Establishing credit when you don't have any is a Catch 22 that even Joseph Heller may not fathom. It's difficult to build and establish credit without first having it. And it's hard to have credit, such as credit cards, without first establishing a credit history.
Getting around that paradox, thankfully, isn't impossible.
Many ways exist to help consumers build credit. From paying your bills on time to starting your credit card journey by getting a secured credit card, we'll go over the best ways to build a credit history and keep an improving credit score in good standing.
- How establishing credit can help
- Credit score ranges
- How credit scores are calculated
- Credit score effects on mortgage
- How to establish credit
- Costs involved in establishing credit
- Pros and cons
- The bottom line
How establishing credit can help
Without good credit, many things in life will likely be more expensive than they should be. Credit card interest rates will be high, and you'll face higher interest rates in general to buy a home or car, or renting an apartment can be difficult.
A low credit score or not much of a credit history at all doesn't necessarily mean you'll pay a high interest rate, but chances are you will because lenders see a low score as a sign of risk. The main risk is you won't repay the loan, or at least won't make on-time payments.
Establishing credit and keeping your score in the "good" range, if not "excellent," will allow you to qualify for more credit and better loan terms. A low score will have the opposite effect.
Credit score ranges
FICO Score calculates one of the main credit scores used by lenders. Credit scores from the FICO credit bureaus range from a low of 300 to as high as 850:
- 300-579: Poor
- 580-669: Fair
- 670-739: Good
- 740-799: Very Good
- 800-850: Exceptional
The average score for Americans is 710, according to Experian. In the mortgage example above from Bank of America, improving a credit score 50 points, from 620 in the "fair" zone to a "good" score of 670 could be enough to move your loan application from being challenging to be approved to approved with lower mortgage interest rates and fees.
How credit scores are calculated
Five data points are the main ways a credit score is calculated. Improving in any of them will raise a credit score, though better work in some areas will have more impact than others.
The five main factors, followed by the percentage they make up of a credit score, and a quick tip on how to improve them, are:
- Payment history: 35%. Pay your bills on time.
- Amounts owed: 30%. Borrow no more than 30% of your available credit limit, which is also called credit utilization.
- Credit history length: 15%. Don't close out old credit cards.
- Credit mix: 10%. Have various loan times, including installment loans with fixed monthly payments and revolving credit like credit cards.
- New credit: 10%. Don't apply for too many loans or credit cards at once.
Credit score effects on mortgage
A high credit score can save you thousands of dollars in interest over the life of a home loan. Bank of America gives an example on its website of how someone with a "fair" credit score may be charged almost double the amount of interest on a mortgage than someone with a "very good" score.
Its example is for a $300,000, 30-year fixed-rate mortgage:
With a high credit score, the homebuyer saves more than $93,000 in interest payments over the 30-year mortgage.
How to establish credit
You may be building credit without realizing it. Paying bills such as the phone, electricity, water, rent, and other everyday expenses are added to your credit file. Pay them on time, and you're building good credit. Make a few late payments or don't pay a bill at all, and you're establishing a poor credit history.
Paying your bills on time, as noted earlier, is the most significant way to establish and improve your credit history. Here are some other ways:
Use secured credit cards
A secured credit card is a simple way to establish credit and build it by making on-time payments on the card. It allows you to get credit on cash that you provide upfront as security.
After depositing $200 to $500 in an account tied to the card, you'll receive a credit card with a credit limit as high as your deposit. You get the deposit back when you close the card — unless you don't make payments on charges when the amount due is subtracted from the deposit.
Some secured credit cards allow $100 or so to be charged beyond the deposit amount, but only if your credit score warrants it.
You can build a credit score by using a secured credit card for a year and making on-time payments. After that, you should qualify for a regular credit card without a deposit and get rid of the secured card. It's a card you'll probably want to cancel, too, because most secured cards charge an annual fee. They're also holding your deposit as long as you have the account open, which is cash you probably want to use elsewhere.
Become an authorized user
This is a good way for parents to introduce their teens or young adult children into the world of credit and build good credit before they get their own credit cards. Your parents can add you to their credit card as an authorized user, which essentially gives you access to whatever their credit score is.
