Limited or no credit? You’re in good company.
Many times, consumers with no credit history are new to the world of credit. They can find themselves in a Catch-22 scenario, says Jennifer Tescher, president and CEO of the Center for Financial Services Innovation in Chicago.
“You need to have a credit history to get credit,” Tescher says. “And you need to have credit to build [a] credit history.”
A “thin file” means you don’t have much of a track record with credit. Either you have only a few accounts, your credit is relatively new or both. These consumers may be unable to qualify for unsecured credit cards or “instant” in-store accounts.
If you have limited or no credit, here are five strategies you can follow to beef up your credit file.
- Become an authorized user
- Apply for a secured credit card
- Make a small purchase
- Consider a ‘credit builder’ loan
- Report your monthly rent payments
Become an authorized user
An authorized user is someone authorized to use another person’s credit account. Any purchases made on the account by the authorized user becomes part of the primary cardholders account balance. This strategy can be chancy for the authorized user because the liability falls on the primary cardholder.
The gamble if you’re the authorized user: If the account holder misses payments, goes into collections or declares bankruptcy, that bad behavior can land on your credit report.
The gamble if you’re the primary account holder: The authorized user could max out the card and leave you with the bill.
In the perfect scenario, the authorized user gets charging privileges on another person’s credit card, stays within whatever limits the cardholder sets and establishes a history of on-time payments and responsible card usage. Becoming an authorized user and developing strong financial habits can help boost your credit score.
Before you attempt this arrangement, find out from the issuer if you have the power to remove yourself from the account. Also, ask the issuer what would happen to account information—good or bad—that’s already on your report if you’re no longer an authorized user.
If you become an authorized user, monitor your credit report regularly to ensure the account is being reported to one of the three credit bureaus—Equifax, Experian and TransUnion.
Apply for a secured credit card
Your thin credit history may not be robust enough for you to qualify for an unsecured credit card.
One solution to build credit: a secured credit card.
Secured credit cards are types of credit cards that requires a cash deposit as collateral. The cash deposit required typically determines your credit limit. It is often equal to 50 percent to 100 percent of the initial deposit. While this limits the amount you can spend, it provides individuals with damaged or limited credit histories an opportunity to qualify for a line of credit.
Applying for a secured card and making your monthly payments on time is an excellent way to build credit. Some secured credit cards automatically graduate to traditional credit cards when cardholders have a history of making on-time payments.
Beware of cards that come with a bunch of charges, like application fees, annual fees and maintenance fees. Good cards for people with limited credit history exist—even ones that pay rewards.
Make a small purchase
While most negative information comes off your credit report after seven years, even the good accounts can disappear after 10 years if they’ve been closed or inactive. In addition, some scoring formulas can’t generate a credit score if it’s been awhile since any of your creditors reported to the bureaus.
That means some people who had robust credit files at one time could potentially find themselves with a thin file or no credit score if they close accounts or stop using credit.
If you have a history of credit but no longer have a score, make a small purchase on one of your existing accounts and pay it off right away.
That will give you the recent activity the scoring formula needs to assign you a score.
If you’re new to the credit game, it could take a while to get a credit score, depending on the scoring model used to compute it. For a FICO score, your oldest account needs to be at least six months old. Using the VantageScore model, a consumer’s credit report could be scored after the first month of paying on a credit account.
Consider a ‘credit builder’ loan
This product is very similar to a secured card, except that it’s in the form of a loan.
One example: Your bank makes you a small loan, which you use to purchase a CD. The bank holds the CD, and you make monthly payments. At the end of your loan, you own the CD. Your gain: a new item, plus a record of good credit.
The price: any fees and interest you pay on the loan.
Paying for money you don’t need can be counterproductive—the point of good credit is to save money—so reserve this step as a last resort. If you use it, look for low rates, minimal fees and a lender that reports good behavior.
Report your monthly rent payments
If you don’t want to use a credit card to build credit, there are a few other options to consider. When you pay your rent each month, it typically isn’t reported, however, those payments could help boost your credit score.
A service offered by Experian allows individuals who rent from a landlord or property management company (that does not already report data) to sign up through a rent payment service working with Experian RentBureau. This service allows rent payments to be collected electronically while having the ability to report your rental payment history to Experian RentBureau.
If this is not an option, there are other rent-reporting services that can help boost your credit, but it comes at a cost. Using a third-party rent payment service may not be the most cost effective method to build your credit, but it is an option worth considering.
Ask questions before you apply
With little or no credit, consider talking to lenders before you apply.
Some lenders have access to services that pull data from other sources for people in just your situation, Tescher says. These services help lenders identify potential customers by analyzing data from nontraditional sources, such as rental or utility records, when potential customers don’t make the cut based on traditional data.
While seeking lenders who consider this information won’t change your “classic” FICO score, it could lead you in the right direction towards building your credit.
Ask before you apply: If your conventional credit score or application doesn’t make the grade, does the lender have a way of considering any additional data to underwrite you for credit?
The bottom line
After opening your first line of credit—in whatever form that may be—it is important to adopt smart financial habits in order to build a strong credit history. You can do this by keeping your balance low and making on-time payments each month. It may take a few months before your payment history can generate a credit score, but it is always better to start working on building your credit before you actually need it.