Even if you’re not looking to borrow now, building a credit history is one of the most important financial planning steps you can take now. A good credit history can save the average borrower over $250,000 in their lifetime. After coming of age during the 2008 financial crisis, many millennials — now in their mid 30s — have avoided credit cards and debt of any kind, instead using debit cards and cash. As a result, many have little credit history.

Building a Credit History Takes Time

It takes time to build a strong credit history, as credit reports are backwards looking and typically cover the past 7-10 years. If you’re thinking of financing a major purchase in the coming years – like a car or house – you’ll want to began laying the foundation now.

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You Don’t Have to Go Into Debt to Build Credit

The myth that you have to go into debt in order to build a credit history / get a good credit score is an enduring one. While the information (“tradelines,” in industry speak) on your credit report reflect your payment history, you don’t have to carry debt (and pay interest) month to month build your credit history.

What are the best products to build a credit history?

With credit card issuers tightening credit policies in response to the coronavirus pandemic, the chances of being approved for a traditional credit card, if you have little to no credit history, is low. If you bank with a credit union (or are eligible to, through an employer, school, or union affiliation), check their website or call a membership advisor to see if they offer any credit builder products. Otherwise, your best options are a secured credit card or credit builder loan.

Secured credit card

With a secured credit card, you pay a refundable security deposit to the card issuer, which will typically be equal to your credit line. This “tradeline” and your payment history will be reported to the credit bureaus, building your credit history.

Once the security deposit is paid, the card operates like a traditional credit card — meaning you could carry a balance that would accrue interest (we don’t suggest doing this). Instead, to build your credit history without accruing debt, pay any balance in full each month.

Two key things to keep in mind to build a positive credit history: always make your payment on time, and keep your credit utilization (a key factor in your credit score) below 30%. That means if your credit limit is $1,000 (a $1,000 deposit), your balance at month’s end shouldn’t be more than $300.

If you’re worried about temptation, setup a single bill (like a cell phone bill) to be paid with the card automatically each month AND set the card to be automatically paid by your bank account. Let’s say your credit limit is $500 and your cell phone bill is $50 — you’ll have a 10% credit utilization ($50 / $500 limit) and an on-time payment each month, which will build a positive credit history.

Reputable secured cards will re-assess your account after 6-12 months, and either increase your credit limit (without requiring more deposit) or refund part or all of your security deposit.

Key things to look for in a secured credit card:

  • Reputable credit card company. There are a LOT of questionable companies that offer secured cards. Stick to a well known company like CapitalOne or Discover, both of which offer secured cards.
  • Watch for fees. Look for a card with no annual fee. And you should never pay an application or “activation” fee.
  • Verify the card reports your payment history to all three credit bureaus (Experian, Equifax, and TransUnion).
  • Pay your bill in full each month. You are able to carry a balance on a secured card – but it will accrue interest charges, the same as a normal credit card. Avoid this and build your credit history without going into debt by paying your charges, in full, every month.

Credit builder loans

Credit builder loans are kind of a “reverse” loan, designed specifically to help build credit. You apply for the loan and, once approved, the proceeds are paid into a holding savings account (rather than to you). You make monthly payments, which should be reported to all three credit bureaus. Terms are usually one year, but can be shorter or longer. At the end of the loan, the balance is transferred from the savings account to you. Note that this type of loan typically does carry some type of fee and/or interest rate.

Credit builder loan quick facts:

  • Designed specifically to help build credit.
  • Usually offered by credit unions, CDFIs, or other specialty organizations.
  • Loan amounts $300-$1,000 paid back over 6-24 months.
  • Typically carry an account opening fee (equivalent to 1 monthly payment) or interest (usually around 10% APR)
  • Should report to all three credit bureaus
  • May go by other names, like “Fresh Start Loan” or “Starting Over Loan”

When Building Credit, Focus on the Basics

Whichever route you choose, remember the basics. For either of these products to help, you must still make your payments on-time, every time. If you choose the secured card route, pay your balance in full every month to avoid paying interest charges. For either product, shop and compare, as not all lenders are created equally – particularly for secured card products.

Have a personal finance question?

We’re here to serve you. Send us your personal finance questions, and we’ll address them in upcoming posts.

photo: Ruth Enyedi on Unsplash