Credit is a paradox: you have to have credit to get credit. Establishing new credit can be a pain, but for those just starting out in the world or immigrants new to America, it’s one of the most important things they can do to set themselves up for future success.
In This Article
Credit Reports and Credit Scores: The Basics
- Bill payment history
- Current debt
- Financial information
- Employment history
- Where you live
- Whether you’ve been sued
- Whether you’ve ever filed for bankruptcy
This information is available to lenders to assess your level of credit risk — whether you’re likely to pay them in a timely fashion. This determines whether they will offer you a loan and, if they do, what the interest rate will be.
Your credit report is for more than just loans. Employers sometimes look at a prospective employee’s credit report. Utility companies use them to determine whether you’ll need to pay a deposit. Landlords often use them to determine whether or not you’re likely to pay rent on time.
Every American is entitled to a free copy of their credit report from each of the three credit bureaus each year—which you can obtain by visiting Annualcreditreport.com. Checking your credit report regularly can help you avoid identity theft and make smarter credit decisions by viewing your history.
The challenge of establishing new credit is obvious: lenders make decisions based on credit reports. However, without a credit history, building a credit history can be a challenge.
Your credit score (sometimes known as your FICO score) is a standardized numerical score that takes several factors into account to determine your creditworthiness. Scores range from 350-850, with a higher number meaning you’re considered a lower credit risk. Generally, anything over 650-700 is considered good, while anything over 750 is deemed to be excellent.
While the exact formula used to determine these scores is a trade secret, we do know the basic components of this score. Bureaus and lenders calculate your credit score based on the following factors (in order of importance)
- Payment history: If you make payments on time and never miss a late payment, lenders see that as a strong indicator of your creditworthiness. Late payments, charge-offs, liens, bankruptcies, foreclosures, and settlements, among other things, impact your payment history.
- Debt burden: This includes factors such as the number of loans you have active, your credit utilization ratio (how much of your credit is being used in relation to your credit limits — the lower the better), and your total amount owed.
- Length of credit history: Two things impact this category: the age of your oldest credit account, and the average age of your credit accounts.
- Types of credit used: Banks like to see a mix of different types of credit, such as mortgages, credit cards, car loans, etc.
- Recent credit searches: A consumer applying for many credit products in a short period is an indicator of credit risk.
Establishing New Credit
There are several ways of establishing new credit from a clean slate.
Credit builder loans
Credit builder loans are an outstanding option for those who want to establish a credit history quickly, so long as you have the income to make the payments. You take out a loan, but the bank holds the loan balance in a special account while you make loan payments. When you’ve complete paying the loan, they release the funds to you. This gives you a chance to build credit and also works as a form of savings.
Credit builder cards
Similar to credit builder loans, credit builder credit cards allow you to build your credit.
Some types of credit builder cards, known as secured credit cards, require you to deposit a sum of money with the bank. You then receive a credit card with a spending limit equal to the amount deposited. While it’s not specifically a credit builder card, the Prosper Card® is great for those with less-than-perfect credit because it doesn’t require an initial security deposit. It starts with a low credit limit, limiting risk and keeping you from getting over your head.
Either way, using a credit card helps you build up a payment history. Use your credit builder card for everyday purchases and pay it off each month. You’ll likely see a significant rise in your credit score.
Get credit for your everyday bills
Services such as Experian Boost report your utility bills, phone bills, etc., to your credit report, giving you a slight score boost. Also, some rent-reporting services, such as Rental Kharma and LevelCredit, report your rent payments to your credit report. These may not be enough to establish credit on their own, but they will help you boost your score in concert with the other methods listed here.
Become an authorized user on an existing account:
Suppose you have a family member or friend with good credit. In that case they can add you to their existing credit accounts as an authorized user, allowing you to ‘piggyback’ off their credit and supercharge the process of establishing new credit. However, this is not without risk for either party. The other party is trusting you not to run up their credit card balance, and you’re depending on them to make their payments on time and maintain a low balance to build your credit. If they make late payments or have a high balance, that will reflect on your credit. This is an option to use only after careful consideration.
Building Credit Well
To maximize the effort you put into establishing new credit, it’s important to build a good credit history—not a bad one. Therefore, in any of the options listed above, it’s crucial to do a few things:
- Make your payments on time: This is critical, as it’s the single biggest variable in your credit score.
- Keep your balances low and pay them off each month: Your credit utilization ratio plays a part in your credit score. Paying balances off in full each month avoids expensive interest charges in most cases.
- Monitor your credit report: Lenders, creditors, and credit bureaus can make errors. Take advantage of your free credit report every year from each credit bureau. Check and ensure that your efforts to build your credit reflect on your credit history. Also, this helps protect you from identity theft. If you see items that are incorrect or that you don’t recognize, you can dispute them.
- Budget carefully: While building your credit history, establish good financial habits to help you maintain good credit into the future! Create and maintain a budget to make sure you pay everything on time and stay in control of your finances.
Follow these steps, and you’ll have an established credit history in no time! Good credit helps you reach many common financial goals, such as homeownership and access to financing for purchases or life events. For example, with a good credit score you can take advantage of Prosper personal loans for healthcare expenses, home improvements, or many other purposes, giving you enormous flexibility!
Establishing new credit is just the beginning of your financial empowerment journey. Prosper will be here to help every step of the way.
Results are not guaranteed.