Today, October 20, is Get Smart About Credit Day, and we’re walking through the basics of establishing and building credit. Though it may seem daunting to start, with patience, you can build not only your credit but your financial confidence and security.
Building credit is important for overall financial success. If you’ve never had credit before, it is important to remember that the process takes time. A lack of credit can feel isolating, but know that it is a problem faced by many (approximately 45 million Americans have no or low credit), and there are many ways to establish and grow your score.
Your top three options for establishing and building credit
Building credit means gaining access to at least one of the following three common credit lines:
- Personal loans
- Credit cards
- Auto loans
These three top the list because they are the most attainable for people who have no or low credit access. All three lines of credit are easiest to access through a bank or credit union where you already have an account.
A personal loan typically has the highest interest rate, but a fixed term to complete full repayment. This will make it easier for you to budget and plan your repayment of the loan, which in turn will boost your score. Personal loans can be used for a variety of things, like home repairs or medical needs. Personal loans offer a lot of flexibility but must be paid back on time.
Credit cards are a more common way to build credit. You could start by becoming an authorized user on another person’s account – like a parent or spouse – and then branch out to a card of your own. Remember that as an authorized user, you can have an impact on your cosigner’s credit score. Only go into a venture like this with someone you trust.
- If you have low or no credit, but do have cash on hand, a secured credit card may be easier to qualify for. With secured cards, you put down a cash security deposit (usually equaling your credit line). The bank will hold that deposit as you use your card. You’ll get the deposit back once you pay off your bill.
- In the case that you don’t have extra cash for a secured card, you can open a more traditional unsecured credit card. These cards require no deposit, though may be harder or more expensive to qualify for as someone with low or no credit.
Regardless of the card you choose, you should still remember to:
- Shop around for low APR, interest rates, and fees.
- Find a card with tangible benefits that meet your needs.
- Pay the balance in full every month.
If you need a vehicle to get to your job or to school, taking out a car loan is a logical way to build credit. Very few people can afford to pay cash for a new or used vehicle, and this is true even when the vehicle is your sole source of transportation. Because of this, dealers may offer more affordable financing options that can help build your credit.
You can secure an auto loan from a variety of places (including dealerships, banks, and online lenders), all of which will report your timely payments to the three credit bureaus, Experian, Equifax, and TransUnion.
How to decide where to begin?
Evaluate what type of loan makes the most sense to you. Don’t need a car? You can rule out an auto loan. Want to remove the risk of overspending? Budget out the price you can pay back on a personal loan and resist the temptation of overspending on a credit card.
Low interest rates and APR are the first things to look for. If you’re going to borrow simply to build credit, you want to accomplish that as cheaply as possible.
Most loans include interest (the additional amount you’ll be charged for borrowing the money) and APR (or the fees charged for taking out a loan, also known as an Annual Percentage Rate). Some credit cards offer 0% introductory interest rates, and if you can nab one of those, that’s a fantastic place to start.
If you were already looking for a car, be on the lookout for auto loan lenders who offer 0% interest for a few months or a very low rate over a longer period. These can be great options if you’re able to keep up with the monthly payment. If you’re able to pay off the loan even faster than required, you’ll be building your credit history and paying less in interest.
Pay off your statements in full
You can avoid paying interest on a loan – the catch is to always pay those cards in full and not leave a balance on the card (especially after an introductory rate is over). After that period is when the real fees can kick in, and they can be quite high. While your instinct might be to close the credit card after the intro rate has come and gone, you’ll want to keep it open for a while – even if you barely use it. Learn more about managing credit and common credit mistakes.
Play it safe
No matter the product you choose to build credit, be sure to play it safe. Don’t overspend, and always pay on time. You want to build a positive credit history, and late payments over a short credit history do the opposite. Paying on time and borrowing responsibly will make it easier to get competitive rates on your next loan.
When in doubt, a secured credit card is a great way to ensure you’re covered. Although these function more like a debit card, the payments still get reported to the credit bureaus. Paying consistently allows you to build your credit safely.
Feeling smarter about credit? We’ve teamed up with Freddie Mac to bring free credit and financial education courses to everyone. Check out CreditSmart® Essentials in our Credit Education hub.