How to Build a Good Credit History From Scratch

Building your credit from scratch can be a catch-22. It can be hard to get approved for a loan if you don’t have a credit history — and you can’t build up a credit history if you’ve never been approved for a loan. Thankfully, there are things you can do to avoid this vicious cycle and build your credit from the ground up. 

Apply for Secured Credit Card

If you do not have a good enough credit score to qualify for a traditional credit card yet, you can start building credit with a secured credit card. A secured credit card is backed by your cash deposit, which is also typically the amount of your credit limit. The deposit is refundable when you close the account. The card then works like any other traditional credit card. You can use it to make purchases and then pay the balance each month or incur interest on any unpaid balances. 

The purpose of a secured card is to prove your responsibility with credit, so it is important to pay the balance on time and in full each month. Once you build up your credit score to the 630-689 range, you may be able to qualify for a traditional credit card that has lower interest rates and doesn’t require a deposit. 

When shopping for a secured card, look for the one with the lowest annual fees and interest rates. Also, be on the lookout for one that reports to all three credit reporting agencies – Equifax, Experian, and TransUnion– so your credit report will reflect your history of responsibility. You can find out more about each company’s credit reporting practices online or by calling the credit card company.

Get a Credit-Builder Loan

If you’re not able to qualify for a loan because you have no credit history, consider a credit-builder loan, which was created for this very purpose. Credit unions and community banks typically offer credit-builder loans to help people build up their credit. 

Credit-builder loans work differently from a traditional loan. When you apply for a credit-builder loan, you may pay a small administrative fee. Once approved for a loan, which typically ranges from $300-$1000, the bank will open a savings account in the amount of the loan. Some lenders offer interest-bearing savings accounts. You will make loan and interest payments to the bank, usually over a period of 6 to 24 months. Once the loan is paid in full, you can withdraw the funds. 

The banks report your payment history and balance to the credit reporting bureaus to help build your credit history and a healthy credit score so you can qualify for traditional financing in the future. Look for a credit-builder loan with the lowest origination fees and interest rates, payments and terms you can afford and that reports to all three credit bureaus. 

Become an Authorized User

If you have a close friend or family member who is a long-time and responsible user of credit and is willing to add you as an authorized user on their credit card account, this move could benefit your credit history. As an authorized user, your name is on the account, and you will receive a card in your name — although you do not have to use the card or even have it in your possession. 

The primary cardholder is responsible for making the payments, so be prepared to discuss payment arrangements for any purchases you make. Also, since the purpose of becoming an authorized user is to build your credit, make sure the credit card issuer reports the account to all three credit bureaus. While most major credit card issuers report to all three credit agencies, call and ask if you are unsure. 

When you are added to the account, your credit report will reflect the credit balance, limit, and payment history. This can give your credit score a boost and also reduce the amount of time it takes to create your FICO score. However, be aware that if the primary cardholder misses a payment, this will also appear on your credit report. Also, if the account  has a high utilization rate, this can hurt your credit score. 

Once you no longer are an authorized user, the history of the account will be removed from your credit report, so it is beneficial to use this time to achieve a credit score that will allow you to apply for your own credit card. 

CAUTION: Becoming an authorized user isn’t necessarily a sure-fire strategy for improving your credit. Credit bureaus have begun to recognize this as a credit improvement tactic and may choose not to recognize it on your credit history. 

Get Credit for Utility and Rent Payments

When the only bills you pay are your phone, utility, and rent payments — and you’re making them on time, without fail — you can leverage that diligence right onto your credit report. Through rent-reporting services like Rental Kharma and LevelCredit, you can get your rent payments added to your credit report so you can start building up a healthy credit score. Be aware that each company has different fees and reporting practices. Rental Kharma charges an enrollment fee and a monthly fee and currently reports to TransUnion; they are in the final stages of adding Equifax. LevelCredit requires a monthly fee and reports to all three credit bureaus.

For utility and telecom bills, Experian Boost offers a free opt-in service that scans your bank account for utility payments, then gives you the option of choosing the bills that get reported to Experian. 

Maintain Your Healthy Credit

After working hard to build a healthy credit score, you can move into the maintenance phase of your financial wellness plan. This means taking steps to ensure your credit report is clean and your credit score will allow you to qualify for the financial services you need. 

Make your payments on time. Getting into the habit of paying your bills on time will serve you well since payment history is one of the most important factors on your credit report. 

Limit your credit usage. Keep your balances low and your credit utilization rate under 30%. Most lenders see a utilization ratio of 30% or less as an indicator that the borrower is a responsible user of credit.You can calculate your credit utilization rate by adding up all your credit balances and dividing it by your total credit limit. 

Unpaid balances ÷ credit limits = utilization ratio

Apply for credit cards only when necessary. Making multiple applications for credit cards and loans results in hard inquiries on your credit report, which can stay on your credit report for two years and affect your credit score for about one year. 

Keep credit card accounts open. When you pay off a credit card, keep the account open, as long as you are not paying an annual fee. 

In Conclusion

Building a healthy credit score if you have limited credit history may seem like a challenge, but there are opportunities to prove your creditworthiness. Use this time you spend building your credit wisely. Once your credit score is built up, you can qualify for the best terms on the financial services that will help you to achieve your goals. 

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