Okay, now you know your score, and you have a good idea of what goes into creating it. So, how do you make it better?
Because your credit score is based on your credit report, you should begin by ordering your reports from all three credit bureaus and reviewing each one for accuracy.
By federal law, U.S. consumers are entitled to one free credit report from each of the bureaus every year. You can order your reports from the Annual Credit Report Request Service by calling 877-322-8228 or by using its Web site, www.annualcreditreport.com. (If you use the online service, be sure to enter the Web site address correctly. If you mistype even one letter, you could wind up at the wrong site.)
After you’ve used your free annual peeks, you can get additional reports from a service such as MyFico.com, or you can order from each bureau separately online or by phone:
• Equifax—www.equifax.com, 800-685-1111
• Experian—www.experian.com, 888-397-3742
• TransUnion—www.transunion.com, 800-888-4213
Canadians can also get their credit reports online:
• Equifax Canada—www.equifax.com(click on the “Canada” link)
• TransUnion Canada—www.tuc.ca
• Northern Credit Bureaus, Inc.—www.creditbureau.ca
If you’re accessing your reports online, you might want to print out the files to make the review process easier. At the very least, grab some paper and a pen to make a list of the changes needed as you go through the reports.
Exactly how your information is organized varies from report to report. But the basic sections are pretty similar and proceed more or less in the order outlined in this chapter.
At the top of each report is identifying information about you. Watch especially for the following:
• Names that aren’t yours (not just misspellings of your own name)
• Social Security numbers that don’t belong to you
• An incorrect birth date
• Addresses where you have never lived
These are the kinds of errors that could indicate someone else’s information is in your file.
You might find other errors, such as an employer listed that you no longer work for or a misspelled address. You can ask the bureau to fix those problems as well, but that shouldn’t be your highest priority.
The next section lists credit accounts that you’ve opened, along with such information as the date you opened them, whether the account is still open or now closed, the type of account, the account number (typically abbreviated), your payment history, your credit limits, and your balances.
Scan this section closely for the following:
• Accounts that aren’t yours
• Delinquencies that aren’t yours (including late payments and charge-offs)
• Late payments, charge-offs, or other negative entries—other than a bankruptcy—that are more than seven years old
• Debts that your spouse incurred before marriage (unless they improve your credit history—more on that later)
• Any other incorrect account notations, such as showing a debt as past due when it was wiped out in a bankruptcy filing
If you find a number of incorrect entries, especially if they’re delinquent or unpaid accounts, you could be a victim of identity theft. You’ll find more information about how to handle this situation in Chapter 8, “Identity Theft and Your Credit.”
On the other hand, you could be suffering from a credit bureau mix-up that accidentally merged someone else’s information with yours. Although the bureaus say they have improved their systems to reduce the chances of this happening, it still occurs. I hear about it most often when two family members share similar names.
Don B. and his father have the same first and last names and share a middle initial. They live in different states (Florida and Indiana, respectively) and, of course, have different Social Security numbers. That hasn’t prevented the credit bureaus from getting the two men confused.
When Don bought a piece of property recently, the bank pulled his credit reports from all three bureaus. He discovered that his and his father’s credit information had been mixed together:
“For example, his car payment is on my report, but my car payment does not show up on my own report,” Don said. “I was shocked at the number of discrepancies I found on each of the reports. As important as one’s credit history is, one would think that these agencies would take the necessary steps to ensure accuracy.”
You might find other errors, such as accounts you’ve long since closed still being reported as open, or not indicating accurately that you—rather than the creditor—closed the account.
The FICO scoring system doesn’t really care who closes accounts, so you needn’t worry too much about fixing those notations. And don’t rush to change the notation on your closed accounts if they’re listed as active; as I explain later, they could be helping your credit score.
Inquiries show who has asked to review your credit report. Your credit score doesn’t count inquiries made by lenders looking to make preapproved credit offers or your own requests to see your credit history. These are known as soft inquiries.
The inquiries that matter are the ones from lenders that resulted from you applying for credit. These are called hard inquiries.
What you do want to look for are these:
• Credit inquiries older than two years
• Hard credit inquiries that you didn’t authorize
Add these to your list of items to dispute with the credit bureaus.
