Having a credit score is essential if you hope to one day rent an apartment or take out a car loan or mortgage on a new home. That magic number between 300 and 850 from one or more credit rating agencies (Equifax, Experian, and TransUnion) is one important way potential lenders determine the likelihood that you will pay back the money you borrow on time, and in full. If your number is high, you’ll have access to more lenders, and will likely get lower interest rates on any money you do eventually borrow — which could potentially save you thousands of dollars in interest over the course of a lifetime.
But what if you don’t have a credit score at all?
According to a report by the Consumer Financial Protection Bureau (CFPB), 26 million Americans are “credit invisible” meaning they have no credit history whatsoever.
If you’re younger, you’re more likely to be in this group. The CFPB also found that 80% of 18 and 19 year olds were credit invisible, while 40% of individuals age 20 to 24 were in the same boat. This is in large part because younger consumers have not had time to establish a credit history.
While many people build their credit by using a credit card, you often have to have a credit history in order to get a credit card in the first place. Alternatively, maybe you’ve heard horror stories about friends who are up to their eyeballs in credit card debt and don’t want to suffer the same fate. The good news is that to escape this seeming catch 22, there are several options available to build your credit without necessarily using a credit card.
We’ll review how you can build your credit without a traditional credit card, and also how you can ensure that your score is as high as possible. That way, when you finally do go to take out that auto or home loan — or whatever future life goal that requires a great credit score — you’ll be ready.
What Tools Are Available to Help You Build a Credit History?
If you don’t yet have access to a credit card, or prefer not to use one, there are still several options available when you’re building credit.
1. Secured Credit Card
If you’re just starting out and would like to build credit with a credit card but don’t yet have a long enough credit history to apply for a traditional credit card, you might want to consider applying for a secured credit card.
With this type of card, you make a cash deposit upfront to the issuing company when you open your account, perhaps $1,000. This deposit serves as a type of collateral for your credit limit, so if you don’t make your payments on time — which you always should — the lender can draw from this deposit to make up the difference. (You will get this deposit back when you close the account.)
Because the bank or credit card company issuing the secured credit card is taking on very little risk, you will likely qualify for this type of account — even even if you don’t have an established credit history or meet the requirements for more traditional credit card accounts. While a secured credit card doesn’t offer the benefits of a shiny Visa Signature card, such as cash back and rewards points, it presents the opportunity to reap the rewards of good credit down the road.
You should hold this card for at least one to six months — the minimum amount of time you need for FICO or VantageScore to report a credit history — in order to ensure you have a credit report on file with the U.S. credit bureaus. Then, if the score reported is good enough, you can ask your bank or credit card company for a more traditional credit card that offers more benefits.
2. Take Out a Credit Builder Loan
Another option is to take out a specific type of personal loan that is designed to establish or improve your credit history — a credit builder loan. These loans are usually issued by credit unions or community banks in small increments of a few hundred dollars. In essence, they’re a kind of a credit habit training program.
Unlike traditional loans where the bank gives you the money up-front and you pay it back over a specified period of time, credit builder loans work in reverse. Let’s say you want to take out a $600 credit builder loan at 2.5% interest with a loan term of six months. In this case, the bank or credit union would accept your monthly payments of $100 plus interest for six months and hold them in a bank account — usually a Certificate of Deposit (CD) or savings account — for you. Once you’ve paid the financial institution the full $600 for your loan, they will issue you the amount in full.
The benefit of this unique type of loan for the financial institution is that the bank or credit union is taking on very little financial risk, as they haven’t actually parted ways with any money until you’ve already paid off the loan. As a result, no upfront credit score is required. However, because each of your payments is reported to the major credit bureaus, at the end of the credit builder loan, you’ll have a credit score that is all your own.
3. Get a Co-Signer
If you find yourself in a situation where you might need to provide a credit history in order to move forward with a purchase or a life change — perhaps you’re in need of a loan right now, or want to sign the lease on your first apartment — there is another option. You can ask someone you know who already has a credit history to co-sign the loan or the lease with you. But be aware that if you don’t make the required payments on time, your co-signer is on the hook for the full amount owed.
4. Leverage Your Rent History
If you’ve already been able to rent an apartment, you might also be able to use your monthly rent payments to establish a credit history. There are several rent reporters, such as Rental Kharma and RentTrack, that will report your rental payment history to the credit bureaus, effectively using a bill you already pay to help you establish your credit history.
5. Become an Authorized User
On the other hand, if you don’t want to open any new accounts yourself, you can become an authorized user on a family member’s credit card account. With authorized user status, you can use the credit card to build your credit history, but are not legally obligated to pay the charges you incur.
