Building Credit

This story is inspired by one of my dearest friends, N (though some details have been changed.) During college, N lived in a college town, sharing an apartment or house with several roommates. Since this was a college town and turnover was high, it didn't take much for a group of college kids to sign a lease on a slightly-dumpy apartment. Presumably, parents co-signed as well.

When N graduated from college and moved to a big city, she had to find a place to live. She and her boyfriend were looking for a small apartment. However, this being a big city, competition for starter apartments was high. N and her boyfriend didn't have super high-paying jobs, and worse, they had no credit.

At 22, N should've had some credit built up. A credit card or two, college loans. However, all of these things were done entirely in her parents' names. She was using their credit, and had no credit of her own. She was denied a place to live mainly because she had no history to prove she was a reliable payer.

Why do we need credit? Fair or unfair, companies use your credit score to determine your worthiness of paying obligations. In other words, if you have an excellent credit score, companies will lend you a lot of money, at a low interest rate, because they trust you to pay it back on time and in full. If you have a low score, companies will give you a much smaller loan, if at all, at a high interest rate, because they do not trust you to pay it back. This comes into play when you take out a loan for a car or a house. However, landlords almost always will run your credit history to determine if you will be a tenant that will pay the rent on time. Even employers these days days are running credit histories on prospective employees. If this person cannot manage his money (as evidenced by his low credit score), then how can I trust him to do his job? That's why it is very important to get your credit score as high as can be.

Your credit score is based on many factors, and the three main credit bureaus use slightly different algorithms to calculate your score. Some of the factors are: length of credit history; timeliness of payments; late payments and bankruptcies; use of credit.

What this means is:

-open a credit card as soon as you can; this is usually on your 18th birthday, but recent laws have increased this to age 21 unless you can show proof of your ability to pay. If you don't have a credit card yet, go open one. Look for a card with NO annual fees and rewards that you will use. If you actually pay the card in full each month, the APR (interest rate) doesn't matter. (I'll have a more detailed post in the future on choosing the right card.)

-you can get a credit card on someone else’s account (for example, a parent’s) with no age requirement*

-use the card, but don't use all of your credit each month (keep it low, but above zero): for example, if the total credit limit on all your cards is $2000, charge $500 of your expenses (groceries, gas, etc.) to cards each month. Pay the rest in cash. That's a ratio of 25%. There's no magic target ratio, but keep it between 5% and 30%.

-only buy what you can afford i.e. can pay back in FULL (not just the minimum payment) by the due date each month, and actually do so.  

*When you receive a credit card as an authorized user on someone else’s account, you do not actually build any credit at that point. However, once you open credit in your own name, the history of the authorized user account is added to yours. My dad gave me a card from his account when I was 16. After I turned 18 and established my own credit, the use from my dad’s card appeared in my report. My credit report shows that I have a credit card account for 15 years, even though I’m in my 20s.

Other agencies can also report to the credit bureaus. Pay your internet, electric, or telephone bill late? They will report this, and your score will go down. Landlords can report evictions too.

This is how I built credit: When I was 16, I asked my parents for a credit card. I was a responsible kid, would always tell my parents where I went and what I bought, so my parents trusted me. My dad added my name to his account, and gave me a card with a whopping $100 limit. I used this credit card as my allowance: the occasional movies with friends, shopping at the mall, even picking up last minute groceries for my parents for dinner. I didn't see the card as "free money;" I thought of it as strictly a convenient alternative to asking my parents for cash every time I wanted to hang out with my friends.

When I got my first "on the books" job at 16, my dad and I went to the (his) bank and opened up a shared checking account. My paycheck was direct deposited into this bank account. No longer did I receive an allowance. I used the credit card my dad gave me, and would pay him back from my checking account, funded by my after school job.

On my 18th birthday, after school, I went to the bank. I knew the bank my parents used had a no-fee, no minimum checking account. So I walked in, opened up my first bank account with the few hundred dollars cash I had saved up, and transferred my direct deposit from my job into this account. Within a few weeks, I received several credit card offers in the mail. I read them carefully, and applied for the card that had absolutely no fees attached. I didn't look at the APR -- it didn't matter, because I was never planning to actually pay interest on the card. I received my first official credit card in the mail a few days later, with a $75 limit.

I made all of my purchases on this card (up to the limit, of course) and paid the bill in full, by the due date with a check from my checking account. After six months, my limit was doubled. Another six months later, it was doubled again. This continued, until I had a credit limit of $7,500. By this time, I was able to open another two credit cards, get a car loan, and obtain a mortgage at an excellent rate, all because of my long-term credit. I was never turned down for a loan, offered a high interest rate, or been turned down for an apartment.

In a future post, I will explain how to monitor and track your credit.