But if you don't make the payments or use too much of their credit limit, their score and yours could drop. You hopefully have good parents who will prevent you from doing such things. If so, then your credit history is being established as an authorized user, and you should have a higher score when you open your first credit card than someone without this advantage.
Watch credit utilization
Whether you have your first credit card or use a parent's card, you'll want to keep well under the card's credit limit. Also called credit utilization, it's a measure of how much of your available credit you're using.
Ideally, use no more than 30% of your credit limit. Remember the five factors we listed earlier that affect credit scores? Amounts owed is the second-biggest factor after paying your bills on time. Keep a balance below 30% of your credit limit, and you'll be building credit quickly. For a $10,000 credit limit, aim to keep your card balances at $3,000 or less.
Try a credit-builder loan
As the name states, if you have poor or no credit, a credit-builder loan can help you start building credit.
In exchange for taking a chance on a borrower with little or no credit history, a lender provides money from a credit-builder loan only after paid off in full. Your on-time payments are reported to the credit-reporting agencies, and you're creating a credit history. A good one if you don't have any late payments.
Credit unions and community banks often offer these loans. The money is put into a bank account held by the lender, and you make monthly principal and interest payments for six to 24 months before the loan is paid off, and you get the money.
Apply for an unsecured credit cards
If the ultimate goal is to get a credit card, you may want to skip any runarounds and apply for a regular, unsecured credit card to be your first credit card. It can't hurt to apply, even if you have no credit history.
Some credit card companies specialize in helping such people. They may have to pay an annual fee and have higher interest rates on balances than someone with a good credit score would, but if used wisely, a first credit card can be just the start you need to establish credit.
Look for a card without an annual fee and don't get a secured credit card. You may not get any credit card perks, such as reward miles, but you'll get more offers than you'll want when your credit score skyrockets.
Be sure to make your payments on time, pay off the balance each month to avoid interest charges, use the card consistently, and not charge more than 30% of your credit limit.
Enroll in Experian Boost
If you pay your cell phone, utility, and streaming video bills on time, using a free service called Experian Boost will raise your credit score. The boost may be enough to be approved for loans with lower interest rates.
On-time payments are the most significant factor in a credit score. Experian Boost uses on-time payments to Netflix, your phone company, and related services to raise your FICO credit score. Specifically, it can help increase a FICO 8 score, the credit scoring model used most widely by lenders.
You start by connecting your checking account to pay such bills and then choose which positive payment histories to add to your Experian credit report. People without a credit history are most likely to see such on-time payments raise their credit score.
Only positive payment history is pulled, and it won't report any negative information that could lower a credit score.
Experian is one credit bureau, and this boost will only affect a FICO 8 score. Not all lenders use this scoring model. The other two major credit bureaus — Equifax and TransUnion — aren't part of the Experian Boost, so lenders that use those two credit bureaus won't see the effects.
See How Much Experian Boost™ Can Raise Your Credit Scores Instantly
- Experian® is one of the three credit bureaus providing your credit scores
- Experian Boost is a free feature that can help you increase your credit scores for making on-time payments for your phone, utility, or streaming service bills for 100% free and in minutes
- Average users who received a boost improved their FICO® Score 8 based on Experian Data by 13 points. Some may not see improved scores or approval odds. Not all lenders use credit information impacted by Experian Boost™.
- Credit score calculated based on FICO® Score 8 model. Your lender or insurer may use a different FICO® Score than FICO® Score 8, or another type of credit score altogether.
Pay rent on time
Utility and rent payments weren't always reported to credit bureaus. They are now making it essential to pay your rent on time.
Not all landlords report rent payment histories to credit bureaus, with large property management companies most likely to.
Pay car loans on time
A car loan is among the many types of loans reported to credit bureaus and can affect your credit score.
Car loans often last years and are for high amounts. Both factors can work in your favor if you make payments on time and don't default on the loan.
Repay student loans
Repaying student loans on time and in full is another way to show creditworthiness. Student loans are easier to qualify than other types of loans.
Student loan payments usually aren't due until after graduating from college. Once you start making payments, then you'll start building credit. A year or so of regular payments should make it easier to get another line of credit.
