Building credit for first time

Learn everything about building credit, credit reporting agencies, credit and debit cards, best ways to go about it along with case studies under one roof.

Updated by Taskeen Fatema on 14th October 2019

Don’t hassle yourself with the worry of being late in line to build good credit, you are never too late if you have the right guidance and direction. Whether you’ve just turned 18, or are in your early or late 20’s, vex not, you are now in the right place and might I add, at the right time. If you go to see, this is a win-win situation as you get dual benefits- learning how to build solid first-time credit will inculcate in you, good and steady financial habits for the long term.

Most millionaires have also begun from scratch with no or minimal credit history, so if you are in this position at this moment, convince yourself that you’re on the right track. And if you aren’t yet confident enough, the next 15 minutes ought to change that.

Just like how you need money to make money, you need credit to make a credit history.

We are here to break the myth that credit scores are the most confusing aspect of personal finance. Make a personalized agenda as per your financial habits, nature, and capabilities, and follow the same steadily without defaulting or making any out-of-the-blue dents, and voila, you’ll soon be bragging with a smile of how reaching a good credit score so fast was such a smooth ride without much botheration.

Let's begin with the basics, all that you need to know before making any decisions.

Table of Contents


What is credit?

Once you have set your aim at building credit, for the first time, there are few things that you have to be mindful about. First, let’s focus on some terminology. Here are some of the main terms you need to know when it comes to building credit:

1) Credit: Money that has been lent to you by a financial institution.

2) Creditor: A financial institution, retailer, or other company lending you money via a loan or line of credit.

3) Credit Report: A report that reflects the credit accounts you have, your payment history, your balances, and other key information that reflects your borrowing behavior, basically your entire financial background.

4) Credit Reporting Agency (CRA): Also known as a credit bureau, it is the organization that compiles and maintains your credit report by corralling all your past debt and loan details that are reported by other companies.  The three most commonly known bureaus in America are Experian, TransUnion, and Equifax.

5) Credit Score: A score of your behavior as a borrower, not to be confused with your credit report. To understand better, it's sort of like a student’s GPA, only here, it acts as a transcript of one’s financial life. It’s a three-digit number that’s calculated using the info in your credit report and it gives lenders a quick snapshot of how healthy your credit is. (It’s also not on your credit report.)

6) Debt to Income Ratio (DTI): While credit reports and scores are major, they actually aren’t the only factors lenders may take into account when you apply for a loan. Your debt-to-income (DTI) ratio, or the amount of money you owe compared with how much you earn, can also play a role. Simply put, your DTI is the percentage of your monthly income (before taxes) that goes toward paying all your debts.

7) FICO and VantageScore: These are the two top credit score developers in the U.S.

8) The Fair Credit Reporting Act (1970): This act addresses the fairness and privacy of the information contained in your credit report. It legally binds CRAs to only report accurate information on your credit file, among other things.


Best Options To Build Credit For The First Time

We have listed some of the most viable options that you, as a student can opt for if you are in the beginning stages of building your credit.

1) To become an authorized user with a family member

One of the easier options to be considered while building first time credit is to take the help of a family member, whether a parent or significant other or a guardian, by asking them to add you to their credit card account as an authorized user.

Ensure that you’re being added to the account as a fully authorized user, as some companies will issue extra cards in different names but only tie the account to one owner. (which means that they will ask for your social security number while adding an authorized user, if not, then this may not help you in an intended way)

After this, as long as they keep paying their bills on time, you will start to build credit. (But it goes both ways, if they stop paying, this could actually hurt your credit! Therefore, proceed with caution)  

Primary Cardholder

Ask the primary cardholder to find out whether the card issuer reports authorized user activity to the credit bureaus. That activity generally is reported, but you’ll want to make sure — otherwise, your credit-building efforts may be wasted.

The biggest perk here is you don’t even need to use or even physically possess the card. Instead, you can enjoy a budding credit score just by having your name on the account. 

2) Use a co-signer to get a loan

Another method that involves getting the help of a family member is by using them as a co-signer in order to open a loan account or to get an unsecured credit card.

In simple words, if someone co-signs a loan for you and you don’t make timely payments, your co-signer’s credit will suffer along with your own. If you default on the loan—meaning you stop paying altogether— your co-signer is legally responsible to repay the debt.

Don't take out a personal loan for the sole purpose of building credit. Loans come with interest rates AND origination fees (the cost to process the loan). So you'll be paying extra even as you repay the loan. Only take this route if you actually need the loan, like when you're buying a car. 

3) Obtaining a secured credit card

Getting your first credit card or loan from the same provider with whom you already have an existing bank account is always the choice to go for especially if you already have a history of doing good business with the bank, they know you and value that business.

That existing relationship can carry some weight when it comes time to get your first line of credit although you don’t need a credit history as such to obtain a secured credit card as the approval process is rather easy.

