How To Establish Credit
If you're a young person just starting out in life and have never financed a car loan, a computer, or other major purchase, how do you begin to establish credit? First, consider applying for a secured credit card issued by a major credit card bank. I recommend the Capital One Secured Card or the Discovercard Secured Card. Both of these banks have a solid reputation of giving people a chance to build their credit without outrageous fees; both companies report payment histories to the three major credit bureaus; and both banks will offer you an unsecured credit card with a decent credit limit sometime in the future if you pay on time and don't max out the card.
You could also join a credit union and request a secured credit card, which would either be a Visa or Mastercard. Secured credit cards usually don't have a very high limit, often just $500, but that's okay, because you don't want to use the credit card to run up a large bill you can't afford to pay off. Ideally, you shouldn't use more than 30 percent of the card's credit limt and pay the card off every month. Use it to pay bills or buy groceries and that's all. The purpose of using the secured credit card, but not to its maximum credit limit, is to show the credit score companies that you are using credit wisely:
(1) you don't max out the credit card;
(2) you pay your bill on time every month
After six months of using the credit card responsibly, you will begin to really build a good credit score. Unfortunately, having just one open account isn't good enough to establish a really good credit score. Having less than three accounts is referred to as having a "thin file", meaning you don't really have enough credit history to calculate a credit score. But you have to start somewhere, and after six months, you might apply for a second credit card and use it responsibly too. Then, after a year or two, you might qualify for a small auto loan.
There are also new programs now that allow you to report your payment histories of rent, utilities and such to the credit reporting agencies to flesh out your credit report and improve your credit score. If you have a year-long history of always paying your rent on time, your water bill on time, your phone bill on time, etc. you can get those accounts reported to your credit report to help you build a good credit history.
Keep in mind the following when applying for a credit card or any kind of financing:
You must be at least 18 years old to be approved for a credit card. Why? Because under contract and federal law, a minor can rescind a contract at will in most circumstances. If a credit card issuer were to give a credit card to a minor, the minor could charge up to the credit limit and then rescind the contract and refuse repayment. Minors wanting to have a credit card in their own name must have a parent, guardian or other adult over the age of 18 contract for the credit card. The Card Act prohibits credit card companies from issuing credit cards to college students who don't have sufficient income to pay for the credit card.
You Must Have An Income. This does not really need an explanation. Would you lend money to someone who had no means of repaying it? The good news is that you don't have to have a particularly high income to qualify for many standard credit cards. Whether your income is sufficient to be approved for a credit card depends on the issuer since each has their own minimum income requirement. Your credit line will be very small if you have a small income, but you must start somewhere. If you make your payments on time, your credit line will be increased after periodic reviews.
You Must Have a telephone number in your name. If you don't have a telephone number at all, you will not get unsecured credit. Likewise, if you can be contacted only from a telephone number that belongs to your Uncle Joe's second cousin, this will make lenders very nervous and they will be much more likely to decline to give you credit.
You Should Have Checking and Savings Accounts. There is a reason that you are often asked if you have a checking or savings account when applying for credit. This is used to score your credit worthiness. Answering "yes" boosts your odds of getting credit; answering "no" does the opposite. Just don't answer falsely; it is an act of fraud to give false information when applying for credit. You can open a checking account for as little as $100 in many places and increase your credit score a little bit.
Stay in one place. If you move from apartment to apartment or city to city, this will send up red flags all over the place. Lenders are concerned about you disappearing and not being able to locate you. Living at the same address for a long time adds points to your credit score. The longer you stay at one address, the better.
Stay at the same job. Moving from job-to-job is frowned on by lenders, too, because it shows instability and makes them less likely to approve your application, particularly when you have no credit history. If you can't keep a job and you have no credit history, you're at a much higher risk of being unemployed and, consequently, unable to pay your debts. Working for the same employer for a long time adds points to your score.
Pay Your Bills on Time. Once you have been issued credit, it is very important that you are not late making payments or even worse, miss making a monthly payment entirely. Missing a single payment will damage your credit rating for years, and being late several times will come back to haunt you. If you are late making your payments now, you can be sure that in the year 2015 when you apply for a car loan, you'll be asked about the late payments you made back in the year 2012 and you will be paying a higher interest rate on the car loan because of it. Be sure you don't damage your credit rating needlessly -- always send your payment in at least 10 days before the due date to give plenty of time for your payment to be received. The credit card companies report delinquent and missed payments automatically to the credit bureaus by computer every month. If you're payment hasn't been received by the due date shown on your statement, you automatically get a negative entry placed on your credit report. And it isn't fun trying to get negative entries removed from your credit report. So don't adopt the attitude that, "I'll pay that bill when I'm good and ready!" because you are only hurting yourself.
Don't spend more than you can pay off each month. Keep in mind that when you are issued your first retail credit card from Sears or whomever, your purpose is to establish an excellent credit rating so you qualify for the Visa or MasterCard that you really want. Use your Sears card to buy necessities, such as shoes and clothing, and pay your balance off each month. Don't run your Sears account up to its limit -- department store cards come with a significantly higher interest rate than Visa or Mastercard -- around 20% or 21%. Another good reason to pay off your balance each month or frequently -- it shows you're a better credit risk. When you're ready to apply for that Visa or Mastercard, your credit report will reflect that you paid off your Sears (or other card) regularly. Once you have established a good payment history with a single trade account (e.g., Sears card, gas card), and you have sufficient income, you'll probably qualify for a standard credit card.
What to do if your credit card application is denied
Lenders are required by law to send you a letter telling you why your application for credit was denied, but sometimes these letters can be vague. Possible reasons could be that you haven't lived at your current address long enough or that you haven't been employed with your current employer long enough. Perhaps it is that your income isn't sufficient to meet the card issuer's minimum income requirement. If the reason for being denied is vague, ask someone within the organization for clarification. Find out why before you apply for credit with another organization. If you are turned down a second time, you might want to wait another six months before applying again.
If you are determined to get a credit card now, your only option is to get a secured credit card. It requires that you send in a deposit that will be used to guarantee repayment. This deposit earns 2% or 3% interest while it is being held by the credit card issuer. Your credit line will be a percentage of your deposit, typically from 50 to 100 percent. Application and processing fees are not uncommon for secured credit cards; however, there are a few on the market have low or no application or processing fees.
Another possibe means of obtaining a credit card is to consider asking someone with an established credit history perhaps a relative, to designate you as an authorized user on their credit card account. As an authorized user, the primary card holders credit activity is reported to your credit report. There is a downside to being an authorized user. If the primary cardholder ever pays late, defaults or goes bankrupt, that too is reported to your credit report, which would ruin your credit rating.
The above measures are just little steps you can take to establish credit and add a few extra points to your credit score. If your credit card application was denied because you have bad credit, take necessary steps to improve your credit score so that you can qualify for a credit card sometime in the future.
Next topic: Reasons Your Credit Application was Denied
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