Establishing Credit is one of the most ass-backward processes I have ever seen.
To be eligible for credit, you need to have a history of good credit, but to get good credit you have to have credit to begin with…. I mean… like what…?
It’s like some portal of ridiculousness that you would find in a complicated video game.
A little backstory:
When I was fresh out of high school I applied for my first credit card. Actually, my first three credit cards, and I was declined for every single one of them.
The reason? “I didn’t have enough credit history”
I was sitting there staring blankly at my computer thinking, “Well… duh… that’s why I’m trying to get credit you fools.”
After three rejections, I felt like I was in middle school asking all my little crushes out again.
But, just like in middle school, I did some research and figured out the best way to approach the situation, and I succeeded. Surprisingly, it’s not as hard as you’d think. (Establishing credit I mean, asking girls out WAS as hard as you’d think.)
So, today, my goal is to teach you exactly how I established my credit with no credit history, what I did right and what I did wrong, and the things I wish I would have done differently.
I have now walked many people through establishing their own credit and taught them how to best approach the process.I am now just a few points from the 800+ credit score club and am so grateful to know that I will have no issues getting approved for anything I may need to get in the future.
(Oh, and encase you were interested, I also got better at asking girls out, and my girlfriend is like super good looking, light years out of my league.)
So, let’s jump right into how you can get these same results when trying to establish your own credit.
What is a credit score?
To get credit, you must first understand what credit is. (Well, this isn’t necessarily true… but it will definitely help)
Your credit score is like a progress report that gives lenders an idea of how responsible you are with your money and how able you are to pay back money that is borrowed.
Credit scores range between 300 and 850. 300, in this case, is this worst possible score, and 850 is the best possible.
According to Experian, a good basis for scores is as follows:
Very poor: 300-579
Very Good: 740-799
Many factors go into the calculation of a credit score.
According to creditcards.com, The Five Factors (in order of importance) are:
Payment History – 35% of your score is based on payment history.
Your payment history is a track record of all the payments you have missed, or made on time. (Hopefully, you will have more of the latter).
If you miss a payment then it will be recorded in your credit history and it will have a major negative impact on your score. This is the most important part of calculating your credit score.
It is important you always pay your credit dues on time, EVERY MONTH. Even if you can only pay the minimum payment, it’s always best to make some payment rather than none.
If you are unable to make your payment it is best practice to reach out to the lender you borrowed from and let them know you will not be able to pay for the time being. Many times they will be lenient or give you thirty days before reporting you to collections.
Credit Utilization – 30% of your score is based on credit utilization.
Your credit utilization refers to the amount of credit you use vs. how much credit you have available.
For example, if you only have one credit card that’s limit is $100 and you spend $95 on the card without paying it off before the end of your billing cycle, your credit utilization will be 95%. This is VERY BAD.
Your credit utilization should stay around 1-5% and ideally it should never surpass 30-35% as this is considered very high.
The reason for this is that lenders see people who consistently max out their credit cards and are always close to their credit limits as high risk.
This is why you should aim to carry low balances and never max out your credit cards.
Length of Credit History – 15% of your score is based on the length of your credit history.
When trying to establish your credit from scratch, the most likely problem you will run into is that your “credit age” is too low. You don’t have enough credit history.
This is why when you first begin establishing credit it takes some time for your score to increase. Even when using your credit responsibly. The longer your credit history is, the more clear it is to lenders whether you are an ideal borrower or not.
Your credit history is usually comprised of an average and is the average of all open accounts divided by the number of accounts you have.The goal is to continue to increase this number so that lenders can have a clear image of how you handle credit over time and that you are a responsible spender.
New Credit – 10% of your score is based on New Credit accounts.
This means that being approved for new credit will increase your score.
This happens for many reasons, it can increase available credit which can lower your credit utilization, and it can add to the types of credit you have (loans, revolving, etc.).
But, it is important to keep in mind that applying for new credit can impact your score in a negative way. Every time your credit score is run for an application, you receive what is called a hard inquiry on your credit report.
This shows lender’s how much credit you have applied for in the past and if you are “credit hungry” as I like to call it. (These inquiries come off your report after two years, and as time passes, the impact of these inquires lowers)
It is also important to note that you receive a hard inquiry whether you are approved or not, so it is vital that you only apply for credit whenever it is actually needed.