Before you decide to go this route, there are two things you need to be absolutely sure of:
- That the credit card issuer reports all user history to the credit bureaus.
- That you’ve discussed with your family member who is responsible for paying for the purchases you add to the card’s monthly balance.
The first point is important because if the credit card issuer doesn’t report your activity, your efforts may be in vain. Meanwhile, the second is critical if you want to remain on good terms with the generous soul who allowed you to build that credit in the first place.
6. Federal Student Loans
Finally, if you’re like 33% of millennials with a student loan balance, you might be able to use that debt to your advantage. While making your monthly loan payment is definitely not fun, if you borrowed the money through the federal government, they might at least help you build your credit history. This is because federal student loans appear on your credit report, and if your loans are in good standing with a history of on time payments, it can help you demonstrate to future lenders that you are a worthwhile risk. Don’t miss your payments to Uncle Sam!
How Do You Ensure You Have a Good Credit Score?
If you’re going to go to the trouble of building your credit history using one of the methods listed above, you’ll likely want to make sure that at the end of all your efforts you have a good credit score. After all, having bad credit or even poor credit is often just as limiting when it comes to taking out home or auto loans as having no credit at all.
To ensure that your credit score is as high as possible, it’s important to understand how the two primary credit scoring systems, FICO and VantageScore 3.0, determine that score. When looking at your credit history, there are five factors that play a role in assigning you a credit score. Below, the criteria is listed, along with the percent it contributes to your overall FICO score:
- Payment history (35%)
- Credit utilization (30%)
- Length of credit history (15%)
- Type of credit (10%)
- New credit/inquiries (10%)
Based on these criteria, the three major credit reporting bureaus will then assign you a credit score between 300 and 850. Now, if you’re just beginning to build credit, you will have little control over several of these criteria, so it is essential that you focus on a few items: your payment history, your credit utilization, and keeping new credit applications (for other credit cards or personal loans) to a minimum.
1. Make Your Payments On Time and In Full
This is critical to building good credit, and late payments could eviscerate a burgeoning credit score. In fact, this factor comprises 35% of your total FICO credit score. And if you’re just beginning to build credit, it’s even more important. After all, being able to prove you can responsibly repay money is what the majority of lenders care most about.
2. Don’t Use All the Credit Available to You
Another factor that affects your credit score is your credit utilization ratio. For instance, if you’re approved for a credit card with a $10,000 line of credit, then you have $10,000 worth of available credit.
However, you shouldn’t spend every cent of that $10,000. Instead, most personal finance advisors recommend you keep your credit utilization ratio low — ideally at less than 6%. In the case of a $10,000 credit line, that would mean spending only $600 per billing cycle.
3. Minimize Inquiries on Your Credit History
Although banks and credit card companies make money when you borrow from them, they get concerned when you seem to borrow too much or apply for too many credit accounts.
If it appears like you’re shopping for the best credit card or loan for you, meaning the inquiries on your history appear within a brief period like 30-45 days, then the credit bureaus might consider that one inquiry instead of many. But if you apply for several credit accounts over many months, the bureaus might think that your risk profile is increasing because you’re seeking more debt — and penalize your credit score as a result.
How Do You Check Your Credit History and Score?
Once you’ve begun to build your credit, you should be aware that it takes a bit of time to build enough credit history to actually receive a score. In fact, according to Experian, receiving your first credit score can take anywhere from three to six months.
Once you’ve waited the appropriate amount of time, you can easily check your score online by visiting the credit bureau’s website, usually for a fee. On occasion, the credit bureaus — Equifax, Experian, and TransUnion — promote their services with offers of free credit histories with or without credit scores.
There are a number of websites, such as FreeCreditScore.com, CreditCards.com, AnnualCreditReport.com, and CreditKarma.com, that will provide you with a free copy of your credit report and the accompanying score — but note that these websites are also compensated for any ads you click on or credit products you apply for from their site. Remember that each credit inquiry or new credit account can negatively impact your credit score, so be careful if visiting these sites.
For this reason, we recommend you check with the credit bureaus first, and take advantage of any of their offers to obtain your credit report. Legally, you are entitled to one credit report from each of the credit bureaus each year, but not with your credit score. Still, you can view any credit inquiries and ensure your on-time payments are being reported accurately, and take action if you find any issues.
Maintain Your Credit and Improve Your Score for a Brighter Future
Establishing credit and ensuring you have a good credit score is one of the most important steps you can take toward securing a bright financial future for yourself and your loved ones. Like it or not, good credit is essential throughout your life if you want to achieve some of those important life milestones many Americans dream of, such as buying a house or a car.
Fortunately, you can build your credit history and improve your credit score with or without a credit card. With many options available, you can feel confident as you set out on your credit-building journey.