The final section of your credit report includes any collection actions or public records, including bankruptcies, foreclosures, garnishments, lawsuit judgments, and tax liens. Here’s what you want to look for:
• Bankruptcies that are older than ten years or that aren’t listed by the specific bankruptcy code chapter (Chapter 7, Chapter 13, and so on).
• Lawsuits, judgments, or paid tax liens older than seven years.
• Paid liens or judgments that are listed as unpaid.
• Duplicate collections, such as a loan that’s listed under more than one collection agency. (An account you didn’t pay often is listed twice, once with the original creditor and once with a collection agency, but there shouldn’t be more than one collector listed at a time for the same debt.)
• Any negative information that isn’t yours.
If in this review process you didn’t find errors of note, skip to the next step. If you did, read on.
Your credit report comes with a form for disputing errors by mail (if you ordered by phone) or online, depending on the way you ordered your report.
Credit bureaus are required by law to investigate any mistakes you bring to their attention and report back to you within 30 days. Typically they ask the creditor that reported the information to check its records. If the creditor can’t vouch for the accuracy of what it reported or doesn’t respond, the offending item is deleted from your report.
That doesn’t mean the error stays off. Unfortunately, some creditors persist in reporting inaccurate information. A consumer might follow the rules to get a problem removed, and the creditor simply reports it again a few months later.
That’s what happened to Stan, a homeowner who encountered problems when his mortgage was transferred during a bank merger. The new bank made a mistake and reported to the credit bureaus that he was late with a $232 payment.
When Stan discovered the negative mark on his report, he contacted the bank and a representative agreed to fix the problem.
“She worked with me by giving me a letter stating [that the late payment was] reported in error,” Stan said. Several months later, the late payment showed up again on his credit report. Stan contacted another bank official, who again promised to fix it after Stan faxed him the first representative’s letter. When Stan pulled his report 60 days later, however, the delinquency was still there.
As you can see, the creditor holds a lot of power in this process. Although many errors are fixed promptly, permanently, and without fuss, an unethical or indifferent creditor could make your life difficult by verifying to the credit bureau that incorrect information is, in fact, accurate or simply re-reporting an old error. If you run into this problem, check out the information in “What to Do If the Credit Bureau Won’t Budge” in Chapter 8.
If you’re successful in getting errors removed from your report, you might—or might not—notice an improvement in your credit score. It all depends on the information remaining. The following section presents the best and most effective ways to make sure that information reflects well on you—and in your score.
If you’re new to the idea of credit scoring, you might have no idea how damaging just one late payment can be. I got this email from Brenda, a woman in Douglasville, Georgia, who was flabbergasted that all of her recent efforts to improve her credit score could be undone by one unpaid bill:
“I recently had a score of 640. I was late on a payment for a personal loan, and now it’s 555. I now know that I can’t afford to be late again, but that shouldn’t have dropped my score that much, should it?”
Oh, yes. And the better your credit, the more a late payment can hurt.
Lenders are looking for any sign that you might default, and a late payment is often a good indicator that you’re in financial trouble.
Because payment history makes up more than a third of the typical credit score, ensuring that your bills get paid on time—all the time—is essential.
Now, for those of you panicking over that credit card bill you sent in two days past the due date: You can stop sweating. Normally a payment has to be at least 30 days overdue for a creditor to report it to the bureaus.
That doesn’t mean paying even a day late is a good idea, of course. Creditors increasingly are eager to slap their customers with late fees and jack up interest rates in response to late payments. Some have moved from due dates to due times; for example, a payment is considered late if it isn’t in their hands by 1 p.m. on the date that it’s due.
Furthermore, you can face higher interest rates on all your credit cards and your insurance policies if you fall behind with even one creditor. Many lenders and insurers periodically review their customers’ credit reports and adjust their rates based on what they find.
You also can’t skate on creditors that don’t regularly report to credit bureaus. You might not have seen your cell phone account or your electric bill showing on your credit history, but that doesn’t mean these vendors won’t report your delinquencies if you don’t pay them on time.
I occasionally get letters like the following, which try to put the blame for late payments on someone else:
“I recently checked my credit report after moving and found that my credit card company was reporting that I was 60 days overdue. I’m absolutely certain I haven’t received the bill for that card in several months, or I would have paid it. Aren’t they required to give me some notice before they report information like that to the credit bureaus?”
