Credit History 101: How to Build Credit and Get a Loan with Any Credit Score

It is exceptionally important to be familiar with credit and have a good credit history. It empowers you to be financially stable and puts you in a position where you can qualify for the services, products, and opportunities you need, and get the best rates to save money.

When it comes to home ownership, having an established credit history is essential. Without it, it is very difficult to find a financial institution that will consider financing you. Even if you are not looking to purchase a home, having a strong credit history will help you with renting an apartment, signing up for a cell phone plan, looking for new employment, or applying for utilities in your name.

Furthermore, if you are looking to finance a vehicle, such as a car, boat, snowmobile, motorcycle, or any other recreational toy, having a strong credit history will not only make you more likely to qualify for the loan but also get the best interest rate. This can save you a lot of money in the long run!

If you’re looking to improve your credit score or just learn more about credit in general, this guide can help.

BUILDING CREDIT

Strategies for building credit vary, but those fortunate enough to have someone co-sign for them have a great way to get started. When using a co-signer (also known as a guarantor), the primary borrower is more likely to qualify for the loan, as the approval is based on the strength of the co-signer.

However, co-signing can put someone in a compromised position. The debt is counted against their debt-to-income ratio, which could affect their ability to qualify for other loans. Additionally, if payments are not made, the co-signer is liable and may suffer credit blemishes.

Furthermore, not everyone has a co-signer or wants to put someone in that position. For those without a co-signer, a secured credit card or loan is often the easiest way to establish credit. A savings-secured credit card offers guaranteed approval, and usually no credit check is required. However, it is easy to over-utilize your available credit, which can hurt your credit score.

A savings-secured loan is a better option, as it is an installment loan with set monthly payments. The borrower can use their own money or the financial institution’s money as collateral for the loan, by placing it in an account in their own name. In either case, the borrower’s interest rate on the loan will be slightly higher than the rate on the collateral account. As payments are made and the principal balance decreases, the financial institution usually releases the amount paid down in the account to the borrower.

Savings-secured loans are an effective way to build credit with minimal cost and risk. For those looking to build credit rapidly, opening both a savings-secured loan and credit card simultaneously may be beneficial, but remember to be careful to avoid utilizing too much of your available credit to best improve your score.

THE DIFFERENCE BETWEEN A CO-SIGNER AND AN AUTHORIZED USER

It’s important to understand the difference between a co-signer and an authorized user on a credit card. A co-signer or guarantor, who is usually a parent, family member, or friend, assures that if the primary borrower cannot repay the loan, they will. In this way, both people are liable for the loan.

For example, if you were a co-signer for your son, he would qualify for a credit card or loan based on your creditworthiness, but his credit report wouldn’t show your other existing credit.

An authorized user is different. Parents often set up their young adult children as authorized users, giving them access to the parent’s credit card through a card in their own name without being liable for the debt. While the child may build a good credit score from being an authorized user, they may still have difficulty qualifying for a debt in their name alone because they have not actually proven their creditworthiness.

Adding an authorized user can help someone build their credit score, but it can also have drawbacks. If the parent over-utilizes their available credit, it can negatively affect the authorized user’s credit score. It’s important to be aware of the pros and cons before making a decision. There is also risk involved for the cardholder as they will now be responsible to repay any debt accrued on the card by the authorized user.

ALTERNATIVE CREDIT REFERENCES

As an underwriter, I often encounter people who don’t have credit scores. If you find yourself in this position, speak to your financial institution to learn more about using alternative credit references.

Alternative credit references can include a letter of reference from a landlord, statements from places like Rent-A-Center, proof of paying utilities on time, and copies of canceled checks for recurring bills. These are indications that the person is creditworthy, even if they have no traditional credit history or have consciously chosen to avoid using credit. Utilizing alternative credit references may help someone qualify for a car loan or other type of loan without a co-signer. Your credit union or bank may be willing to go this extra mile if you have a long-standing relationship.

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CREDIT COUNSELING AND DEBT MANAGEMENT COMPANIES

Don’t be afraid to seek help from a credit counseling or debt management company.  Working with one of these companies could be a great way to help you avoid collections, charged-off accounts, or bankruptcy.

