How to Build Up Your Credit from Scratch

Establishing credit can be a challenging process. Applying for the majority of loans and credit cards and purchases such as buying a house or leasing a car will require you to have a credit history. If you’re one of the 26 million Americans who are considered credit invisible, it may seem like you have no options. Although your options are limited, there are various ways you can build up your credit from scratch. This article will dive into the best avenues to pursue that will get your credit history rolling.

Apply For A Credit Card

The easiest and most accessible way to build your credit from scratch is to apply for a starter credit card. Although most credit card lenders will require you to have some credit history before applying, there are a couple of different options for you to pursue.

Secured Credit Cards

A secured credit card is a personal credit card designed for individuals looking to build or rebuild their credit. These types of cards are similar to traditional credit cards in many ways. However, the main difference is they require a refundable security deposit used as collateral until the account is closed.

Some lenders require you to place a deposit when you apply, but others may wait until you get approved. The minimum deposit may vary depending on the lender, but the minimum deposit is typically around $200 or $300. If you get approved, the deposit will act as your spending limit for the month. For example, if you put down a $500 deposit, the card’s limit will be $500. If the balance is paid in full at the end of the month, you can put another deposit down to use for the month. However, if the balance is not paid in full, interest will be added depending on the card’s annual percentage rate.

Aside from the deposit, secured cards act like regular credit cards. Information about your account, like repayment history, will be reported to the three main credit bureaus—Equifax, Experian and TransUnion. If you are using a secured credit card responsibly, meaning you are paying the balance in full each month and staying below the limit, you should see your credit score increase within a year.

A secured credit card isn’t meant to be a long-term solution. Once you’ve built up your credit history, you may want to get an unsecured card that comes with a lot more benefits.

Student Credit Cards

If you’re a college student looking to establish credit, a student credit card may be the best option for you. However, not all college students may be eligible to apply for these types of cards. For example, if you are under 21, you must prove you are earning a steady income to make payments, use a co-signer or add a parent as an authorized user.

Student credit cards are comparable to regular credit cards regarding building credit. If you use a student card responsibly by making payments on time, it will reflect positively in your credit report.

However, there are some subtle differences. Here are a few things to consider when thinking about applying for a student credit card:

• Lower credit limit: Since students are most likely new to credit and the issuer may not know if you can pay back the balance, these cards generally have lower credit limits than regular credit cards.
• Rewards may be an option: Depending on the card you’re applying for, rewards like cash back on certain purchases may be offered.
• Most student cards are unsecured: As mentioned above, there are secured and unsecured credit cards. While you can find secured student cards, most are unsecured, meaning they don’t require a deposit.
• The average APR is similar to the national average: According to CreditCards.com, the average APR for a student card is roughly 16%.

A student credit card can be a good starting point for college students to build credit. However, be sure to shop around to find the best option available for you.

Retail Credit Cards

You may remember shopping at a department store like Target, Walmart or Best Buy and the person at the checkout counter offering you to purchase a credit card—those are retail credit cards.

Retail credit cards or store credit cards operate like traditional credit cards where you make purchases and pay the balance off later with potential interest. Retail credit cards can be another great way to establish a credit history. Like a credit card from a bank, your information will be reported to the three main credit bureaus. However, the approval requirements and process may be less strict, and often you may be approved on the spot. If you apply for a store credit card, it’s important to manage the account responsibly to help increase your credit score.

If this is an avenue you wish to pursue, it’s important to understand there are two different types of store credit cards:

• Closed-loop retail cards: These cards are only accepted by the retailer or stores associated with the retailer. A benefit to a closed-loop card is they typically don’t come with fees.
• Open-loop retail cards: These cards offer more freedom and are described as general-purpose cards cobranded with the American Express, Discover, MasterCard or Visa logo. You can generally use open-loop cards wherever the aforementioned brands are accepted. However, these types of cards are more likely to carry fees.

While responsible use of retail cards can help build your credit history, there are a few drawbacks that may drive potential users away.

• Higher interest rates: Retail credit cards typically carry an exorbitant amount of interest. According to WalletHub’s Credit Card Landscape Report, the average interest rate for store credit cards is roughly 24%. However, when compared to secured credit cards, there is approximately a 7% difference.
• Lower credit limits: The credit limit per month is generally lower on store cards when compared to secured cards from a lender such as a bank.
• Limited rewards: While retail cards may offer rewards like cash back, the options are limited compared to a traditional card.

Become An Authorized User

If you’re struggling to get approved for credit cards or that’s not an avenue you wish to pursue, becoming an authorized user can be a great way to start building credit. To become an authorized user, you will need to ask a family member or significant other to add you to their existing credit card account. Since you are trying to build up your credit history, it’s important to ask someone who you know has a long history of paying their bills on time.

