In the past few months I’ve been asked by several clients how to build credit. While these individuals may be making very good income, paying for expenses in cash has not helped them build up their credit history. We were recently surprised when one client was denied a credit card and another denied a mortgage because of insufficient credit history.
So, what steps can you take to build your credit history?
Get a secured credit card
To get a secured credit card, you must make a deposit with the financial institution that issues the credit card. Often it is around $500, which is also generally the credit limit. The credit limit is the maximum you can charge on the credit card.
There are some important details to know when getting and using a secured credit card. You want to make sure the card is helping your credit, not further hurting it, so you’ll want to pay attention to these factors-
- Fees-Secured credit cards often have fees: annual fees, monthly fees, and others. The credit card issuer cannot charge fees that add up to more than 25% of the credit limit in the first year. Read the fine print. Make sure the fee structure does not increase after the first 12 months.
- Credit utilization rate. This is the amount of credit you are using on the card relative to how much credit is available. Be sure to keep the amount you charge as low as possible compared to your credit limit. Borrowers who have large balances in proportion to their credit limits may see their credit scores fall. We have been advised that using no more than 25% of the available credit is best with secured credit cards when it comes to how credit agencies view credit utilization.
- Missing payments. Be sure to pay the full amount due each month. Getting a secured credit card will not improve your credit scores if you miss payment deadlines. The creditor must receive the payment by the due date. To avoid paying late, we usually suggest clients set automatic payments for at least the due date, if not a few days in advance.
- Reporting. Check your credit reports to ensure the financial institution regularly reports your payments to Equifax, Experian, or TransUnion. The purpose of getting the credit card is to have the reporting agencies recognize your creditworthiness, so you will want to make sure they are picking up your credit history.
Once you have had a secured credit card for about six months you should be able to be approved for other more traditional credit cards. After six months of good credit history, you should consider requesting higher credit limits from the credit card companies. You might also want to consider some of the other credit building options below.
One very important point here is that whatever credit card you secure, keep the balance at 25% of the available credit or less. People with limited credit have their FICO score heavily impacted if the ratio of balance to high credit is 25% or more.
Get a credit-building loan
These are installment loans usually for $1,000 or less, like a loan for furniture. You repay them through regular, scheduled payments for 6 to 12 months.
Here are few details to be aware of when it comes to installment loans. Again, you’ll want to make sure you are using these loans to boost credit, so paying attention to these details can make the difference between helping and hurting your credit.
- Interest rates. For most loans, you will have to pay interest. Be sure you can afford to repay the loan, including the interest. Remember, even if the loan is deposited in an account and you make the loan payments from this deposit, you will still need additional money to cover the interest. We have noticed with some of these loans that they’ll have teaser rates for a short period of time, but then jump to a high interest rate. Your goal here is to take a loan that you can pay off on time to show you are credit worthy. Avoid letting the loan extend to where it becomes a financial burden with a high interest rate.
- Missing payments. While regular, on-time payments can build your credit, missing or late payments will harm it. Be sure you can afford the payments before taking on this loan. Find out if you can set up automatic payments so you can be sure you won’t forget to make them.
- Reporting. Check your credit reports to ensure the financial institution regularly reports your payments to Equifax, Experian, or TransUnion.
Apply for a credit card at a store or gas station
These credit cards typically have a lower credit limit and a higher annual percentage rate (APR). It may be easier to get approved for one of these cards than other types of credit cards. Like the prior steps we mentioned, you’ll want to know the details of the credit you are using.
- Interest rates. The interest rate is likely to be high. Make sure you do not charge more than you can pay. Keep the balance on the card as low as possible compared to your credit limit. Plan on paying this off monthly, and not holding a balance to avoid the hit of high interest rates.
- Reporting. Check your credit reports to ensure the lender regularly reports your payments to Equifax, Experian, or TransUnion.
Make a large down payment on a purchase and negotiate a loan for the balance
Offering to make a large down payment can make it more likely that a lender will approve your lending application. And, you will not have to borrow as much money. For example, if you are buying a used car for $5,000 and have enough cash, you might consider making a down payment of $1,000 to $3,000. Repaying the loan as agreed can help you build your credit history.
Some considerations here are the interest rate charged and the importance of paying these loans on time.
- Interest rates. The interest rate is likely to be high. Make sure you do not borrow more money than you can pay.
- Loss of asset. The loan is likely to be secured by the asset you are buying. If you do not make your payments on time and as agreed, the asset may be repossessed.
- Reporting. Check your credit reports to ensure the lender regularly reports your payments to Equifax, Experian, or TransUnion.
In our next blog on this topic we’ll be covering steps to repair and improve your credit if it needs some work. And if you’d like to learn more about how we help guide professional women to build credit and how that affects their financial goals, please contact us!