Why is it called 'secured' credit card?

Some banks offer credit cards for those who want to establish, strengthen or even rebuild their credit. It’s called a secured credit card because you secure the amount you borrow with a security deposit. In other words, a sort of collateral is provided, by depositing money upfront in an account with the bank, something the lender gets to apply a portion of, or all, should you default.

Your credit line is equal to the amount you deposit. (If you deposit $500, you’ll get a credit line availability of $500). You won’t be able to touch that money of course or use it to pay off your balance, and you’ll still have to prove to the bank that you have sufficient income to pay the credit card. Since this would be your first card to build your credit, you’ll want to make sure that once active, your lender will report all those on-time payments to the bureaus before you apply.

Is secured credit card the same as a pre-paid card?

The concept may sound similar to that of a pre-paid card, but pre-paid cards don't report to credit bureaus.

Secured credit cards are definitely not meant to be used forever. The sole purpose of a secured card is to build your credit enough to qualify for an unsecured card — a card without a deposit and with better benefits. Its like training wheels before you move onto the regular credit card system.

If you’re a full-time college student or looking to build or rebuild credit, this one’s the option for you. These cards are designed to approve students and you can upgrade them when you graduate. Most don’t have the lowest APRs or best rewards out there, but you’ll have a good shot at the beginning to build better credit.

TIP! - A great way to build credit would be to put a small charge on your card each month (like a Netflix subscription,) and set an automatic payment to be paid in full. That way you'll be staying well below your credit limit and establishing a history of on-time payments.

4) Credit Cards

After the responsible usage of a secured credit card for a certain amount of time, the user can upgrade to a traditional credit card.

As opposed to a debit card that doesn’t build credit, the use of a credit card has potential rewards if utilized appropriately.

Once you either close your secured credit card or upgrade to a traditional credit card, you’ll get your security deposit back as long as your balance was paid in full. Even though the credit limit is now high, don’t let it tempt you into spending more than before. Now, more than ever, it’s important to maintain those good credit habits you worked so hard to develop.

5) Store Credit Card

Store branded credit cards are also an option but only if you are not prone to having frivolous spending habits. These cards typically have lower credit limits in comparison to major credit cards. That means stores are willing to approve applicants with less credit history.

If you get a store credit card, make a small purchase that you can immediately pay off and keep this practice on every few months, in order to keep a build a credit history. Remember never buy more than you can afford to repay and never forget to pay the bill either!

As long as this is done, it really doesn’t matter which store card you get, because there is no question of interest payment here. But some store cards are better than others because you can avail ongoing discounts—and not just on the day you sign up.

6) Applying for credit builder loan

These are small personal loans, offered by some lenders, designed for anyone new to credit. The repayment of such a type of loan in a timely fashion will help you build credit, but come at a cost.

Typically, the money you borrow is held by the lender in an account and not released to you until the loan is repaid. You can call it a forced savings program of sorts, wherein your payments are reported to credit bureaus. These loans are most often offered by credit unions or community banks, and at least one lender offers them online.
The interest rate is typically a bit higher than the interest you’re earning on the account, but it may be significantly lower than your other options.

What is Self-Lender?

A fairly unique program that allows you to take out a loan and re-pay yourself is Self Lender. Loans range from $500 to $1,700 and the term of the loan is either one year or two years.

The idea behind Self Lender is straightforward, you open a loan, repay yourself and show the credit bureaus you are responsible with credit. It is like a test-yourself program to exhibit that you’re now accountable enough to be trusted and given a better credit rating.

There are certain costs to use Self Lender, but its less expensive keeping in mind that the end result is an improved credit score. 


How to avoid leaning towards a bad credit score?

Now that we have a basic understanding of what a credit score is, and the various ways in which one can build up a good score; lets look into all the probable factors that determine your credit score.

Payment history (35%): Whether you pay bills on time and/or carry a balance.

Credit utilization (30%): The amount of credit you're using compared to the total you've been given.

Length of your credit history (15%): How long you've had credit accounts and the activity involved.

Types of credit (10%): The kinds of credit you have (credit cards, car loan, student loan, etc.)

New credit (10%): Number of inquiries and/or new applications for credit. Too many inquiries can hurt your FICO score, since that could indicate you're trying to borrow money from many different sources.

It is but obvious that if your score is bad, lenders will not be as willing to give you a loan. Or rather may charge a higher interest rate, which could translate into thousands of dollars more over the course of the loan, and that, we definitely do not prefer.

NOTE: Age, occupation, income, employment history, and marital status don't impact your credit score. But a lender may take these things into account when deciding to offer you a loan.


Top Financial Priorities For Every Young Adult

There are certain habits that young individuals must inculcate in themselves to ace the credit building area, and in turn, financially secure their career and future. 