Financial institutions may provide credit counseling services for their customers or members but generally do not provide debt management services. A debt management company helps you manage your debts by negotiating with creditors for lower payments and/or interest. Generally, you will pay less with a debt management company than you would have previously. Be forewarned, debts overseen by one of these companies may be coded on your credit report as being managed by a debt management company and creditors may take this into account when you apply for new credit.

An additional benefit of working with a debt management company is that they can simplify the process of paying your debts. You send them one lump payment for the month, which they then distribute to pay off your bills that are part of your debt management plan. One payment is better than several! They may charge a fee for their services, but you will usually still save money.

Do your research and seek out a reputable company to assist you with managing your debts and/or building, re-establishing, or repairing credit.

USING CREDIT WISELY

When it comes to using credit wisely, there are several tips to keep in mind. Paying off balances in full every month, avoiding high balances, and paying bills on time are all important points to remember. It is also essential to understand how your FICO score is calculated and what they look at for each of those areas.

Payment history is given the most weight, accounting for 35% of your score, so it is critical to pay bills on time to ensure that you maintain a good credit score.

Amounts owed, which looks at how much of your available credit you are using on revolving accounts, how many debts you are carrying, and how high your overall balances are, accounts for 30% of your score. This means that it is important to not overextend yourself and keep your balances low to maintain a good credit score.

New credit, or taking on new debt, is factored in at 10% of your score. Take on new debt only when necessary to ensure that your credit score is not adversely affected.

The length of your credit history is 15% of your score; the longer you have had credit, the more beneficial it is for your score. As a result, know that closing out your oldest accounts in good standing can have a substantial effect on your score. If you decide to close out a credit card, especially one you’ve had for a long time, your score is likely to drop in the short-term. Consider the implications of doing so.

Lastly, credit mix is 10% of your score, meaning it’s important to have a diversified credit history to achieve a good balance of debts. This can be done by having a variety of types of credit accounts such as credit cards, loans, and lines of credit.

By keeping these tips in mind and understanding the importance of each factor that affects your FICO score, you can ensure that you are using credit wisely and maintaining a healthy credit score.

THE IMPORTANCE OF BEING PERSISTENT

It takes time to build or repair credit. My neighbor gave me the same advice when I bought my 1850 farmhouse: these issues didn’t arise overnight and won’t be resolved overnight. It takes a minimum of six months to establish a credit score when starting from scratch. Even if you pay as agreed every month, it’s unlikely that a credit score will show up in less than six months.

If you’re looking to establish credit, start with basics like a savings-secured loan, a co-signer, or a savings-secured credit card. Seek guidance from those with expertise in this area, such as your local banker or parents. Research good options online to help build credit.

If you’re looking to repair credit, come up with a practical action plan. Figure out what you can do to make it manageable, such as paying off a collection account. There are a couple of different techniques to pay down your debt. With the snowball technique, you have a certain amount of money budgeted for your monthly debt payments. You pay the minimum payment due on each debt and apply any surplus money to the debt with the lowest balance. Once it’s paid off, take the extra money and apply it to the next debt.

The other debt pay-down method is to pay off the debt with the highest interest rate first. This will save you the most money in the long run. However, it may not feel as rewarding because you won’t see the results of paying off an individual debt and feel as motivated to stick to your plan. Having someone to check in with can help, such as a credit counseling agency or local banker. They can provide encouragement and support to keep up with paying down debts and building a strong credit history.

No matter the approach, it’s important to stay consistent and disciplined! With perseverance and knowledge, you can improve your credit score in no time.

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About Abbi Kiley

With nearly two decades of experience in the financial industry, and well over half of that at VSECU, Abbi Kiley has become a trusted resource and ally to countless members. Although she grew up in the shadows of Manhattan, her love of hiking, swimming, gardening, and all things outdoors helped her to realize that she and Vermont were perfectly suited for one another. She has been proud to call Vermont home since moving here in 2002. She takes great pride in helping people gain or improve their financial stability and in turn have a better quality of life.

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