9 Ways to Build Credit From Scratch
It's much easier to start with good habits than to repair black marks later on.
Establishing a good credit history has never been as important as it is today.
It's not just that you'll need good credit to get decent rates when you're ready to buy a home or a car. Your credit history can determine whether you get a good job, a decent apartment, a deal on your cell phone and reasonable rates on insurance. One seemingly minor misstep -- a late payment, maxing out your credit cards -- can haunt you for years.
If you're just starting out, you have a once-in-a-lifetime opportunity to build a credit history the right way. Here's what to do and what to avoid.
Check your credit report
You'll first want to see what, if anything, lenders are saying about you. That kind of information is contained in your credit report at each of the three major bureaus: Equifax, Experian and Trans Union. You're entitled to a free annual look at your reports from AnnualCreditReport.com.
Credit reports are used to create your credit scores, the three-digit numbers that lenders typically use to gauge your creditworthiness. Lenders also may look at the reports themselves, as may the landlords, employers, insurers and utility companies who use credit to evaluate applicants.
Can you have a credit report if you've never had credit? Maybe.
Somebody else's information could be mixed in with your report, either through a credit bureau mistake or because of identity theft; i.e. someone using your personal information to open bogus accounts.
If that's happened to you, you'll need to clean up your credit report before trying to apply for new accounts. The Federal Trade Commission's identity-theft site has information that can help.
Establish checking and savings accounts
Here's a basic step that's sometimes overlooked by people seeking credit. Lenders see bank accounts as signs of stability.
Opening checking and savings accounts is also one of the few things you can do as a minor to start building a financial history. While you can't get a credit card in your own name until you're 18 and can be legally held to a contract, many banks have no problem letting you open an account.
If your bank balks, look around for another bank or consider opening a joint account with an adult.
Understand the basics of credit scoring
You need to know that the two most important factors in your scores are:
- Whether you pay your bills on time.
- How much of your available credit you actually use.
It's essential that you pay all your bills on time, all the time. Set up automatic payments or reminder systems so that you're never, ever late. All it takes is a single missed payment to trash your credit scores -- and it can take seven years for the effects to completely disappear.
You also don't want to max out any of your credit cards, or even get close. Keeping your credit use to less than 30% of your credit limits (10% is better) will help you get the best possible credit scores -- and should help keep you from getting over your head in debt, as well.
Finally, you don't need to carry a balance on a credit card to have good credit scores. Paying your bill in full each month is the best way to keep your finances in shape and build your credit at the same time.
Piggyback on someone else's good credit
The fastest way to establish a credit history can be to "borrow" another's record, either by being added to a credit card as a joint account holder or by getting someone to co-sign a loan for you.
Having a co-signer can allow you to qualify for loans you might not otherwise get. The loan will show up on your credit report and, if you pay it off responsibly, will help boost your credit scores.
If you default, however, you won't be the only one who suffers. The co-signer has basically promised to make good on this account, so any delinquencies will show up on her credit report as well.
Being added as a joint account holder also has its risks, for you as well as the person giving you access to the card.
If your father adds you to his credit card, for example, his history with that account can be imported to your credit bureau file, giving you an instant credit record. If he has handled the account well, that reflects well on you. But if he hasn't, his mistakes would also become yours. You become responsible for any debt on the card, and it's difficult to get your name removed. Any late payments or other problems could make it harder for you to get future credit than if you'd established your history without help.
Being added as an authorized user to a credit card will no longer help you build a credit history. After credit-repair companies took advantage of the system and lenders protested, score-keeping companies are ignoring authorized-user information.
Apply for credit while you're a college student
Credit experts used to warn college students away from those booths set up on campus by credit card lenders -- the ones that promise free stuff for signing up. It turns out, however, that there's no easier time to get a card than while you're a college student, said Gerri Detweiler, author of "The Ultimate Credit Handbook."
Lenders are willing to take risks with you that they won't once you graduate, probably because they know that your parents' willingness to bail you out will end once you get your sheepskin.
You still have to exercise some caution, though. Look for a card with a low or nonexistent annual fee and low interest rates. For now, just get one: Opening a slew of credit accounts in a short period of time can make you look like a risky customer. Later, you'll want more than one card.
Apply for a secured credit card
If you can't get a regular credit card, apply for the secured version. These require you to deposit money with a lender; your credit limit is usually equal to the deposit.
Screen your card issuer carefully. To be frank, there are a lot of bad guys in this particular niche of the credit world. Some charge outrageous application or annual fees and punitively high interest rates.
Ideally, the card you pick would:
- Have no application fee and a low annual fee
- Convert to a regular, unsecured credit card after 12 to 18 months of on-time payments
- Be reported to all three credit bureaus.
If the issuer doesn't report to the credit bureaus, the card won't help build your credit history.
Get a store card
Gas companies and department stores that issue charge cards typically use finance companies, rather than major banks, to handle the transactions. These cards don't do as much for your credit scores as a bank card (Visa, MasterCard, Discover, etc.), but they're usually easier to get.
Again, don't go overboard. One or two of these cards is enough.
Get an installment loan
To get the best credit scores, you need a mix of different credit types, including revolving accounts (credit cards, lines of credit) and installment accounts (auto loans, personal loans, mortgages).
Once you've had and used plastic responsibly for a year or so, consider applying for a small installment loan from your credit union or bank. Keeping the duration short -- no more than a year or two -- will help you build credit while limiting the amount of interest you pay.
Use revolving accounts lightly but regularly
For credit scores to be generated, you have to have had credit for at least six months, with at least one of your accounts updated in the past six months.
Using your cards regularly should ensure that your report is updated regularly. It also will keep the lender interested in you as a customer. If you get a credit card and never use it, the issuer could cancel the account.
Just remember the credit tips I mentioned earlier:
- Don't charge more than 30% of the card's limit.
- Don't charge more than you can pay off in a month. You don't have to pay interest on a credit card to get good credit scores. It's much smarter to pay off your credit cards in full each month.
- Make sure you pay the bill, and all your other bills, on time.
Liz Pulliam Weston's new book, "Easy Money: How to Simplify Your Finances and Get What You Want Out of Life," is now available. Columns by Weston, the Web's most-read personal-finance writer and winner of the 2007 Clarion Award for online journalism, appear every Monday and Thursday, exclusively on MSN Money. She also answers reader questions on the Your Money message board.