1. Practicing good credit habits and avoiding debt

This begins by making 100% of your payments on time, with all the accounts that you hold, be it credit accounts or even utility bills. You can automate your bill payments in order not to cross the deadline. Even if it's only a few days late, just one overdue payment—on any one of the hundred or so credit obligations—can seriously damage your FICO score.

FICO guidelines

FICO pays a lot of attention to whether you make a habit of missing due dates, so a series of late payments can really hurt your score. In the same manner, a consistent record of on-time payments for six months to a year can improve it.

If you have defaulted on any payment, make immediate amends to not repeat that behavior. The longer you keep it up, the more noticeable it will be. The negative weight FICO gives to bad behavior as delinquencies lessen over time, so as long as you stay on the straight and narrow, those black marks will eventually disappear from your record for good.

Also, avoid multiple applications for credit accounts simultaneously as it can cause a hit to the credit score. If need be, new applications can be spaced by about 6 months.

Does closing my bank account help my credit situation?

Unless you have a compelling reason to close an account, consider keeping it open. 

Closing an account can hurt your credit utilization and reduce your average account age—neither of which is good for your score. If you have to close an account, close a relatively new one and keep the older ones open. Also, a point to be noted is that closing an account will not remove a bad payment record from your report. Closed accounts are listed right along with active ones.

In the aftermath of the credit crunch, the credit card industry had begun closing inactive accounts. This could hurt your credit score, since it reduces the average age of your credit accounts. So a good suggestion might be to pull out your old cards, if any and start putting at least one charge on each of them every month. This will keep the account open, which in turn will keep your credit history nice and long—and ultimately raise your score.

2. Spend less than you make and invest wisely

Since you are in a phase of building credit, it is a good time to live by only needs and necessities and not dwell into the boat of wants and desires. Strict financial rules for yourself will only get you to your destination sooner than anticipated. The best way to raise your score is to demonstrate that you can handle credit responsibly—which means not borrowing too much and paying back what you do borrow on time.

There are a lot of investment options available in the market as of today, don’t get carried away by the easy schemes with lustrous fast gains, they will only pull you down the ladder to earning a good credit score. Stability and consistency is the key here.

3. Get your credit report and check it for errors

After a few months of credit-building, it’s a good idea to start looking at your score to see where you stand. For this, the law permits consumers to check their credit reports for free from each of the three top credit bureaus/credit reporting agencies once a year. (Equifax, Experian, and TransUnion.)

Since you have access to your credit report from each of the three CRAs, you could check several times per year by spacing them out. For example, you could check your Experian credit report early in the year, TransUnion a few months later, and Equifax a few months later. In this way, you’ll always have a general idea of how your credit score is faring, without paying anything extra.

Free credit score check

Several credit card issuers print FICO scores on customers’ monthly statements and allow online access as well, for free. Some card issuers offer free scores to anyone, cardholder or not. Discover, for example, offers a free FICO score at CreditScorecard.com. This is a good opportunity to make sure your issuers correctly report to the credit bureaus and also, to check for any fraudulent activity.

Just keep in mind that these credit reports can vary slightly as different creditors might not always report to all three CRAs. The score you see isn’t necessarily the same one your lender sees. Many companies who can show you your credit score only show you an educational credit score. That’s a score meant to give you an idea of what your score is. However, lenders tend to use various other types of credit scores, like proprietary ones or industry-specific scores.

4. Dispute any errors or fraudulent accounts

The Fair Credit Reporting Act (FCRA) is a federal law that defines how credit bureaus are supposed to operate. Under the FCRA, consumers have the right to an accurate credit report. Even though your credit reports from each of the CRAs can vary, that doesn’t mean you should ignore large discrepancies.

If you find errors(for example, late payments that were actually paid on time or credit limits that are lower than they should be) in your credit report or the display of a fraudulent account,  you're allowed to immediately dispute these errors with the credit bureaus along with verification of what you’re saying with a copy of related documents.

Role of Credit Bureau

The credit bureau is then required to do an investigation and correct the errors when necessary.

Once you get your report back, scrutinize it with a fine-tooth comb. (Occasionally, errors can help you, as when accounts you closed are listed as being open; don't feel obliged to correct these.) 

Nonetheless, never ignore an error on your credit report. It could signify fraudulent activity or it could mean that someone else’s data is being included on your report. Either of these situations can greatly damage your credit, so take care of it early.

As a matter of fact, each one should have these financial priorities as they will enable us to achieve financial freedom. Financial freedom, in turn, will allow us to pursue our life’s purpose, whatever it may be.


Case Studies

Here we have compiled a few case scenarios that we found to be common among borrowers or people looking to build credit for the first time. Each scenario is unique to which plausible solutions have been offered.

(The information given below is purely meant to supplement your understanding of growing a good credit score and then maintaining the same. Any resemblance to a person, place, situation is purely coincidental.)


