The Smart Way to Create a Credit History
For modern consumers, credit scores are hugely important. Lenders use the three-digit grades to decide how much borrowers pay for credit cards, auto loans and mortgages. Insurers rely on credit scores to determine how much to charge policyholders for coverage. Landlords and employers have gotten in on the fun, too, rejecting tenants and job applicants for low scores.
For college students, there’s a catch: If you’re not using a credit card and you don’t have a car loan, you’re invisible to the credit-scoring industry. That lack of activity protects you from sabotaging your credit score at a young age, but it also means you’re starting from scratch. While credit scoring giant FICO doesn’t use your age to calculate your credit score, it does take your credit history into account. That might explain why consumers under 30 have low scores compared to older Americans: Young people simply haven’t had time to cultivate healthy credit histories. This guide offers some simple steps to give you a head start on building your credit score.
Top 7 Ways to Build a Positive Credit History
Back in your parents’ day, credit card issuers set up booths on the quad and offered T-shirts or free pizzas as sign-up bonuses. College students could start building — or destroying — their credit the day they moved into the dorms. After many young consumers got into financial trouble with easy credit, Congress in 2009 passed the federal Credit CARD Act, which prevents lenders from issuing cards to consumers younger than 21 (unless they provide proof of income). The law also limits card issuers’ ability to market on campus. That means building a credit profile takes some extra work. Here are seven strategies for building a positive credit history:
- “Piggyback” on your parents.
Presuming that your parents have good credit habits, ask them to add you as an authorized user to one of their cards. This arrangement lets you build a credit history, and it also gives you access to a credit card. Your parents can keep an eye on your spending habits and let you know if you go off track.
- Apply for a credit card.
If you’re 21 and still a student, you’re eligible to apply for a credit card of your own. Start cautiously, though. Look for a card with no annual fee and a low interest rate. And keep your spending in check: Use the credit card for small purchases that you’d make anyway, such as groceries or your Netflix subscription. If you have money from scholarships or student loans, you could use the credit card to pay for bigger expenses, such as textbooks. Always remember the tradeoff: Paying off your card promptly helps your credit score. But missing payments or carrying a hefty balance will hurt it.
- Be sure to shop around.
Credit cards come with a staggering array of options in terms of rates, fees and rewards. Spend some time researching the options that are best for your needs. When you’re just starting out, a no-fee card with few bells and whistles typically makes the most sense.
- Don’t apply for multiple cards.
Opening a single credit card and using it responsibly will build your credit over time. But taking out multiple cards, or even applying for a flurry of multiple cards, can damage your credit score.
- Automate your payments.
Exams, papers, lectures, labs — as a student, you have a lot on your plate, and it’s easy to lose track of when your credit card payment is due. Forgetting to make a credit card payment will ding your credit score, even if it’s an honest mistake brought on by a heavy load of courses. You can foolproof your payments by asking your credit card issuer to withdraw the payment amount, which should exceed the minimum payment, on the due date every month. If you opt for this payment method, however, make sure you have enough money in your checking account to cover your credit card payment.
- Consider a secured card.
If you’re scared to open a traditional credit card, or if you simply don’t have enough credit history to get an unsecured card, try a secured card instead. Unlike a traditional credit card, which lets you spend money you don’t have, a secured card requires you to deposit the balance. Send $500 to the credit card company and you can spend up to $500. The activity is reported to credit bureaus, so it’s a no-risk way to build your credit. Look for a card with no annual fee.
- Avoid major purchases on credit.
In a few years, when you have a regular income and a cash cushion, you’ll be able to use your credit card to splurge on a vacation or a new TV. For now, you need to match your spending to your means. Running up a big balance that you can’t pay not only hits you with big interest payments — it also hurts your credit score, which takes into account how much of your available credit you’re using.
Q&A on Credit Reports and Scores
Scott Schang is a veteran of the mortgage industry who helps borrowers navigate credit scores. He writes about borrowing and credit scores at FindMyWayHome.com
What advice do you give college students about building their credit scores?
First and foremost, you have to understand that it’s part of your life. A lot of borrowers I work with don’t have bad credit. They just don’t know how to play the game. It shouldn’t be called a credit score. It is a debt score. It is a measurement of how well you handle revolving debt. Say you get a credit card with a $5,000 limit. Can you be responsible enough not to charge the entire $5,000?
