As a young adult, you may be eager to establish credit to allow you to get the things you want and need in life. The desire to establish strong credit becomes even more important and urgent when you move away from home and need to buy a car, rent an apartment or get the appliances and technology you need to run your life. Some have an easier road to credit than others. Help from parents, such as becoming an authorized user on an adult’s account, or gaining a parent’s trust as a cosigner on a car loan, can quickly bootstrap your credit life and get you on your way to opportunities with banks and lenders. However, some people don’t have it quite as easy and must start from scratch with little, no, or even bad credit as the only foundation.
Your Credit Situation
There are basically three scenarios that may define your credit situation as a young adult starting out. If you have parents or adults who are willing to “bootstrap” you by co-signing for your first loan, then you have a pretty good start and may not need much help continuing to establish good credit. Many start their life with a blank slate, and no credit at all, and need help with strategies to build good credit. A few, however, start with bad marks on their credit due to some fraud or misuse that may have started years before. Whatever situation describes you, we are here to help you make the most of your credit standing. We’re going to begin with the most common situation facing young people today.
Starting With No Credit
In a world that demands a credit score for most anything, including a car loan, insurance, apartment or home loan, the proverbial chicken and egg problem rears it’s head for the young adult with no credit. You may find yourself perplexed when faced with a credit denial and ask yourself “How can I build credit when it takes credit to get credit?” Well, we are here to help. Here are a list of items you must try, in order of difficulty, and try in this order. One word of caution: you must be very careful when applying for credit, because every time you apply for a credit card, loan or insurance, an “Inquiry” is placed on your credit report, and every inquiry reduces your score and also reduces the likelihood of future approvals. Inquiries impact your score less as they age, and they eventually fall off, but just go easy on the applications to keep from racking up a large number in a short time. The first method costs nothing upfront. The second requires a little money to get going, and the third requires you to save up a substantial amount of money. Get in the habit of saving up money and work your way down as you go to build stronger and stronger credit.
Store Credit
I can’t stress the following point enough when mentioning credit cards: revolving credit is a trap. But it does have one very, very good use, and that is to build a strong credit score fast. If you have no existing credit, you still have a chance of getting certain store cards, especially if you are a customer who’s built a relationship with the store through repeat purchases or a loyalty program. Don’t shoot for the stars if it’s your first card. You probably won’t be approved for a $20,000 credit line at an electronics store, but you have a good shot at a modest credit line at a small clothing or makeup store. Likewise, you likely won’t be approved for the store’s branded Visa or Mastercard, but you will probably be offered their store credit card. Here’s an important tip: apply at the register and apply when asked. Applications taken at the register, in-store, have a higher chance of approval due to you physically being present, a pending sale taking place, and the cashier’s ability to immediately scan/verify your ID. While these cards are almost always underwritten (issued) by a partner bank, the store and bank agree to unique criteria for approval.
Secured Credit Cards
If the store card route fails for you, or if you simply want to fast-track the process, the option of getting a secured Visa or Mastercard is always on the table. A secured credit card looks and works just like a normal credit card. The only difference is that the card is approved on the condition that you deposit an amount equal to all or part of the credit line in a special savings account with the bank, to guarantee that the bank is paid back should you default on your credit card account. Typically, when applying for a secured credit card, you will select an amount that you are able to deposit to secure the card. This usually ranges from $200 up to $5000 or more. Banks will generally approve secured credit card applications even with no credit history, because it’s easy for the bank to just close the account and pay themselves back if you choose not to pay your bill. Some banks will go out on a limb and give you a higher credit line than the amount you deposit, and these are great cards to start with since a higher credit limit always works in your favor when it comes to calculating your credit score.
Auto Loans with Down Payment
When you have even more money saved up and a few small revolving accounts on your record, you may consider borrowing money for a vehicle. One issue that many young people with high credit scores run into when trying to get their first auto loan is the lack of high credit. Well, this is a bit of a misnomer because your high credit is actually a value attached to each account on your credit report that indicates exactly how much money you have borrowed on that particular account. You will, however, probably hear the car dealer grumble about your lack of “high credit” when they take a cursory look over your credit report. Here’s the issue: you have, thus far, borrowed smaller amounts of money on small revolving credit cards or store accounts. If you paid your bills on time, you have proven that you can pay, say, $200 or so back. But the bank the car dealer uses will need to trust you to pay a substantially higher amount back, possibly $10,000 or much more. The magic bullet to overcome this problem and induce the dealer’s bank to take a chance on you is to greatly reduce the risk they are taking by putting up a significant down payment toward your car loan. This shows your good faith and seriousness about paying the loan back (who wants to lose a $1000+ down payment by defaulting on the loan?) and as a bonus, it reduces the bank’s liability should you default.
If you need more personalized credit help related to building new credit, contact us to learn about personalized credit coaching and get ahead of the game. And, stay tuned for part two, where we explore growing a small fledgling credit file into something much more powerful.