Reader Question: How to Establish Credit

With authorized user accounts being taken out of credit scoring models starting next month, the issue of how to establish credit has suddenly become a hot topic. Here's a question we received last week:

How do I obtain new accounts to boost credit score when no one will give me credit?

It used to be so easy! Just have relative or friend with good credit add you as an authorized user on an established account.  They wouldn't even have to give you the credit card. Your credit would benefit from their established credit as soon as the authorized user account appeared.

Now that FICO has decided to stop counting authorized user accounts in their credit scoring models, this easy strategy is out the window. No more loopholes, it's back to establishing credit the hard way. There are a few good ways to get started:

1. Secured Credit Card - Secured cards work by having you deposit a cash amount into a savings account to "secure" the credit limit. If you put $500 in the savings account, you'll have a $500 credit limit. Getting together this deposit may be tricky, but you'll save a lot in rates and frees over unsecured cards. When the card is closed or moved to being unsecured, you'll get your deposit back with interest.
2. Student Credit Card - A student credit card is a great option for anyone who is a full or part-time student. You don't even need to be attending a major university. Many cards will accept community college or online college students as well.
3. Unsecured Subprime Credit Card - You can also find unsecured (no deposit needed) credit cards for people with bad or no credit. However, these offers are often paired with extremely high interest rates and fees. Be sure to read all the small print when considering these offers.
4. Retail or Gas Card - Not quite as good as a secured or unsecured card but also an option for establishing your credit.
5. Auto Loan - Auto dealers will often go the extra mile to help a buyer with bad credit or no credit find an auto loan. Just be very careful about the interest rates and costs of these loans. It doesn't make sense to buy a $20,000 car at 18% APR when a secured card would work just as well.

Now, let's talk about what's not an option for establishing your credit:

1. Pre-Paid Credit Card - No matter what their marketing says, pre-paid credit cards do not help you build your credit history. They might report to some no-name credit bureau, but they don't ever send data to the credit bureaus that really count.
2. Checking Account - Checking, banking and savings account don't help to establish your credit. Even an ATM card with a Visa or MasterCard logo doesn't count.
3. Any Account that You Will Not Use Responsibly - It's better to have no credit history than to have a credit history full of late payments and problems. If you can't afford a credit card or loan right now, wait until you can.
4. Co-signed Accounts - Okay, so technically co-signed accounts can be a good way to establish your credit. However, I think the risks are too high. If one person makes a late payment or defaults, both credit reports are damaged. And if one person can't pay, they'll come after the other.  Stick to getting your own account if you can.

Good luck establishing your credit!

Emily Davidson – Credit.com's Communication Director and former TransUnion credit expert. Emily writes about credit reports, credit scores, loans and personal finance as the CreditBloggers.com moderator.

 

Comments

[Gerri Detweiler]

You're right about the risk with joint accounts. I just received an email from a consumer whose wife had to file Chapter 13 and the cosigners on her student loans now have charge offs listed on their credit reports -- even though the loans will be paid in full through the bankruptcy!

Even if the loan is paid on time, the debt may affect the cosigner's credit score, debt ratio etc.

It's too bad the authorized user option will be going away...but it really just comes back to establishing your own credit the old fashioned way.

[Jim]

I'm going to assume this person is young and has absolutely no credit history. In high school I remember my parents telling me to establish my credit, so I applied for a couple credit cards. Ended up getting a student credit card with a $500 limit and high 24% APR. The only way to establish credit is to use the card and make payments.

Now that I'm older and know how this stuff works, I am trying to eliminate credit cards. The debit card is all I need now. I'm tired of paying interest on the balances that built up over the years and I have been paying on for a long time.

[EmilyPeters]

Not necessarily. These instructions work for students, young people, older people with no credit, people new to the country, etc.

You might want to consider keeping at least a couple of your credit cards open (even if unused) just to preserve your credit history. Remember that the rates you'll pay for home insurance, car insurance, utilities and cell phone service will still depend on your credit.

[Jim]

Your argument regarding credit history does not make sense. If you have not established credit history and are shopping for car insurance on cars you already own, why would you not get the best rate? Same goes for home owners insurance. If you own the house and there's no trace of a loan, why not be able to get a good rate if you can pull 100% down payment?

Utilities and cell phone service don't trust you'll pay them because you don't have credit history? I don't believe that for a second.

Employers also consider your credit history in their employment screening. If you don't have any does that mean they won't give you the job yet the guy who makes plenty of regular payments and needs the job has a better shot?

What is the difference between having no credit history and someone who has a perfect 850?

[EmilyPeters]

The use of credit scores in the insurance, utility and cell phone industry isn't necessarily logical...but it is true.

Even for a car or home you own, your insurance rates can be heavily impacted by your credit score.

Having no credit is better than having bad credit but not as good as having a healthy score in these cases.

[credit card offers]

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