This might be a shock to some folks, but the answer is no. You’re responsible for paying your bills whether you get a statement or not. You need to keep track of what you owe to whom and make sure that everyone gets paid, even if the U.S. Postal Service falls down on the job.
Keeping track of these details also can help you detect identity theft. Some criminals like to steal credit card statements out of residential mailboxes. The bolder ones file a change-of-address form with the post office so that your mail gets redirected, allowing the bad guys to sort through it at their leisure.
To stay on top of what you owe and when, you should make a list of every bill you must pay each month and the date that it’s due. (Although credit card due dates can vary, they’re usually around the same time each month, give or take a few days.) Then list any bills that are due less regularly—every other month, every quarter, every six months, and annually.
Now, using either a paper calendar you can hang prominently on a wall or an electronic calendar in your computer, enter all your bills. Get in the habit of checking the calendar at least weekly to see what bills are coming up and to make sure they’re all getting paid.
You can set up electronic reminders to help you, as well:
• If you have a Palm or other personal data assistant, you can configure it to alert you.
• Many banks and online bill-pay systems offer free email reminder services.
• Bill-reminder features are part of personal finance software, such as Quicken and Money.
• Some credit cards, including Discover, email you when your bill is due.
If you really want to protect your credit, though, you should take further steps to avoid human error. The more of your bills that you put on automatic, the less worries you’ll have about late payments, late charges, and dings on your bill.
There are a few options.
An automatic payment allows the companies that you owe to take their payments directly from your checking account each month, with no action on your part—no checkbook, no stamps, no fuss. This is my favorite way of paying bills, and it could be yours. Just muster up the guts to try it.
A lot of people balk at the idea of letting a mortgage lender, utility company, or other vendor have regular access to their bank accounts. Some feel it’s somehow an invasion of privacy. In reality, the vendor can’t “see” into your account or monitor what other activity is going on there. The money comes out basically the same way it would if you paid by check or by other electronic transfer.
A federal law prohibits vendors from taking out more than you authorize. If a mistake is made—and in more than a decade of paying bills automatically, it’s only happened to me once—the company is obliged to replace the money it took in error.
Many people insist that they need control over when bills get paid. Typically, these folks have gotten into the bad habit of juggling bills or of not keeping enough cash in their checking account to cover their ongoing obligations. It’s a good idea to always keep a “pad” of $500 to $1,000 in your checking account, regardless of how you pay your bills, and to sign up for overdraft protection on your checking account. These lines of credit, which usually cost less than $50 a year, can pay for themselves the first couple of times you avoid a bounced check.
Or perhaps you’ve fallen into another bad habit—not paying your credit card balances in full. If that’s the case, be sure to read later about how that can hurt your credit score. In the meantime, know that most credit card companies have several automatic payment options. They can take out just the minimum payment or a set dollar amount each month instead of the full statement balance. If you opt for these partial payments, you can always pay more by check or online.
Really, you only have two choices: to pay your bills on time, or pay them late. If you want good credit and don’t want to worry about missing due dates, automatic payments are the answer for many, if not most, of your obligations. You will still get a bill each month with plenty of time to correct any problems on the statement before the payment is made.
My suggestion to you is this: Try it. Pay one bill a month this way. You can start with a mortgage payment or a student loan, because these payments tend to be the same each month, and the lenders might even give you a break on the rate if you agree to automatic payments. Just phone your lender and ask whether they offer automatic payments. (Some call it “direct debit” or “direct payment.”) If they do, they will send you a form to fill out. Do so, send it back, and you’ll be on your way.
You’ll probably soon find yourself converting more and more bills to automatic payment. Then you’ll never again have to worry about forgetting a bill or missing a payment while you’re on vacation.
You may not want to use automatic payment for everything, however. There are certain vendors—health clubs, phone companies and Internet service providers among them—that are rather notorious for abusing automatic payment privileges by continuing to bill a customer after their services have been discontinued. With these companies, it’s probably best to use one of the methods discussed in the following sections.
If you don’t want to let vendors have access to your checking account, you can have many of your bills charged automatically on your credit card.
