Building Credit from Scratch – The Dos and Don’ts
September 27, 2017
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DO – Apply for a Secured Credit Card
A secured credit card uses a cash deposit as collateral. Normally, the cash deposit will be equivalent to the spending limit on the credit card. This allows the issuer to lower their risk taking on a new credit card user. The collateral works as a back-up plan for the credit card issuer; if the credit card bill isn’t paid on time, the issuer can use the deposit to pay off the balance.
If you’re responsible and pay your credit card off monthly and in a timely fashion, the deposit will work the same as per say, a rent deposit on an apartment – you’ll get it back.
Another benefit of using a secured credit card is that most have the option of upgrading to an unsecured credit card after a certain period of time or a certain credit score has been achieved. Even if the issuer doesn’t have this opportunity, however, there is always the option to close the secured card and apply for an unsecured card once credit has been established.
Here’s a link to a few of the most popular secured credit card providers.
DON’T – Take Out a Loan without a Purpose
First, it’s important to understand the concept of interest. Loans either accrue simple interest or compound interest. Simple interest is computed based purely on the principal (base) of the loan. Compound interest is computed from the principal plus the interest that has already been incurred. Many times, this is referred to as “interest on interest.” Although credit cards accrue interest as well, if the balance on the card is paid in full at the end of every cycle, interest will never be incurred. With a loan, interest is constantly accruing. Even though some interest can be avoided on loans if the payoff happens earlier than scheduled, all interest will never be avoided – causing cash flow to go out the window if the loan wasn’t taken out of necessity.
Second, always remember that loans should be taken for a purpose. Student loans, for example, are taken because although you may not have enough cashflow to pay for schooling at the current time, the reward is more than the risk – as the payoff from a future career in your field will outweigh the payback of the loan. Know your needs and make pro/con lists. Not all debt is bad debt, but do your research to make sure that your debts will benefit you in the long run.
DO – Sign Up as a Secure User on Someone Else’s Credit Card
If you’re in a position in which there are resources available to you such as a co-signer or someone who would allow another authorized user on their credit card, this is a fantastic way to begin earning credit. A lot of times, dependable family members or significant others are great resources to use when establishing credit.
The disadvantage in this situation is that the owner of the card is legally responsible for the card. Therefore, if the new authorized user is not responsible with their spending and/or use of the card, the owner of the card has to pay the price – literally.
However, the lack of legal obligation is also a huge benefit to the credit-beginner. It allows the newbie to build a credit background without the normal stresses that come with starting to use a credit card of their own.
DON’T – Apply for Just Any Credit Card
Some credit cards have annual fees. Some credit cards have ridiculously high interest rates. And some credit cards just aren’t meant for the new-user. It is extremely important that as someone just starting their credit-life, you do your research and decide on a credit card that is easily manageable and fits your specific needs. It’s not always about the travel perks or the cash back. Just because your favorite store offers 20% off your purchase if you apply for their credit card doesn’t always make it worth it. Don’t forget – you’re just starting. There’s plenty of time to reap the rewards of ‘benefit’ credit cards.
Depending on your level of responsibility and your specific needs, there are a wide variety of options to choose from when deciding on your first credit card. The list given above is a great resource for secured credit cards. However, it is never a bad idea to speak to your banker or other reliable resources. The Internet is a great resource as well – if you use secure websites and trustworthy sources.
DO – Use Your Rent Payments to Prove Credit-Worthiness
There are reporting services out there that offer to relay rent payment information to credit companies. Unfortunately, this information has to be reported by those service companies, and cannot be reported yourself. A few companies that offer these services include Rental Kharma and RentTrack.
Another catch is that many credit scores will not use the information that these rent-reporting services provide. If this is a good credit-building option for you, then the scores that will reflect this information are FICO 9, FICO XD, and VantageScore.
Overall, the credit building process can be very overwhelming. By starting slow and doing the research, one can build a credit history that will only continue to benefit them in the future.