Another way it negatively impacts your score is that the average age of your score will be lower as you get approved for new credit.
So keep in mind that while having a good credit mix is important, do not become credit hungry and apply for too many loans or credit cards.
Credit Mix – 10% of your score is based on your Credit Mix.
Your credit mix can be a little confusing and somewhat vague.
Basically, all this means is that you have the ability to pay back multiple types of credit.
So for example, you have a student loan, a credit card, and a car loan. Paying each of these back responsibly will show you can efficiently handle many types of credit.
This is a good sign to a potential lender and will make it more likely you get approved in the future.
It is necessary that you understand each of these so you know what you need to do to improve your score over time.
So how do you get credit when you have none?
So now let’s get to the reason you are here! You need some dang credit am I right?
There are actually many options for establishing credit now, and I have seen many advertisements for different apps and services that allow you to establish credit over time.
I, unfortunately, cannot recommend these with a good conscious as I have never tried them (at this time). What I will do is tell you how I established mine and what I have seen work really well for others.
There are two main options I use when teaching someone to establish credit from scratch.
- Secured Loan – A secured loan is a loan that is backed by some sort of asset you possess.
The asset is usually your car or cash, you must provide collateral that can be paid to the lender in the case you don’t pay back the money you borrowed.
I personally went up to my local bank at Regions and asked to take out a secured loan. Some do have minimum amounts so keep this in mind.
To be approved for the loan I had to put $500 dollars in my savings account, allow the bank to put a lock on this money, then they gave me $500 dollars as a loan. In this case, the $500 dollars serves as collateral for the loan, I know it sounds ridiculous.
But, keep in mind while you are establishing your credit the bank has no reason to believe you are a responsible lender. This is how they cover their rear end.
Once you pay back the $500 dollars they loaned you, the bank will then unlock the $500 dollar collateral and you will now have access to your money once again.
It’s simple, easy, and it works.
The only problem with this method is that once the loan is paid back in full, it will appear as a closed account on your credit report. You need some revolving credit.
This is where the next option comes in,
- A Secured Credit Card – A secured credit card is similar to a secured loan as an asset is required to be used for collateral in the case that you do not pay your balance. The difference is, that your credit limit is a revolving balance you can continue to use every month for as long as you have the card.
For the most part, this is the best option. Depending on which card you choose.
Most secured cards require a deposit of $49-$500 dollars and your monthly credit limit will be equal to your deposit in most cases.
Nerd Wallet has an awesome article ranking the best-secured cards,
It just so happens the first two cards on the list where the two secured cards I had when I first started out.
The reason being is that the Discover it Secured Card provides many benefits that an unsecured card would offer.
In fact, the Discover It secured card offers all the same benefits of the unsecured Discover It card. They even give you the double your cashback bonus at the end of the first year offer as well.
The other reason I always recommend this card to newbies is that they not only have rewards and bonuses, but they also will graduate your card to unsecured after you prove you are a responsible credit user.
What this means is that they will send you your deposit back, make your card unsecured, and in some cases give you a credit limit increase.
Unfortunately, with the Capital One Secured card, you will not get your deposit back until you cancel your card, and there is no graduation to unsecured.
Your card will remain secured for the entire time you use it, no matter how responsibly you use it.
The one benefit of the capital one secured card is that it does have a lower initial deposit in some cases. I only had to pay $49 dollars for a $200 dollar credit limit.
I think that between the two secured card options, discover is by far the superior choice. You should always lean more towards the cards that offer good rewards that you can maximize and offer excellent customer service and user experience.
This is why I chose, and still choose Discover’s secured card over all other available options when beginning to establish your credit.
Establishing credit from scratch can be a daunting task at first.
But just like all things in life, with a little money and enough research, it is by no means an impossible task. Just be sure you are getting credit for the right reasons and understand that any mistakes you make can leave a permanent scar on your credit for the future.
Having good credit is important for getting the best rates on your future homes, cars, and any other loans or cards you may apply for.
Now go forth and prove yourself a worthy borrower.
Until the next one,
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