Using a credit card can give you an extra layer of protection, because if a mistake is made, you have the credit card company to act as a middleman. You can dispute an erroneous charge and not have to pay it until the problem is resolved.
This method of paying bills comes with two rather large caveats, though:
• You should try this only if you can pay off the card in full each month—Paying credit card interest is rarely a good idea, but it’s never advised when you’re paying basic monthly expenses.
• You should use this only with your smaller bills—It matters to your credit score how much of your available credit you use and whether you pay your bill in full each month. If paying your bills would bring you anywhere close to your credit limit, you’ll be hurting—not helping—your score.
Millions of people pay at least some of their bills online. Most credit cards, for example, allow you to log on and pay your balance from their sites. The most efficient online bill-pay systems, however, allow you to pay a variety of your bills from one Internet location. The most popular choice is using your bank’s payment system, but plenty of other sites around the Web offer bill-pay services.
You can set up your system so that you decide when each bill gets paid, but you also can set up recurring payments so that bills get paid automatically. The difference is that you, not the vendor, can decide when these recurring payments start and stop.
Of course, this works only for bills that are the same amount every month. Credit cards and other bills that vary require that you specify the amount that gets paid each month.
The downside of many online bill payment systems is the cost, which can range from $5 to $15 a month. Although many banks have wised up and now offer free online bill paying, others still insist on charging. If your bank does, you might nag them about making it free.
Online bill paying has another advantage, one shared by automatic charges. Electronic transactions leave excellent “trails” that can show exactly when the bill got paid, so there’s never a question of a check getting lost in the mail. If you have a vendor that’s constantly slapping you with late fees, and you suspect they’re deliberately not processing your check, you can put a stop to those games with electronic payments.
What if none of the solutions thus far works for you? You have one more good option.
If you sit down and pay each bill immediately as it arrives, most of your worries about late payments will be solved. You’ll still need a calendar to keep track of your statements and due dates to make sure a bill hasn’t gone awry, but you won’t have to worry about losing a notice in a pile of other paperwork.
Remember that the second most heavily weighted factor in credit scoring is how much of your available credit you’re actually using. The lower your balances compared to your credit limits, the better.
The score gauges how much of your limit you use on each card or other revolving line of credit, as well as how much of your combined credit limits you’re using on all your cards. The score also factors in any progress you’re making on paying down installment accounts such as auto loans and mortgages.
Paying down your debt over time is a way to show consistent, responsible credit-handling behavior and will boost your score.
What does that mean in practice? Read on.
You can improve your credit scores in the short run by making sure you’re using only a portion of the available credit limit on each credit card account. If you have a large balance on one card, and other cards are sitting empty, it makes sense to transfer some of your debt to the unused card. That’s because it’s better to have small balances on a few cards than one big balance on a single card. But ultimately, you need to pay down your debt. If you continue to charge on your cards instead of paying down your balances, you’re using more and more of your available credit limit—and doing more and more damage to your score.
The way to improve your score is to stop the merry-go-round and start actually making a dent in your debt. To do that, continue reading.
The usual advice to debt-ridden consumers is that they should pay off their highest-rate debts first, and use lump sums to retire any bills they can afford to pay off in full. That makes a lot of financial sense, but unfortunately isn’t the fastest way to improve your credit score. Instead, you should do this:
• Prioritize your debts by how close the balances are to the accounts’ credit limits—If boosting your score is your goal, look for the card or other revolving account that’s closest to its limit. After that’s paid down below 30 percent or so, you can switch to the card or other account that’s the second closest to its limit. Your goal should be to eventually pay off all this debt, continuing in this round-robin fashion.
• Avoid consolidating your debts—Many people want to transfer their balances to a single card, either to take advantage of a low rate or for the convenience of having only one due date and interest rate to worry about. But for credit scoring purposes, it’s typically better to have small balances on a number of cards than a large balance on one card or other revolving line of credit. That’s because the score looks at the gap between the balance and the limit on each card, as well as on all your cards put together.
If you’ve already consolidated, though, you should probably just stay put. Applying for new credit or transferring balances, as noted earlier, can hurt your score and offset any gain you might get.
If you think all this doesn’t apply to you because you never carry a balance, think again.
