Earning credit can be a frustrating process, as you cannot get approved for a loan or credit card without already have a credit history that proves you can be trusted with a loan. When you first start building credit, it may seem as if no one is willing to give you a break; however, there are steps you can take to kickstart your credit history.
This guide will show how to start building credit so that you can get a loan when you need one. As with most endeavors, the first step is the most difficult, but once you take it, you will be on the path to building your credit.
Analyze Your Situation
Before you start working on your credit, you need to figure out why lenders are unwilling to work with you. Likely, the issue is your credit score, which measures your ability to pay back credit card balances or loans. A credit score works much like a resume, which reflects your work ethic. If you do not have a credit history, it is like searching for a job without a work history. A creditor just has to trust that you will pay them back. Would a potential employer blindly trust that you would be a good employee if you had no resume? It is possible, but a bit unlikely. However, just as you can still land that first job, you can also build credit, but you will need to find lenders who are willing and able to take a risk and work with you.
Apply for a Secured Credit Card
A secured credit card is different than a traditional credit card, because you have to deposit money into your account to use the card. Do not confuse a secured card with a prepaid debit card, though. With a prepaid debit card, you can load and unload funds into your account at any time. With a secured credit card, you deposit money into your account, which translates into your credit limit. For example, if you deposit $1,000 into your account, you can charge up to that amount. If you charge $500 on your card, you will need to pay that back to maintain a positive credit history.
When you make a payment on time, this positive information will be reported to the credit bureaus, which will help you build your score. However, if you fail to make payments on time, you will be charged late fees, just as you would with a traditional credit card, and this negative information will be reported to the credit bureaus. The only difference between a secured and unsecured card is who supplies the initial funds.
If you decide to close your secured credit card account, the company will use your initial deposit to pay off any balance you have. Then, they will refund the rest to you. If there are any unpaid fees, that money will also be deducted from your account before a refund is issued. If you have no outstanding balance, you will get a full refund of your investment. Thus, secured credit cards are a risk-free way to get credit when you do not have credit.
Try a Secured Loan
A secured loan works much like a secured credit card in that you have some form of collateral to cover the amount of money that you are borrowing. For example, if you buy a car with cash, you could use the vehicle as collateral toward a loan. Then, you would pay the loan over time to build your credit history. Unfortunately, you will need to pay interest on the loan, but it could be a small price to pay if you are building a positive credit history, and you will discover that all loans will cost you some additional money.
Secured loans are generally only available for property with a title of ownership, such as a car or house. Personal property, such as a computer, is easy to hide if a creditor ever needs to collect on your loan, so they are less likely to be used as collateral. However, it is difficult to hide a house, and cars are easy to repossess, which is why lenders like to use these items.
Another way to obtain a secured loan is through a certificate of deposit from your bank. Open a CD for a certain term and then borrow against it for a pre-determined time period, such as six months, two years, five years, etc. The exact terms will be worked out with your bank. You will deposit money onto the CD and take out a certain percentage (typically 80%). Then, you will make payments on your loan until the end of the term. You will end up paying interest, but you will also build your credit as long as you make payments on time. To get started, you will just need the cash to make the initial deposit.
Some people will take their personal possessions to a pawn shop to use as collateral for a loan, but it is important to know that pawn shops do not report their loans to credit bureaus, which means you will be paying a lot of money for a loan with no benefit to your long-term credit history.
Find a Cosigner
If you cannot get a loan or secured credit card on your own, try to find someone with good credit who will cosign for you. The lender will use the other person’s credit to back the loan in case you stop making payments. The cosigner will need to trust you, though, because if you stop making payments on your car loan, they will be held liable for the balance. Since, in theory, the person will make these payments because they want to protect their own credit, the bank is not at risk.
Most creditors prefer your cosigner to be a relative, such as a spouse or parent. You can use your friends and neighbors, but it may be more difficult to get the loan approved. If you do find a cosigner, keep in mind their credit is on the line, and you will want to protect them by making on-time payments.
Now that you know a few ways to get credit when you do not have credit, you can figure out which option is best for you. Do you have the cash on hand to open a secured credit card or CD? Do you own property you can use as collateral? Is a family member willing to cosign for you? Explore your options and then commit to making payments on time so that you can build a good credit history.