How to Establish a Credit History
Credit is one of life's great Catch-22s. Let's say you've just graduated high school and want to get your first credit card. You dutifully fill out the forms and wait for a reply from the issuing bank, only to find out a few weeks later that you've been rejected. Why? Because you don't have a credit history. But how do you establish a credit history? Well, you get a credit card, of course.
It's a frustrating conundrum, but luckily there are a few easy and cheap methods to build a credit history.
Review Your Credit Report
First, make sure that you truly have no credit history by getting a free copy of your credit report. You might be surprised to find that because of a gym membership or a student loan, you actually do have a credit history. It may be for a very short duration, but it may be all you need.
If you've recently been rejected for a credit card, you have the legal right to request a free copy of your credit report from the agency the credit card company used when checking your credit history. The three major credit reporting bureaus are Equifax, Experian and TransUnion. Even, if you haven't recently been rejected for a credit card, you can still get a free credit report. Federal law allows you to obtain a free copy of each agency's report once a year. You can do this through AnnualCreditReport.com.
It isn't necessary to pay to see your credit score (or lack thereof) — if you need to know your score or are just curious — you can use a free online credit-score estimating tool to get a general idea of your score by answering a series of questions.
(To learn how your credit report is calculated read Consumer Credit Report: What's on It.)
Getting Access to Credit With a Limited History
"Sin writes histories. Goodness is silent." Unfortunately, these famous words from Johann Wolfgang von Goethe often ring true in the area of credit reporting. While it would seem that having no credit is a good thing because it can indicate that you've been financially solvent enough to pay cash for every purchase you've ever made, lenders want proof that if they give you money, you won't take it and run.
If you've established that you definitely don't have a credit history or if a short history hasn't been enough to get you approved for a traditional credit card, here are some of your options.
Get a Card Through the Bank Where You Do Your Checking
You may not have a credit score, but you do have a financial history with your bank that could help you get approved for a card. At the very least, you may be able to get a secured line of credit, meaning that the funds from your bank account can be used as collateral if you fail to pay off your credit card bill or a secured credit card. An ordinary credit card is considered an unsecured loan because there is no collateral attached to it. Secured loans are very common, however. Auto loans and mortgages are both types of secured loans. Your credit limit on a secured credit card may not be very high, but you have to start somewhere. Once you've established a good track record, you should be able to get an ordinary, unsecured credit card.
Note that while many debit cards have credit card logos on them and function just like credit cards at many stores, these do not help you establish credit because the money always comes directly out of your checking account. There is no loan involved.
(To learn more, check out Credit, Debit and Charge: Sizing Up the Cards in Your Wallet.)
Apply for a Store Credit Card
Store credit cards generally have low credit limits and more lenient approval requirements. It seems like every store these days has a credit card. These cards often come with an account-opening bonus such as ten percent off your first purchase. So, the next time you need to buy something from your favorite store, consider taking advantage of their credit card offer to help establish credit. Just make sure you have enough money to pay the bill in full when it arrives, as interest rates on store credit cards are generally higher than you may expect. Don't forget that you're trying to establish good credit. If you don't get approved for one store's card, that doesn't mean you won't get approved for another, so just try elsewhere.
Finance a Store Purchase With a Same-as-Cash Offer
Especially around the holidays, stores often let you purchase items on credit with a deal that allows you to pay no interest for a set period of time — usually for 90 days. Since this is a type of loan, it can help you establish good credit if you pay it off on time. To avoid paying interest or hidden fees, make sure to pay this loan off before the allotted period expires and make sure to read the fine print before signing up. Offers like this can be found both in-store and online.
(To learn more, check out How Credit Cards Affect Your Credit Rating.)
Should You Take Out a Small Loan to Build Credit?
One somewhat poor piece of advice often given to those with no credit history is to take out a small loan from the bank and pay it back on time. This is a bad idea because it is a waste of money. You'll have to pay interest on that loan, and no matter how good the interest rate is, why pay to borrow money that you don't even need? It isn't necessary to pay interest to establish good credit, and the only debt you should incur to establish credit is the very temporary kind that occurs between the time you charge a purchase to a credit card and a couple of weeks later when you pay the bill in full.
Be Careful About Taking on Car Loans
Another bad way to establish a credit history is by purchasing a vehicle from a dealership that advertises "Good credit! Bad credit! No credit at all!" If you currently lack a credit history, you're already doing better than a lot of people because you are probably debt-free. Don't ruin that sense of financial security by incurring thousands of dollars in debt to buy a car. An expensive car is not a necessity, and you'll almost always be better off financially if you stick with whatever vehicle you can pay cash for.
However, if you are already planning to buy a car with cash through a dealership, you can go ahead and take out dealer financing to purchase the vehicle, and then pay the loan back in full after you've made just one monthly payment. This way, you'll pay minimal interest, but you'll establish a reportable history of using credit responsibly and making a payment on time.
Some people have even gotten better deals on vehicles this way because the dealership makes so much of its money from financing auto loans. They might give you a lower total price if they think they'll be making interest off of you, so even though you'll have to pay a month's worth of interest under this plan, you'll probably come out ahead because of the lower price on the vehicle. Just make sure that you understand the loan terms and ensure that there is no prepayment penalty before you sign on the dotted line.
While this tactic won't help you with the length-of-credit-history component of your credit score, it might give you the boost you need to get an unsecured credit card that you can hang on to for many years.
(Find out about alternatives to playing the credit game, see Can You Live a Debt-Free Life?)
Why Credit Is a Poor Substitute for Cash
Once you have credit, make sure to use it responsibly. One of the factors that makes up your credit score is the length of time your accounts have been open. Even if you prefer to pay cash for all your purchases, merely keeping your credit card account open will help you achieve that high credit score you're looking for. Also, make sure to pay your bills in full and on time, and don't open more cards than you can keep track of.
Being turned down for a credit card is frustrating, especially when it's because your credit history is merely a blank slate, but it's a barrier worth breaking. Once you're eligible for a regular, unsecured credit card, you can save thousands of dollars over your lifetime by using rewards credit cards responsibly. Also, if you ever plan to take out a mortgage to buy a house, having an excellent credit history will help you get the lowest interest rate available. Even if you'd rather not deal with credit, taking some of the above actions to begin establishing your credit history is a wise financial move.