  • Installment loan accounts (mortgage, auto or student)

Examples of accounts that DO NOT report to credit bureaus include:

  • Debit cards (regular checking and prepaid)
  • Utility and phone bills (electric, water, cell phones)

So even if you have a checking account and a cell phone, you may not have a credit history. So here are two options for building credit for the first time.

OPTION #1: PIGGY-BACK OFF A FAMILY MEMBER

The easiest way to build credit for the first time is to open a loan account with a co-signer who already has good credit. A co-signer is simply someone who agrees to be responsible for the loan if you stop paying your bills for any reason.

In most cases, a bank will approve a loan for somebody with no credit history if there is a creditworthy co-signer on the application. In order for this to work, you need somebody who:

  • Trusts you enough to put their butt on the line for your loan.
  • Has good credit themselves.

You can do this with a credit card differently, but the process is slightly different. You won’t apply for the card together, but you can ask somebody to add you to their credit card account as an authorized user. Ensure that you’re being added to the account as a fully  authorized user, as some companies will issue extra cards in different names but only tie the account to one owner.

One way to check this: Do they ask for your social security number when adding an authorized user? If not, this trick won’t help you build credit.

After you become an authorized user on a parent’s  or somebody else’s credit card, you don’t even have to use the card…as long as they keep paying their bills on time, you will start to build credit. (But it goes both ways, if they stop paying, this could actually hurt your credit! Proceed with caution.)

OPTION #2: GET YOUR OWN STARTER CREDIT CARD

A starter credit card is designed for people new to credit. Unlike many mainstream credit cards, starter credit cards often have:

  • Lower credit limits ($300-$500 is a common start)
  • An annual fee
  • Higher interest rates
  • Limited or no rewards

Some starter credit cards are also secured credit cards. What this means is that you need to have money in a bank account equivilent to your credit line. So if you want to spend $1,000 on your credit card, you need $1,000 in the bank to cover that. Although this is similar to a debit card, secured credit cards work slightly differently and, unlike debit cards, report your payments to the credit bureaus so you can build credit.

My Recommended Starter Credit Cards

If you’re a full-time college student, try starting with a student credit card. These cards are designed to approve students and you can upgrade them when you graduate. Many don’t have the lowest APRs or best rewards out there, but you’ll have a good shot of getting approved and can start building better credit.

If you have some credit—even if it’s not great–and you aren’t a college student, check out the Capital One Platinum Card. This card is designed for people with average or limited credit. It has a low annual fee and no rewards, but after a year or so of responsible use you should be able to upgrade it to a no-fee rewards card.

Finally, if you have no credit history or bad credit, you’ll have to start with a secured credit card. Again, Capital One offers a good option with their Secured MasterCard. After a year or so of responsible use you may be able to upgrade this to a regular unsecured credit card.

WHAT TO DO NEXT

So you’ve got a credit card; congrats! Now the only things you have to do are:

  • Use the card occasionally
  • Pay the bill on time every month

Ensuring consistent timely payments is the most important part of building credit. Missing your payment just once can set you back a year or two! But as long as you use the credit card some and make regular payments, you’ll start to build credit.

From a financial standpoint, only charge to the card small amounts that you can PAY IN FULL at the end of every month. Treating your new credit line like “free money” and then only paying the minimum balance is asking for a big headache when you realize you owe hundreds or thousands at a high interest rate. I know because I made that mistake. Don’t do it!

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About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.

Comments

  1. Great ideas. I think saving for a deductible to get a credit card is best. Use it gradually

  2. I like this, I have just started making a change with my own personal finanace (trying to get the girlfriend to do the same is another matter – I have read the article about joint accounts ;))
    I have just got authorised for a credit card with £1500.00 worth of credit with a monthly full repayment set up. This should be a good start for me as long as I can manage it.

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