Once you’ve been added as an authorized user, the information on that account may be shared with the three primary credit bureaus, and you can start building up your credit. Additionally, you’ll receive a credit card in your name, but the account owner is responsible for making payments. Being an authorized user, you have an unwritten duty to use the card responsibly. If you make large purchases that the account owner will have difficulty paying back at the end of the month, you may end up negatively affecting both of your credit ratings.

Depending on the card issuer, authorized user policies may differ. Therefore, before you move forward with becoming an authorized user, you should check with the card issuer to see if they report authorized users to the credit bureaus.

Get A Cosigner To Help You Build Credit

Finding a cosigner is another option available to help establish your credit from scratch. A cosigner will essentially vouch for you when you go apply for a loan or unsecured credit card. Although a specific credit score may not be required to be a cosigner, generally, a cosigner will need to be in the very good or exceptional range—670 or better. Each lender will have different requirements, but someone in that range should qualify to be a cosigner. Using a cosigner to build credit is similar to being an authorized user. The only way to establish credit through this method is to be responsible and make payments on time.

Establish Credit Through Loans

Taking out loans can be an effective way to build credit from scratch. However, like all the other methods mentioned above, establishing good credit through loans can only be completed if done responsibly. Therefore, we recommend only taking out a loan if you can shoulder the debt. If not, one of the other techniques may be better suited for you.

Credit-Builder Loan

As the name suggests, credit-builder loans are designed to help individuals rebuild or establish credit. Credit-builder loans are generally offered at lower amounts than traditional loans. According to the Consumer Financial Protection Bureau, this type of loan can range from $300 and $1,000.

Unlike a traditional loan, the amount you’ll receive from a credit-builder loan is put into a secured savings account until the loan amount is paid off. Typically, the payment term for this type of loan is six to 24 months. Then, when the term ends, and all the funds have been paid, including interest, you’ll receive the money from the loan.

While you’re paying the loan off, the lender will report your history to the three main credit bureaus. The goal is to show that you can make regular on-time payments during that period. In turn, you are building up your credit score. According to a study conducted by the Consumer Financial Protection Bureau, participants without an existing loan opening a credit-builder loan increased their likelihood of having a credit score by 24%. Additionally, participants without existing debt saw their credit scores increase by 60 points more than individuals with existing debt.

Secured Loan

The concept of a secured loan is incredibly similar to a credit-builder loan. It’s another option available to individuals who are looking to build or rebuild their credit. However, when taking out a secured loan, your savings are used as collateral. So, instead of using your savings on an emergency or toward major purchases, your savings can stay in your account while using the loan principal to pay for expenses. In addition, since a secured loan uses your savings as collateral, interest rates may be lower than other types of personal loans.

The loan limit may vary depending on the credit union or bank you choose. The minimum can range from $200 and $500, while the maximum may be all of your savings. Additionally, the repayment term could vary depending on the lender. However, the repayment length is generally five to 15 years.

Local credit unions and banks often offer secured loans. Be sure to check with one of them to see if you qualify.

Building And Maintaining A Good Credit Score

Through the various methods mentioned in this article, you can start building up your credit history, but the tricky part is raising and maintaining a good credit score. Understanding the factors that go into your score’s calculation is beneficial. While the three main credit bureaus use similar data, one bureau may consider a factor more important than the others. However, the factors and their importance are generally as followed:

• Payment history accounts for 35% of the calculation.
• Amounts owed account for 30% of the calculation.
• Length of credit history accounts for 15% of the calculation.
• New Credit and credit mix account for 10% of the calculation.

Here are a few additional tips for earning and sustaining a quality credit score.

• Make payments on time: Since payment history is the most important factor of your score’s calculation, making payment on time is essential to building up your credit score.
• Keep a low credit utilization rate: Once you’ve built up your credit history and moved on from starter credit cards to an unsecured credit card, you’ll want to use the card wisely. Financial experts agree that you should keep your credit utilization rate between 10% and 30%—however, the lower, the better.
• Create a diverse credit profile: Credit mix only accounts for 10% of your score’s calculation, but having a healthy mix of credit provides lenders a general idea of how you manage multiple accounts over time.

Learn More About Credit And Personal Finance From The Professionals

Credit is an integral part of your financial health as an adult. It’s needed for things such as renting or leasing a car, applying for a loan or credit cards and purchasing a house. However, building credit from scratch can be a long and frustrating process, but if you follow and implement some of the strategies discussed in this article, you should be on your way to building a solid credit score.

Arizona Central Credit Union is here to assist you no matter what step in the credit building process you may be in. If you have general financial-related inquiries, our financial experts can help. For example, if you are in the market for a personal credit card or personal loans such as a secured loan, mortgage, or student loan, we’ve got you covered. Contact ACCU today to learn more about personal finance.