Case Study 1

R currently has a credit score of 655, one credit card that she always pays on time, is employed full time, has a down payment for a car and still can't get approved to buy a car. What does she need to do?

Solution: Firstly, R needs to get a FICO auto score as this is one of the main scores to look for, geared towards what she is looking to get a loan for. (a car). Make sure the genuine credit reports are transparent, and not hiding anything.

If R is paying her credit card balance on time in full every month, her credit should continue to improve over time, although it can be a slow process if she's relatively new to building credit. She can be added as an authorized user to her mother/father’s credit card and if that company reports authorized user to the bureau, it will, in turn, ameliorate her credit length. There are also a number of auto loan options that might help since there are many lenders who require a credit score of far less than 655.

As far as it’s the question of her credit card, she needs to only utilize a maximum of 30% of the available credit. Lastly, looking for a car that’s payment is less than 20% of her gross monthly income. (It’s all about debt to income ratio with cars as well as credit factor.)Doing all of this may take up to 6 months but it will help her.


Case Study 2

 ‘A’ is currently 17 years old and will be turning 18 next month. He will graduate this year from high school and currently, he has no credit. His parents won't permit him to piggyback off their credit. ‘A’ has had his current job for more than 7 months now so it hasn’t been a year yet. He plans on attending a community college close to home but he can't stay with his parents any longer. He is perplexed to know how to establish any type of credit for himself without having a parent involved.

Solution: In this case, there are some unsecured credit cards ‘A’ can make use of since he has no/limited credit history. Capital One Platinum is one of the best choices among students. (they have 3 tiers: a secured, an unsecured for limited to average history, and an unsecured top tier for those with excellent history. He should be able to qualify for bottom tier unsecured card or he can apply for the secured card as well). There’s no annual fee as such,  and they’ll either provide a $49, $99, or $200 deposit. Given that he has no history; they’ll either make him do a $49 or $99 deposit.


Case Study 3

‘M’ got his first credit card in 2 years ago; a basic, no benefits nor rewards card. The limit has been increased twice and now the bank is offering another card with a number of other attractive cashback benefits etc. Is it too soon to get another card? Will it help or hurt?

Solution: The fact is that the credit score takes the biggest hit right after a new account is opened but after a slow month or two of responsible use, there will be a boost in the score. On the other hand, ‘M’ must keep the older account open as well.


Case Study 4

‘Z’ has a credit score of zero. She is 29 years of age. She pays her bills on time, and has had a bank account since she was 18, with no loans taken, nothing on her report except a few inquiries from when ‘Z’ had applied for a card (and got denied.) 

She has been looking into a secured card, but there's one point that has confused her. Is it better to pay the balance in full, or does making minimum payments over time raise your score more? 

(Her main motive of good credit is in the interest of buying a house and vehicle)

Solution: Z can go with the option of making at least 3 on-time monthly payments before paying off the debt completely. This will create a payment history. So after applying for a credit card and whatever the limit Z gets, she must go charge something on that card but only use 10% of the total limit and then, commence the minimum monthly payment for 3 consecutive months on-time and in the 4th month, complete the remaining payment. This will boost her score faster than paying the card off after one billing cycle.

For example: If Z gets a $1,000 credit card limit, she must charge 10% of that limit which is $100 and then make the monthly minimum payment on that $100 for 3 months and in the 4th month pay the complete balance off on that $100 charge.

OR

If it is more convenient to you, you always have the option to pay it off in full. Even though it doesn’t create credit history as such, it will still get reported to the credit bureau.

 ‘Y’ has a clear credit history that shows everything positive. But the student loans that he had borrowed still show on his credit report. Being on the report, will it hurt his score? Y has inquired and found out that these details will stay on his credit report for many years even though he has paid it off. What are the implications Y will face if any?

Solution: Outstanding student loans do not hurt your credit score unless

a) you are overextended with too much credit or

b) you have missed student loan payments.

But in this case, Y’s student loans having been paid off, will remain in his account (which is a good thing as it shows that he had student loans AND paid them off) for a period of up to 10 years. All negative (and positive) things on your credit report go away in 7 years (10 for chapter 10 bankruptcy)


Conclusion

Going to grad school, buying a home to call your own, landing a dream job, and various other milestones like these are on the basic bucket list of majority of the youth or as millennials like to call it, #lifegoals. Apart from these goals that connect them, the other phase that each one has to compulsorily go through is that of accomplishing a good credit.

Your credit can greatly influence your ability to make progress on big financial goals or rather even personal goals—and that’s why it’s so important to make sure you understand the lay of the land of everything related to it and get a grip on the whole picture in an organized manner.  With that in mind, we have formulated the above points relating to different methods of building credit for the first time, the ins and outs and importantly, the points to keep in mind while in this process.

Using credit sensibly early on can help open doors for you financially, professionally and personally. Develop these strong habits now and see where your future takes you.