Learning The Basics: How to Establish Credit

When requesting credit, you are asking to make a purchase with borrowed money. The basic idea is to have use of your purchase today, and defer the some or all of the cost until a later date. Depending upon the type of credit you are entering into, you may be required to extend a down payment as a condition of the loan, which usually is a certain percentage of the total purchase price of the item. There may be a payment agreement, and you may be expected to pay interest for the privilege of paying later. Regardless of the type of credit, there is always the expectation that you will be responsible for the repayment of the loan in full in the future.

Why Does Credit Matter? Because Credit Adds Flexibility to Your Finances

Credit gives you financial flexibility that is not always available with cash. For example, if you need a vehicle for work, but the ones that can be bought with the cash you have on hand are far from the reliable transportation you need, a car loan could allow you to purchase a more dependable vehicle, and pay the cost over time. Credit can be helpful to make financial management smoother, giving you a little more freedom, less restrained by cash flow issues. If you need a new suit for a job interview, but your paycheck is still 3 days away, with a credit card, you can get what you need and pay for it at the end of the month, when your salary is in your bank account. If you have no dental insurance, credit can allow you to spread out the cost of that painful and expensive toothache that required emergency treatment, rather than spending the rent or mortgage payment on the dentist. If credit is used judiciously, it can be a wonderful tool to give you a little security for those unexpected expenses.

To Establish Credit Means to Build a Reputation Showing Financial Responsibility

When you use credit, the lender is taking a risk based on your promise to pay the debt in the future. If you honor your agreement, making timely payments as required, it is likely that credit will be extended to you again. If you do not hold true to your end of the credit arrangement, making late payments or skipping payments on occasion, the lender will be less likely to do business with you again, or may charge a higher rate of interest to do so. Your credit deeds, good and bad, will follow you to form the basis by which your future credit applications will be either accepted or denied. If your credit history shows a pattern of financial responsibility, you will be considered a good credit risk, and the credit you need in the future will be more easily obtained. If, on the other hand, your credit reputation is one of late or missed payments, you will be considered a poor credit risk making it increasingly difficult to have credit extended to you in the future.

Lenders Use Credit Reports to Determine Credit Risk

Lenders rely on information collected in a credit report that details your credit transactions to judge your payment history and assess their level of risk when extending credit to you. This information is gathered and compiled in your credit report by credit reporting agencies that, with your permission, will give this information to a lender during the approval process.

A credit report contains information that includes your address, your job or business, your income level, and your credit transaction history. Your credit transaction history will contain details such as the lenders that you have obtained credit with, the amount that was borrowed, the date of the loan and the date of repayment, whether and how often late payments were made, and whether there have been any collection actions or judgments taken against you or bankruptcy has been filed on your behalf.

Credit Access is Dependant on a Good Credit Report

Establishing a good credit report is the key to opening the door to credit opportunities. You will find it very difficult to obtain credit without a favorable credit report on file with a credit-reporting agency. You may fill out all the financial information accurately on the credit application, but if those details cannot be easily confirmed with a credit-reporting agency, you may often be denied. Verifying such details independently is a time consuming process that many lenders are unwilling to undertake. It is quite common for lenders to consider having no credit information to judge upon to be almost as risky as a poor credit history, and to deny your credit application on that basis.

Step One To Building Credit: Secure Income

To build a credit history you must have a regular and secure source of income. This can be employment income, investment income, government benefits or any other verifiable income that is reliable and continuous. This is necessary to demonstrate your ability to meet payments regularly.

Apply With Lenders That Report to a Credit Bureau

Lenders are not required to report your credit repayment information to a credit reporting agency, and some do not. You will make no progress towards establishing a good credit history with a lender that does not report, so be sure to ask about their reporting policy before you submit an application that may be a waste of time.

Start Small

If you have no established credit, or a limited history, a lender is more likely to take a chance if the amount at risk is small. This limits the lenders exposure, which is the term commonly used for the amount that could potentially be lost should you default on the loan. A small loan paid religiously can be the first step towards establishing the good reputation that will allow a larger extension of credit to be approved in the future.

Low Limit Credit Cards

If establishing good credit is your goal, a credit card with a low spending limit is a good step towards achieving it. A low limit card can be more easily approved than others if your history is limited, and activity on the account will be reported to a credit-reporting agency. If used regularly and paid promptly this can be a great tool for establishing credit history. If you are a student or a credit union member, major credit card companies will often offer small lines of credit to such groups, so it may be worthwhile to check with your school or credit union for such offers.

Retail Store Charge Cards

Many retail stores offer charge cards, which work in much the same way as credit cards, but can only be used for purchases made in that establishment. Often these cards are approved for those with no established credit history, but typically with high interest and low credit limits. If you use this card, and pay responsibly, you will build a credit history.

Secured Credit Cards

A secured credit card offers a line of credit secured with a deposit. Your available credit is equal to the amount deposited. You may use the credit like any other card, making monthly payments, but if you do not pay, the issuer will cover the amount with your deposit. Eventually with a good payment history, you will become eligible for an unsecured card and your deposit will be returned. If you cancel your account your deposit is refunded, with any unpaid balance subtracted.

Gas Cards

Many major fuel companies will offer gas cards to customers with a limited credit history. Often the spending limit is low and the total charged must be paid at the end of every month.

Get a Co-Signer

You may be able to be approved for credit more easily with a relative with a good credit history to help. The co-signer agrees to be responsible for the loan should you default, lowering the risk for the lender. The account activity will be reported in the credit history of both borrower and co-signer, so be sure you are able to make the payments promptly or not only will you not establish good credit, but you will put a stain on the credit of your co-signer.

Credit Terms on Large Retail Purchases

Many retailers, such as furniture stores, jewelry stores, and major appliance stores will offer credit to first time borrowers in order to make the sale. Sometimes these terms are even offered without interest, but be careful to read the fine print, as these offers may require you to pay in full by a certain date or be penalized with interest charges on the outstanding balance.

Government Guaranteed Loans

Full time college students often qualify for government guaranteed student loans, even without established credit. Lenders tend to approve large amounts of credit for these loans because they are assured to receive their repayment from the government if you default. A default will be reported to credit bureaus, and the government will take action to collect compensation for any payment they have made. This is not the fastest route towards credit establishment, as activity is not reported until payment begins after graduation.

Large Down Payments

You will find that a large down payment can often smooth the way to credit approval by reducing the risk of the lender. A larger down payment lowers the outstanding balance and leads to smaller monthly payments. Investing more of your money at the start also can show good faith to a potential lender, assuring them of your sincere commitment to be a responsible borrower. A twenty to fifty percent down payment on a car loan could help get you approved without established credit.

Credit Insurance

There are insurance policies that some automobile dealerships will arrange for customers without established credit called repossession insurance. As with any car loan, you will make a down payment and monthly payments, but you will also be required to pay monthly premiums to the repossession insurance company to cover the loss of the lender if you default and repossession occurs. These policies are expensive, but are an opportunity to obtain a loan that will build credit.

The best way to establish credit is to be someone that lenders want to loan to, someone they know they can trust. Part of that is demonstrating that you know the value of the trust you have requested of them. This is done by learning to handle your finances responsibly, with an eye on the future, and by being an informed consumer, understanding how credit works, what it can do for you, and why it is important. With those steps, you'll be a borrower that can get that auto, home, or business loan easily, and perhaps lenders who will not accept your business now will compete for it later.