The credit score is really designed to see how close to the edge you can get without falling off and dying. Just like you give an employer a resume when you’re applying for a job, a credit score is like a resume for lenders — it’s a snapshot. The credit score is based on a secret algorithm. They won’t tell us exactly what it is. But the two most important things are don’t pay late and have credit cards. You do need credit cards — installment loans don’t really help. If you cannot get a credit card, get a secured card. After about six months, you’ll start getting solicitations for unsecured credit cards.
Some experts say college students shouldn’t have credit cards, that they’re just too dangerous. But it sounds like you disagree. Why?
There are benefits and risks to anything. The benefits of learning to use revolving debt far outweigh the risks of having credit cards. Not exclusively college students, but everyone needs to learn how to successfully navigate the credit system that our country runs on. You don’t get in trouble unless you’re irresponsible. You don’t become responsible without being irresponsible first. I know that’s how I learned. We don’t teach finances in school. Kids need to learn that credit cards are not free money, and the best way to do that is to get a credit card, charge it up and then deal with the consequences. I think it’s dangerous to tell people not to do something because they might get into trouble. You should get a credit card but use it only for convenience — buy your snacks, your groceries and your gas, and pay it off at the end of the month. Use the plastic as a debit card essentially, and don’t buy anything that you don’t have cash for.
Speaking of debit cards, does a checking account with a debit card help your credit score?
No. Debit cards do not report to the credit bureaus. It’s not revolving credit; you’re just spending money you’ve already put in the bank.
What’s the biggest mistake you see students make in terms of managing their credit scores?
Peer-to-peer lending is really big with college students. The way that lenders are approaching it is interesting, but I see it biting people in the butt. Credit card interest rates are 25 to 28 percent if you don’t have good credit. Peer-to-peer lending comes in at 10 percent to 15 percent, so people think the interest rates are significantly lower. But people forget that if you pay off your credit card balance, you’re not paying any interest. A peer-to-peer loan commits the borrower to a higher monthly payment, and it’s an installment loan. It’s the same as a car loan in terms of how credit scores are calculated.
Making your payments on time on an installment loan is like a pinch of salt when you’re baking a cake. The other thing I tell people is don’t cancel credit cards. If you get in trouble with a credit card, pay it off, but don’t cancel it. Even if you never use it again, if you wrap it in three inches of duct tape and throw it in the back of the closet, don’t close it. Closing a credit card is very detrimental to your credit score in terms of longevity of credit.
New businesses have popped up to report rent payments to credit bureaus. Should students take advantage of that type of service?
They should be doing anything to proactively build positive credit. If reporting your rent is something you can do, you should do it.
What about putting textbooks on a credit card? Some people warn against it.
There’s a fine line when it comes to managing your liquidity. If you have $300 in the bank and your books are $300, I’d much rather you put that on the credit card, and pay it off over six or 12 months, instead of spending every penny you have. What if something happens?
More on Building Credit
- The Federal Trade Commission’s guide to credit scores.
This page from the federal government’s consumer-protection agency explains how credit scoring works and provides links to resources such as free credit reports.
- Get your credit score for free.
This site run by credit bureau Experian offers your FICO score for free. One caveat: There are various versions of your credit score that emphasize different variables, so the number you see here is a guideline but not the ultimate word.
- Take an educated guess at your score.
FICO’s Credit Score Estimator guesses at your grade based on how you answer 10 questions.
- MoneyGeek’s guide to credit scores.
This overview walks you through the calculus behind credit scores.
- Try Discover’s credit scorecard.
Credit card issuer Discover Financial Services will give you an Experian credit score for free if you enter your name, address and Social Security number.
- The National Foundation for Credit Counseling’s Dos and Don’ts.
This nonprofit organization supplies sound advice for building your credit.
- Be careful about using your credit card at the bookstore.
It’s easy to drop hundreds or even thousands of dollars on textbooks at the beginning of the semester — and tempting to charge the tab. Do it only if you can pay off the charges in full, Credit.org advises. Otherwise, you’re tacking double-digit interest charges onto the already-outrageous prices.
- Get your credit reports for free.
AnnualCreditReport.com lets you view your credit report information from the three main credit bureaus: Equifax, Experian and TransUnion. The reports show just raw information, not a credit score, but it gives you a feel for the information that goes into your score.
- Opt out of credit offers.
OptOutPrescreen.com is a site run by the credit bureaus that lets you exclude yourself from credit offers. Taking this step might bump your credit score by 5 or 10 points, and it also spares you the temptation of marketing solicitations.
- Credit.org’s words of caution.
Melinda Opperman of Credit.org argues that students should take out a credit card only after thinking long and hard about the pitfalls.
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