Get a co-signer to help with a loan
A car loan or a personal loan can be much easier to be approved for if you have a co-signer. This is usually a parent or relative with a good credit history who accepts equal responsibility for the loan.
If you don't make the loan payments or default on loan, the co-signer is legally responsible for covering the costs and paying off the loan. Their credit will be damaged, as will yours as the primary borrower.
But if you repay the loan on time, it will be reported to the major credit bureaus, and your credit score should rise.
Related: Should You Co-Sign a Loan?
Get your free credit score
A simple way to improve your credit score is to check it for mistakes at least once a year. A free credit score and report can be checked annually at annualcreditreport.com. It's the only official website directed by federal law to provide credit reports for free.
If you time your requests right, you can get a free copy of your credit report every four months. Federal law allows one free copy every 12 months from each credit reporting company. Since there are three of them — Experian, Equifax, and TransUnion — you can request one from a different bureau every four months.
Check that your information on the reports is accurate and updated. This includes the correct spelling of your name, checking for fraudulent accounts that were opened in your name, and incorrect debts.
Costs involved in establishing credit
Good credit habits such as paying bills on time and not maxing out your credit cards can help you establish and improve your credit score. Some costs, however, can still creep in and should be avoided if possible. Here are some to be aware of:
Credit card fees
A secured credit card or regular credit card will often have an annual fee. This fee does nothing to serve you and is simply a way for a credit card company to make money. The average annual credit card fee is $35, according to US News.
Annual fees can be offset with benefits, such as a free hotel stay, airline miles, or even cash back. Those perks may be worthwhile to you if you often travel or spend enough money each month. But if you don't, then a no-fee card may be best.
Credit cards also charge late fees for making a payment late. They average $36. If you don't have enough money in your bank account and the payment is returned, the average returned payment fee is $34.
The average interest rate on a credit card is 16.75%, and the lowest APR, or annual percentage rate, is an average of 12.06%. On a $1,000 balance that's rolled over for a month, that's $167.50 and $120.60, respectively, in interest charges. Avoid them by paying your credit card bill completely each month.
Car loans, student loans, mortgages, and personal loans all carry interest rates too. Be aware of what the monthly payment will be before you agree to a loan, and ask if there's a payment penalty for paying off a loan early.
According to a credit repair company, having excellent credit can get you a car loan at 3% interest or less, while poor credit can lead to paying 15% interest.
A $19,708 loan with a 64-month repayment term would have these total interest costs for different credit scores:
|Credit score||Total loan interest|
Pros and cons
- Cheap credit. An improving credit score will make your financial life a lot easier. You'll qualify for credit cards and loans at low interest rates.
- Less debt, more income. With cheaper access to money, you can avoid extra debt. This can allow you to put that savings into investments.
- Lenders will seek you out. For better or worse, lenders will likely contact you with loan offers when your credit score rises. You're now seen as a good credit risk, and the offers may come in quicker than you can think about them. Avoid extra debt if you can, though adding a credit card that gives you bonus miles so you can go on a free trip next year can be enticing.
- It can be a lot of work. Raising your credit score isn't easy. It requires a lot of discipline with your money, such as knowing when bills are due and ensuring you're not spending more than you earn. Finding a co-signer, being an authorized user on a parent's credit card, and taking out a credit-builder loan, among other things, require responsibility and paying for something that you may not see the reward for in a year or more.
- Being vigilant for identity theft. Checking your free credit report is a pro and con but can be seen as a con if you don't want to spend the time checking your credit score at least once a year. However it's a key way to look out for identity theft and can help you avoid drastic dips in your credit score.
- It may discourage saving and increase debt. While this isn't true in all cases, having access to more credit can lead you to use it more often. There are many stories of people having too many credit cards and running up debts they can't afford. The average millennial has more than $4,000 in credit card debt. Paying off credit cards and other debts can make saving harder.
The bottom line
The problem of establishing credit when you don't have any isn't too hard to overcome. A secured credit card, co-signer, and becoming an authorized user on someone else's credit card are simple, inexpensive ways to build credit.
Just be sure to make the monthly payments on time and pay the loan off by the due date, and you should be well on your way to a credit score that can make future access to credit a lot easier.
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