As an individual, it is extremely important to understand the credit scoring landscape in order to achieve financial success. In the credit and lending sphere, your credit profile/score is a direct reflection of your creditworthiness. Typically, it is difficult to attain a line of credit or a loan without establishing a robust credit profile first. Those with limited credit, who do gain approval for a credit card or loan, will find themselves paying much higher rates and pricing due to their greater risk of default. But how do you build credit, when you don’t qualify for credit?
Below, I will discuss in-detail, the four most-popular outlets that you can use as a vehicle to establish your credit profile.
1) Apply for a retail credit card.
Typically, it is easier to qualify for a retail credit card than another form of credit. However, it is important to understand that retail cards normally have a high interest rate (between 20% and 30%) and a low limit (on average, under $1,000). That being said, a retail card should be used solely as a vehicle to develop credit history. Carrying a month-to-month balance on a retail card can get very expensive because of the high interest rate; in addition, accruing a large balance will affect your credit available vs. credit used ratio. The closer your balance is to the limit, the more your scores can drop. If you choose to go this route, you should make it a point to pay off your balance on a monthly basis. Also, prior to applying for new credit it is important to make sure your balances are less-than 10% of your credit limit. If used responsibly, a retail card can be very helpful in developing a credit profile because retailers report directly to all three credit bureaus.
2) Become an authorized user.
Becoming an authorized user on a credit card with a longstanding credit history, timely payments, and a low balance (about 10% of the credit limit available) can improve your creditworthiness. Of course, you would need permission from the primary card holder, but if you choose to have your name associated on a card belonging to a responsible card holder, their good credit will be reflected on your credit score. Conversely, if the primary card holder’s account is not in good standing, it is important to understand that it will affect your credit score as well. The primary card holder is still able to close the account at any time, manage the account and remove you from the account at any time, and you will not be held liable for any outstanding balances should a large sum accrue. If you are considering this option, it is a good idea to get information regarding the account from the primary card holder first and monitor the account throughout your time as an authorized user. Without having any primary credit in your name being an authorized user will not help your score. Make sure to use this strategy with any credit cards other than American Express. American Express updates the date the authorized user was added as the open date which will not age the credit.
3) Apply for a credit builder loan.
A credit builder loan is a small loan extended to an individual by a credit union. The amount allotted is usually between $500 and $1,000 dollars and the term to pay off the loan is typically no longer than a year. Interest rates on credit builder loans are very low, which is also a plus. The credit union will take the money from your loan, and put it into an interest-bearing account. The sum accrued by the account will belong to you, but you cannot access it until the loan is paid in full. Your payments will be reported to the three credit bureaus and at the end of the term you will receive the dollar amount that was accrued on the account in full.
4) Become a co-signer on a loan.
I do not recommend this option as a first step for building credit. Why? It is riskier than the other options. As a co-signer on a loan, you will be jointly responsible with the other co-signer for a large sum of debt over a long period of time. Co-signers typically apply for auto loans, mortgages, or large personal loans; it is important to understand that these loans can take decades to pay off. If you are considering this option, you need to think about your relationship with the person you are applying with, your ability to make payments over a long period of time, and how it can affect future financing needs. Prior to application, individuals should make sure once the loan is approved they will have equal access for making timely payments; if either party pays late it will impact both credit scores negatively. Also, understanding the new debt-to-income ratio the loan will cause and how that will change their ability to gain future financing will help make educated decisions on whether this type of credit is worth having.
5) Apply for a secured credit card.
If you are having trouble getting approved for a standard unsecured credit card, there is the option to open a secured credit card. With a secured credit card the individual is . Card issuers will report your account activity and payment history to the three credit bureaus, so be sure to keep your balances low and make timely payments. When you are ready to apply for a secured credit card, it is important to research a product with reasonable annual fees and competitive interest rates. This is a viable option for individuals who are looking to grow or fix their credit score.
As you can see, there are a variety of options available that are designed to help individuals with minimal-to-no credit establish a good-standing credit history. Age of credit history is one component of a credit profile, so you should not wait to establish credit when you need credit or funding. Developing a credit profile is not something that happens over night and the longer you wait to establish your credit, the longer your lack of credit history will affect your score.
If you have any credit questions feel free to reach out to us for a free credit review.