It’s the proverbial chicken-and-the-egg problem.
How can you build credit if you need good credit to get approved for credit?
Lucky for you… you are reading this blog today. We asked our in-house credit expert, George Cole, for his top three tips for someone just starting out on their good credit journey.
Here’s what he said…
>>Try a secured credit card
Secured credit cards are easier to get when you are just starting, because they require a security deposit to open. Your credit limit will be equal to the amount of cash you put down. That money is held in a separate account to cover any expenses in case you ever miss a payment. (Which we sincerely hope never happens.)
But (unlike prepaid debit cards) they work just like credit cards. The banks that offer secured credit cards charge you interest for unpaid balances, allow you to carry a balance from month to month, and, most important of all, they report your account activity to the three major credit reporting agencies.
Some secured credit cards charge application fees, but many do not. Some check your credit before allowing you to open the account, others do not. All charge interest for any balance you carry from month to month, but those rates can vary greatly from card to card.
Another great benefit of a secured credit card is that after 12 to 18 months of on time payments you may be given an offer to convert to a traditional credit card. You can get your security deposit back and continue to use the credit card responsibly.
>>Don’t apply for too many cards or loans at once
When you apply for a credit card, loan, or apartment lease, the lender (or landlord) will send a hard inquiry to the credit reporting companies. Hard inquiries affect your credit, so you have to be careful how often you apply. When you are shopping around for a credit card or loan, do as much research yourself online or over the phone before authorizing anyone to check your credit. Then, concentrate your rate shopping into a two week period (or less). The computer programs that calculate your credit score are smart enough to recognize this as rate shopping.
(Soft inquiries come from you checking your own credit score and from lenders checking you out for “pre-approved” offers. These do not count against your score.)
Make a strategic partnership
To put your credit building in to the fast lane, you can become an authorized user on a family member’s credit card. For maximum effect, this person must have an excellent payment record and long payment history. Since you are just starting out, this may be a tough sell. But, you don’t ever have to actually have copy of the card or use the account for this to work! The benefit is in associating yourself with the other person’s excellent track record. Their good habits will now reflect positively on your credit record, giving your credit score a much needed a boost.
Being an authorized user is a huge responsibility on your part – and a huge risk for the other person. You get to “borrow” their good credit history to apply for your own credit. But if you do use one of their accounts irresponsibly, you can cause long term damage to their credit. Use this tactic carefully. Your family relationships are way more important than your credit score.
Always be on your best behavior
>>Keep good records.
Mistakes are EXPENSIVE. If you go over your limit, you will have fees. If you pay late, you will have fees. If you overspend, you will start down a slippery slope of too much debt.
A good rule of thumb is to keep your total credit card balance under 1/3 of your credit limit. So if you have a $500 limit on your first card – keep your balance UNDER $165.
Why? A large portion of your credit score is based on your Utilization Ratio. That’s a fancy way to describe how “maxed out” your credit cards are. The closer you are to your credit limit, the riskier you look.
It’s a common myth to think that you have to carry a balance from month to month to build good credit. You can pay off your balance every month before the due date and still be building up your credit. And… you won’t be paying any interest. That’s a great reason to avoid building up a balance.
>>Keep temptation in check.
If you find it hard to keep your lifestyle in check once you have access to a credit card, try to keep in mind what your bug goals are. You are building your credit to create a financially secure life – not to acquire stuff and rack up debt.
Any time you are tempted to make a big or “just for fun” purchase, give yourself a 24 – 48 hour window of time to think about it. If, after 24 – 48 hours to cool off and think, you still thing the purchase is a good idea (and you know you can actually afford to pay for it!), go ahead.
We even know one woman who has frozen her credit card in a gallon freezer bag full of water. When she wants to use her card, she has to wait for that huge chunk of ice to thaw before she can get to it. By the time it has melted, she has usually changed her mind about the purchase or come up with another way to achieve her goal without having to spend any money at all.
>>Pay on time every month!
The late payment fees are bad enough. But many credit cards, especially for people just starting out, have a very high “default rate” interest. If you miss enough payments (and sometimes it’s just one), your interest rate jumps up to the default rate – which can be as high as 23% or more. And you’ll pay that on new purchases AND any balance you are already carrying. Not a pretty sight.
A quick and easy way to make sure you always pay on time is to schedule automatic online payments. You can do this through your bank, through the credit card’s website, or by calling the customer service number on the back of your credit card. Automatic payments are also easier to calculate into your monthly budget.
It will take time…. But it is worth it!
After about a year of careful work, you can apply for a small loan for a used car or a student loan in your own name. These types of loans, called installment loans, are an important part of building your credit score because of something called Credit Mix.
Credit cards are only one part of the puzzle. Adding an installment loan adds a new type of credit to your record. Smaller loans, like an auto loan or student loan, help build the foundation for larger installment loans in the future, like a mortgage.
The most important thing to remember, is that building good credit takes time. Just like building a house from the ground up… the foundation must be rock solid or else the whole thing may come toppling down.
Same thing goes for your credit. What you do now – when you are first starting out – lays the foundation for your financial future. Build a rock solid foundation (with on time payments, responsible borrowing behavior, and a good credit mix) and you will enjoy the benefits for the rest of your life.
If you have any questions, please give us a call at 770-952-5168 or contact us online.
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This information is intended for informational and educational purposes only and not as legal advice. If you have concerns about your credit report, harassment, identity theft, illegal collections activity, garnishments, or property liens, you should consult an attorney who specializes in consumer rights and defense.