Building Your Credit 101

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Building Your Credit 101: The Basics

Whether building your credit for the first time or recovering from a history of bad credit, there are some great tactics that you can use to get the ball rolling in the right direction.  Any type of credit building or repairing takes months to years to fully accomplish, but incremental progress and credit score increases can be seen along the way and sometimes the most significant positive change occurs within the first few months of this process.

The first step to take is to download your credit reports, even if you think you have no history of credit.  Go to annualcreditreport.com and download your credit reports from all 3 credit bureaus – Experian, Equifax and Transunion.  That is the official government site which is setup to provide free access to your credit reports once each year, or usually when you have been denied credit.  Some people have trouble setting up their account at this site, but it is still your first choice for retrieving your credit reports.  If you are unable to access your credit profiles at annualcreditreport.com, then you can sign up with Credit Karma .  It is also free to join, but will only provide you with your Experian credit report and estimated score.  You would need to simply contact TransUnion and Equifax directly to request your report from them in this instance.  It is important to review your credit report from each of the three credit reporting agencies because it is very common for the information they report about you to differ.  Ensure only accurate information is being reported about you in each report, including your current address.  If you see items that are not accurate, you can either challenge them yourself by filing a dispute or you can contact a professional to have it done for you.

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Once you have a firm understanding of what is currently being reported about you on your credit report and what might possibly be making it difficult for you to obtain new credit you can begin your strategy of rebuilding or establishing your credit quickly with the following:

  1. Open a secured credit card, loan, or both
  2. Make on time payments over time to all of your legitimate accounts
  3. Verify any potentially negative items on your credit reports 

About the plan:

The only way to establish credit is to open an account, and the best way to repair credit is to make on-time payments to current accounts and to deal with the negative information on your credit report.  This article isn’t about how to deal with that negative information, which can become a very complex process in certain instances, but there is lots of information online about how to do it yourself.  This is a good place to start.  People who are currently making monthly payments to a collections agency or someone other than their original creditors will find this information especially important. The road to rebuilding or establishing your credit will involve a couple different types of credit.  Revolving credit, which is one type of credit that lenders extend to consumers, consists of things like credit cards and personal lines of credit.  Revolving credit means that a company offers you a certain amount of credit, say $10,000, and it remains available for you to use as long as you continue to pay it off.  If you charge $500 against your credit, then your available credit changes to $9,500 and your balance owed changes to $500.  Once you pay off the $500, your available credit is again $10,000.  In this type of credit, the amount of credit that you have available, and the amount that you owe, are constantly changing, or revolving. The other main type of credit available to most consumers is secured credit. This is money which is loaned in exchange for ownership of the item it is securing until it is paid in full. Common examples include mortgages and auto loans. Prior to paying off these loans, the bank or lender actually owns the physical property, even though the borrower has full use and control over it.  In some instances, the owner of the property can dictate things that the borrower has to do with the property, such as an auto loan company requiring full coverage insurance on a vehicle or a mortgage underwriter requiring homeowners insurance until the loan is paid off. Credit cards, auto and home loans are some of the most desired types of credit, and if there are barriers to securing one of these resulting from no or bad credit, then this strategy can be very powerful.  It combines some aspects of secured debt with some of the properties of unsecured debt to get you where you want to be.  In order to establish or begin re-building any credit profile, it is best if you can qualify for several of these loan or credit types, which can have a cumulative effect on your ability to secure ever increasing amounts of credit.  Having already been approved for an auto loan and making on time payments, for example, is one example of a type of loan which can actually help your chances of being approved for a larger loan, such as a mortgage.  Of course there are other factors involved such as your income to debt ratio, length of credit history, inquiries and other factors, but in general, companies who are considering lending you money can more easily make a decision in your favor if you have a history of managing larger credit extensions, like auto loans.  Most people’s largest loans will be their mortgages, and with mortgage interest so expensive over a typical 30 year loan, its very important to take steps to make sure your credit is as good as possible as early as possible in order to secure the lowest interest rate possible.

So, now that you have reviewed your credit reports, here’s how you get started.  Check with your bank or do some research online for companies that provide secured loans and secured credit cards.  These are the types of credit that combine an aspect of unsecured lending with secured.  The way secured loans and credit cards work is by receiving a security deposit from the consumer, and then extending them credit based on this deposit.  This is not the same as a debit card, which does not report to credit reporting agencies, because a debit card only works by debiting cash out of your account when it is used.  Debit cards do not extend any credit and are not the same as a secured credit card, which is a type of revolving credit.

Here’s how a secured credit card works.  You go online or go to your bank and find a secured credit card you would like to use.  Make sure that the card reports to all 3 credit bureaus – not all of them do.  Most of the cards from banks and other notable financial institutions will report to the bureaus, just make sure you are 100% certain before opening an account.  Once you find one, you will deposit money to secure your credit.  Lets say you deposit $500.  Typically, you will be issued a credit card with a limit which is the same as your security deposit.  So in this case, you would have made a $500 deposit, and then been issued a credit card with a $500 limit.  This is a great situation because you can now build your credit for free as long as you use your card responsibly.  It’s important to remember that you will still have to make monthly payments on this card.  The amount you charge does not come out of the $500 deposit, rather it comes out of the $500 credit which has been extended to you, so on-time payments are required.  If you can afford to make a deposit of $2,000 or more, your credit will look even better than amounts smaller than that.

By opening a secured credit card account, you will begin building your credit and in just a short amount of time (60 – 90 days) you could see major improvement in your credit score and ability to secure additional credit.  My personal experience with this technique took me from a 540 credit score to a 620 in just under two months.  I opened a $350 secured credit card and paid it on time, and my score immediately began to improve, which gave me more credit options almost immediately after that.  After removing several inaccurate negative items from my credit reports and making on-time payments for over a year and a half my score is now a 760 – just in time for a home loan I will be acquiring in the next few months.

For an even better effect you can combine the secured credit card tactic above with a secured loan.  Secured loans function similar to credit cards, and the credit amount extended is usually the same amount as the deposit.  For this to work you can find a company which offers secured loans, and open an account with them.  Again, assume you deposit $500 and they then give you a $500 loan.  You can then take this $500 loan and open a secured credit card with it.  By doing this, you will have opened $1,000 in secured credit with only a $500 deposit, and you will have two items reporting to the three major credit bureaus.  This will require you to pay off your loan every month on time, along with your credit card.  Paying off your loan as soon as possible will save you on interest, as will paying off your entire credit card balance each month.

By utilizing these simple tactics, you can easily have positive information begin accumulating on your credit reports immediately.  If you combine this with a thorough review of your credit reports and the removal of questionable negative information from them, you can expect to see major improvement in your creditworthiness in the shortest amount of time possible.

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