As noted in Chapter 2, “How Credit Scoring Works,” the credit bureaus—and thus your credit scores—don’t differentiate between the balances you pay off and those you carry from month to month. The balances that are reported to the bureaus are typically the ones that show up on the monthly statements you’re sent. Even if you pay off your bill in full the day your statement arrives, you will likely still have balances showing on your credit report, and those will be factored into your score.
Now, paying your balances in full every month is an excellent financial habit. If you’re not doing it already, that should be your goal. Not carrying a balance can save you hundreds, if not thousands, of dollars a year in interest payments. Besides, carrying a balance leaves you vulnerable to all kinds of nasty creditor tricks, like jacking up your interest rates with little warning—something that’s increasingly common as credit card issuers try to boost their profits.
But even if you can and do pay your balances off, you need to pay attention to how much you’re charging each month. You need to stay below—well below—your credit limits.
You know by now that you shouldn’t max out your cards or come anywhere close to your credit limits. But the amount of your credit limit you should be using might surprise you.
Your balances (the amount you carry plus the amount you charge) shouldn’t exceed about 30 percent of your total credit limit at any given time. The higher your score, the lower the percentage of your credit limits you would need to use to improve your numbers. If your score is already in the high 700s or 800s, you might need to use 10 percent or less of your limit to boost your score.
If you regularly use more than that but can pay off your balance in full every month, there’s an easy way to make sure your charging habits don’t hurt your score: Simply pay your balance off a few days early.
Check your statements to find the “closing date” for your cards. (It’s usually around the same time each month, give or take a few days.) The balance that you owe on this closing date is what typically gets reported to the credit bureaus. If you go online a few days prior to this closing date and pay off your bill, the balance that’s reported to the bureaus will be dramatically reduced.
Just make sure that you pay any balance still owing when you get your bill. Otherwise, you’ll owe finance charges, and your company might even report you as late because they didn’t receive a payment after the closing date.
Finally, beware of cards that don’t report your credit limit. (Capital One, a leading card issuer, used to be notorious for this; it finally changed its practice after considerable consumer outcry.) When no credit limit is reported to a credit bureau, the scoring formulas typically use the highest balance charged as a proxy. If you regularly charge about the same amount, it can look like you’re maxing out your card even if you use only a fraction of your available credit. For example, if your limit is actually $10,000 but you typically charge about $2,000—with the highest amount ever charged about $2,500—the formula could show you using 80 percent of that card’s limit ($2,000 divided by $2,500), rather than the 20 percent you’re actually using.
You can “solve” this problem by racking up a really big bill one month, thus resetting the highest balance. A better course might be to simply use a card that properly reports your limit.
Paying down debt is a lot like losing weight—easier said than done. But most people can find ways to trim their expenses, boost their incomes, and free up more money to pay off their debts. Here are just a few examples. You can find lots more on Web sites devoted to frugality, such as The Dollar Stretcher at www.stretcher.com, or in books such as Amy Dacyczyn’s The Tightwad Gazette.
• You can sell stuff—Hold a yard sale, take clothes to consignment shops, sell unneeded vehicles, and auction off unneeded items on eBay. The money generated might go a long way toward paying off your debts.
• You can trim your spending—The easiest ways to save are to eat out less often, shop using a grocery list, and entertain yourself at home rather than going out, but you probably can find several other places in your budget to trim. Personal finance software, such as Quicken or Money, can help you track your spending, but you also can try just writing down every penny you spend for a couple of weeks. You’re bound to find little ways that money leaks out of your wallet. Stop those holes, and you can redirect the savings toward debt.
• You can moonlight—Few people would want to hold two jobs for long, but you might be able to handle it for several months or however long it takes to put a dent in your debt.
If your goal is to improve your credit score, don’t close any of your current accounts. Closing credit cards and other revolving accounts can never help your score, and it might actually hurt it.
Shutting down accounts reduces your total available credit, and that makes your balances loom larger. That narrowing of the gap between the credit you’re using and the total credit available to you is one of the things that can hurt your score.
Closing older accounts can also hurt you, because the formula notes both the age of your oldest account and the average age of all your accounts. It’s particularly important to keep your oldest account active, because shutting it could make your credit history look years younger than it actually is—and your score could drop as a result.
