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How to build and establish credit: The full breakdown

At a glance:

  • What you need to build credit for the first time

  • How to apply for your first credit card

  • Tips for building your credit score

  • Getting a personal loan if you have no credit history

  • Summary of establishing credit

Establishing credit can seem like a catch-22: If you don't already have it, many places won't give you any. So how can you even get credit at all? To make matters more challenging, lenders can't rely on a FICO score for you, since you have no credit.

Lack of credit leads some people to try out options that prove very expensive, such as payday loans. Some of them get trapped in these situations, unaware that with some preparation and discipline, they can qualify for credit and get better lending terms.

There are ways to establish credit without first having credit. Most likely, you are already doing just that in your everyday living.

Southern states have more credit card debt. (David Foster/Cashay)
Southern states have more credit card debt. (David Foster/Cashay)

What you need to build credit for the first time

Any lender that would extend credit to you wants to know that you are a good bet. If you have never had credit, there are other things about you that lenders can use to make a judgment about your creditworthiness. Let's examine a few:

Your job history

If you can hold a steady job, you will be attractive to lenders. Are there periods of unemployment in your job history? Do you change jobs frequently or get fired a lot? Keep your employment history in mind not only now but for the rest of your life, because it is an important factor.

Your housing history

Do you move a lot? Moving a lot, such as every year or more frequently, can send out a red flag to a lender. It can indicate that you have trouble with your finances. Your addresses are a part of your credit record. Aim for stable residency as best you can. Also, if you have any ownership in your home, that will look good to lenders.

Your bank accounts

Do you have a checking or deposit account at a bank or credit union? If so, your account history can play a role in whether you get a credit card for your first time, even though it won't be reported to the credit bureaus. If it is in good standing — for example, you don't overdraw on it — that is a plus for you. A well-managed bank account indicates to lenders that you are good at managing credit. Also, if you are in good standing with your financial institution, consider applying for your first credit card there.

Utility bills you pay

If you pay a telephone bill, an electric bill, cable bill, or something similar, lenders want to see that. Be sure you are paying them on time and not defaulting on them. It especially pays to have these bills established in your name.

Medical bills

If you have any outstanding medical bills, work on paying them off. Not all medical institutions report these debts to credit bureaus, but it's best to play it safe and assume they do.

The bottom line is, establish a strong history of being dependable, stable, and able to pay your bills on time. Lenders want to know that you are going to pay them back if they extend credit to you.

How to apply for your first credit card

If you have a solid history of paying bills on time, holding a steady job, and staying at the same address, you will begin to look like a good credit risk for a lender. It may be a good time to step out and apply for your first credit card. Where should you begin looking?

Retail stores

If you've shopped at a retail store, you may have been offered a discount if you signed up for their store credit card. The discount is a lure, of course, because the interest rate on these credit cards is typically high.

Experienced credit card holders often avoid these offers, but if you are looking for your very first card, it is worth considering. This is how many people get their first cards. You aren't guaranteed to be accepted, but it is worth a try. And the credit limit will be small, usually just a few hundred dollars. But this will be all you need to get started. Use the card regularly, and charge only small amounts. Be sure you have money set aside to pay the bill in full every month, and on time.

Your bank or credit union

Another place to apply for a credit card is at your bank or credit union. Many of them offer their own credit cards to their customers/members. If you already have savings, checking, or certificate accounts with them, then they have a history with you and may be willing to extend a credit card to you. Consider trying them first; however, success is not guaranteed.

Once you have your first card, other companies may begin sending you offers for their own cards.

Secured credit cards

Most credit cards rely on your credit risk as their backing. That makes them unsecured, and that is why lenders require that you keep good credit if you want to use their cards on good terms. But if you do not have sufficient credit, you have an alternative: a secured credit card. Secured cards are easier to get than unsecured cards.

What does “secured” mean?

To be secured means to be tied to an asset — a source of money that can be tapped if you should default. For example, when you get a loan to buy a car, the car is the asset that can be taken if you default on your loan.

For secured credit cards, the asset can be a savings or checking account at your financial institution. You need to have sufficient money in the account to cover what you charge with the card. Thus, if you fail to pay on your credit card, the bank or credit union can take your deposit. This covers its risk.

You will want to maintain adequate funds in this savings or checking account. Failure to do so can result in penalties.

Where can you get one?

Many banks and credit unions offer secured credit cards. If you get one, use it regularly and pay off the balance each month. You will build up a credit history and eventually you may qualify for a regular credit card.

Tips for building your credit score

Credit is a very tempting risk. As soon as you have all that available money at your disposal, all kinds of impulses can take hold of you. Stories abound of people getting numerous credit cards and going on spending sprees. Only after the bills come to their mailboxes do they feel the hangover … and if it's bad enough, they can feel it for many, many years.

If you are one of them, you can be denied credit in the future, and you can even lose employment opportunities. You can be denied other loans, such as car and home loans. Such are the costs of abusing credit. With this in mind, here are some simple tips for wise use of that little plastic card:

  • Never think of credit as free money. Credit is not free money. You have to pay it back, often with interest.

  • Understand what your credit history is made of. Your credit history is made up of several factors. It is 35% payment history, 30% amount owed, 15% length of your credit history, 10% new credit, and 10% type of credit used. As you can see, payment history factors in the most. A detailed explanation of each of these factors can be found here.

  • Be patient. Building good credit takes years. It is a lifestyle made up of responsible money habits. Give it time.

  • Use your card regularly. Using your credit card regularly helps build up your credit history.

  • Pay your balance fully each month. As you use your card regularly, it is wise to charge small amounts and pay them off each month. That way, you build up a payment history, and you also avoid interest charges.

  • Pay your bills on time. The largest component of your credit score is payment history.

  • Don't use too much credit. Avoid this temptation. If you can use cash instead, do that.

  • Don't use it frivolously. Again, charge only small amounts.

  • Use it for things you already have money for. This will help ensure that you pay your balance in full each month. But more importantly, it is an easy way to help you build a credit record.

To quote the great comedian Bob Hope: "A bank is a place that will lend you money if you can prove that you don't need it."

This paradox is resolved when you see it from the bank's point of view. It loans you money out of its vault so that it can earn money in return. It's a business. Those who do not need credit are therefore the most likely to be able to pay the bank back.

Getting a personal loan if you have no credit history

A personal loan is a loan that is granted by a lender to you for your personal use. Unlike a credit card, which you borrow from over and over as long as you don't exceed the limit on it, a personal loan has a set limit and is loaned to you in a lump sum. You agree to pay it back on a schedule; a portion of your payment goes toward the principal of the loan, and a part goes toward interest.

Personal loans establish credit. They are usually unsecured and based on your integrity and your ability to pay. If you do not have a credit history, but you already have accounts at a bank or credit union, those are an ideal place to apply for a personal loan. Talk to a loan officer; you may get at least a small loan. Alternatively, you may get a loan that is secured by one of your accounts.

Summary of establishing credit

You don't need a credit card or a loan to establish credit for the first time. What you need is a history of stability and a pattern of paying your bills on time. Once you have applied for and gotten credit, you need to nurture it over years and decades.

Should your credit history take a turn for the worst — and it does for millions of us — you can rebuild it and get back to where you were.

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

Read more information and tips in our Credit cards section

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