It may not be enough, by the way, to keep your oldest credit card in a drawer. If you don’t charge something occasionally, your lender could decide the inactive account is more trouble than it’s worth and close it for you. To keep it active, you might want to charge some small, recurring bill to the card—a newspaper subscription, your health club dues—and arrange to have the balance paid off automatically each month.
Responsible credit users don’t apply for credit they don’t need. They also try to pace their credit requests, so that they’re not opening a bunch of accounts in a short period of time.
Although your first few credit accounts serve to build and improve your credit history, there typically comes a point when each subsequent credit application can reduce your score. Where that point is, no one knows for sure; all Fair Isaac will say is that it depends on the other information in your file.
That shouldn’t keep you from applying for a car loan if you need a new vehicle, or getting or refinancing a mortgage. But if you already have three or four major bankcards, you should think twice before applying for another one.
You also should resist the urge to apply for those “instant” accounts retail stores are always pushing. Sure, you might save 10 percent on your current purchase, but you could wind up paying more in overall interest if the application lowers your score.
You might have heard that you need credit to get credit. It can certainly feel that way if you’ve ever applied for credit and been turned down for lack of a credit history.
But people establish credit all the time, and you can do so fairly quickly if you follow the following steps.
If you’re a parent with a teen, you might want to help your child through this process as a way to teach them responsible credit use. As noted later, your student will be able to get credit easily when he or she is in college; more than 80 percent of college students have at least one card. The best time for students to learn about credit is while they’re at home, under your supervision—and long before they pass by their first credit card sign-up booth on campus.
You might think you have no record at the credit bureaus, but you could be wrong.
Charles, an 18-year-old in Moline, Illinois, was turned down when he applied for his first credit card. He pulled his report and was shocked to find a collection action. It turns out that his parents had placed a newspaper ad for him while he was still a minor and then forgot to pay the bill.
The collection never should have appeared on his report. Minors can’t be held to contracts and, therefore, are typically not responsible for debts. But the time to detect and fix the problem was before Charles applied for credit.
Another problem you might run into is identity theft. Part of the surge of recent ID fraud cases involves thieves who use children’s Social Security numbers to get credit, said Robert Ellis Smith, editor of Privacy Journal. This kind of theft can go on for years before being detected.
If that’s happened to you, you need to clean up your credit report before trying to apply for new accounts. See Chapter 8 for help.
These usually don’t show up on your credit report, but lenders see them as important signs of financial responsibility and stability. They are also one of the few steps you can take as a minor to start building a financial history, because you won’t be able to apply for credit in your own name until you are 18.
Getting a debit card can give you some practice in using plastic. Debit cards are ATM cards with a Visa or MasterCard logo. You can use them with a personal identification number, or PIN, or you can use them like a credit card just by signing a charge slip. The amounts you charge are deducted directly from your checking account.
Nan Mead, communications director for the National Endowment for Financial Education, got her son a debit card in the sixth grade. She put a month’s worth of money into the account at a time and made him responsible for managing his allowance, lunch money, and incidental expenses, such as haircuts and school supplies:
“As I knew he would, he went through the first month’s money during his first week of school. He bought CDs, pizza for all of his friends,” Mead said. “I declined to bail him out, so he ended up taking a sack lunch to school for the rest of the month—a very uncool thing to do at that age, of course—and he had no discretionary money left to spend, either. His money management skills improved each month, though, until, by Christmas, he was doing quite well, even saving for some short-term goals.”
As a college freshman, Mead’s son received a credit card with a $500 limit. So far, so good, she says:
“In retrospect, the debit card was probably one of the best things I’ve done, in terms of providing a financial lesson to my son,” Mead said. “The mistakes he made initially were small, in the overall scheme of things, and he learned from them. When he graduates to one or more unrestricted credit cards, I believe he will do just fine.”
You might be able to jumpstart your credit history by being added to someone else’s credit card as an authorized or joint user. Many issuers will import the history for that account onto your credit report. (Before you take this step, have the account holder call the credit card company to make sure such an import will happen. Some issuers only import the account history when the new person is added as a joint user or is a spouse, whereas others don’t have that restriction.)
Being added as a joint or authorized user can be a wonderful boost if the person who’s adding you is responsible with credit. If not, though, the results can be disastrous.
Angie P., a Kansas college student, learned that the hard way. Her mother added her as a joint user on a credit card and then failed to pay the bill for more than two months when money grew tight over the holidays. Angie only discovered the delinquency when she checked her credit report:
“I’m just worried an employer will look at my [credit score, now 637] and think I’m irresponsible because of this mess!” Angie said. “What’s worse—I’m an accounting and finance major, and this makes it look like I don’t know how to handle my money.”
If you’re added as an authorized user, you’re not responsible for paying the bill. But the original user’s mistakes could still show up in your credit file. So if your goal is to establish good credit quickly, pick someone who has been responsible with credit and is likely to continue that behavior in the future.
Another strategy to start a credit history is to get someone with good credit to cosign a loan with you. The cosigner is taking a considerable risk, because if you fail to pay, the delinquencies show up on the other person’s credit report. But sometimes soft-hearted relatives or friends are willing to take this chance.
It will never be easier for you to get an unsecured credit card than while you’re in school. Lenders are much more lenient about extending credit during the college years, because they know your parents are likely to pay your bills if you can’t—and that parental support typically ends with graduation.
One reader told me that she lectured her daughter against the evils of credit cards and advised her to steer clear while she was in college. After the younger woman got out of school, though, the very lenders who had been falling all over themselves to offer her cards were now turning down her applications.
So get a card while you’re in school, but choose it carefully. Look for the lowest available annual fee and interest rate. And don’t go overboard—one or two major bankcards (Visa, MasterCard, American Express, or Discover) should be enough for now.
If you can’t get a regular credit card, consider applying for a gas or department store charge card, which are typically fairly easy to get.
You also might consider a secured credit card. These cards require that you make a deposit with a bank (usually $200 to $1,000), and your credit limit is typically limited to that deposit amount. The best cards don’t charge application fees, have low annual fees, and convert to a regular, unsecured card after a year or so. Web sites, such as Bankrate.com, offer lists of secured cards, including their rates and terms.
Make sure in advance that the lender reports to the credit bureaus. You can’t build a credit history if the lender isn’t reporting your payments.
After you’ve used plastic responsibly for several months, you might try for a small auto or personal loan. Because the credit-scoring formula wants to see that you can responsibly handle different types of credit, adding an installment loan to your mix of credit cards can boost your score.
Amanda got her first credit card at 18, two weeks after she moved out of her parents’ house. The card had a $200 limit and an atrocious 19.8 percent interest rate, but Amanda used it strictly to build her credit history by buying groceries and paying the bill off in full each month.
After six months, she got a credit card with a more reasonable interest rate and a higher limit. Three months after that, she got a used car loan for $6,000:
“Not bad for an 18-year-old,” she said. “A year later, I got a gold credit card with a 12.9 percent [interest rate].”
Today, Amanda checks her credit reports and scores every three months. She enjoys watching her credit score rise, and it motivates her to continue her good financial habits. She just wished more of her peers knew what she knows:
“If parents would address the credit issues with their children,” Amanda said, “and explain the importance of establishing a good credit history and of using credit wisely and responsibly, then maybe there wouldn’t be so many problems.”
Lenders know there’s a big market of the “credit underserved”—people with nonexistent or thin credit histories. Fair Isaac estimates that more than 50 million Americans either have no credit bureau files or have too little information in their files to generate a classic or NextGen FICO credit score.
Some mortgage lenders have been experimenting with ways to tap that market by using new approaches to gauging creditworthiness, such as monitoring whether an applicant has paid rent or utilities on time.
It was only a matter of time before Fair Isaac figured out a way to capitalize on the situation. In mid-2004, Fair Isaac introduced the FICO Expansion Score, which uses nontraditional information sources to create credit scores for people who don’t already have credit. These sources include bounced-check monitoring companies and retail purchase payment plans, such as rent-to-own programs.
Fair Isaac says it has enough of this nontraditional data to provide scores of half of the underserved population, or 25 million people. Other companies have invented similar systems that try to gauge the creditworthiness of folks who don’t yet have credit.
This expansion of credit and credit scoring just underlines how important it is to adopt responsible money habits, such as paying your bills on time and managing your bank accounts so that you don’t bounce checks.