- You've been saving money
for down payment on a new car, exciting.
You applied for an auto loan
with one bank and was denied, bummer.
Another bank approved you,
but with an interest rate of 16%, yikes.
Both lenders say that you don't have enough credit.
- Having no credit is different from having bad credit.
It doesn't mean you necessarily did anything wrong.
Maybe you don't like to borrow money,
maybe you just never got a credit card,
but from the lender's point of view,
you are a total mystery.
They have no idea whether you're the kind of person
who pays their bills on time,
so it's safer for them just to turn you down.
- Unfortunately, the only way to build credit
is to use credit,
and the only way to use credit is to get credit,
and the easiest way to get credit is to already
have a credit history.
- That sounds like a catch 22, but there are ways
to start building your credit from scratch.
It can take an investment in time and money,
but if you ever want to buy a house or get a car loan,
the process is definitely worth it.
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- The best start would be to establish
a revolving line of credit
where how much you pay back each month
depends on how much you use, in other words, a credit card.
Many lenders have pre-qualification applications
which allows you to apply
without a hard pull on your credit.
This is a great option
if you're not sure whether you'll qualify
and don't wanna make your credit worse.
Keep in mind, if you qualify and move forward
with an official application, the inquiry will be reported
and may temporarily affect your credit score.
- You may qualify for an unsecured credit card
which gives you a specific spending limit.
But if you're starting without any credit history,
you'll probably have to go for a secured card.
This type of card requires collateral
in the form of a deposit, which sets your credit limit.
In other words, you give the bank say $1,000
and they give you a credit card with $1,000 limit.
While there are a number of secured cards
that eventually graduate to unsecured, others don't,
so be sure to do your research before taking the leap.
- Now, this may not sound much like credit
since you're essentially borrowing your own money,
but it's a way to show the bank that you're reliable.
And the two main things they're looking at
are payment history and utilization.
- Payment history weighs the most
when it comes to credit score.
So it's imperative that you pay all of your bills on time.
If you miss your due date, you'll incur a late fee,
but lenders will not report your late payment
to the credit bureau
until you're more than 30 days past due, tick-tock.
- Utilization is how much credit you have available
on your card in relation to how much you currently owe.
So if you have $1,000 limit and you've borrowed $500,
you have a 50% utilization rate.
The lower your utilization, the better you look to lenders
because it suggests you have discipline and self-control
and don't run up cards to their limit.
For optimal results,
try to keep your utilization percentage below 30%.
- But payment history and utilization
aren't the only things that credit bureaus look at
when calculating your score.
- They also factor in the length of your credit history,
credit mix and inquiries and new accounts.
- There's not much you can do about length of credit history
except to get the process started as soon as you can.
Credit mix refers to having
a healthy balance of revolving credit,
like credit cards, and installment credit,
like mortgages, car loans, and student loans.
Now, should you go take out a big car loan
just to build credit?
No way, it's never a good idea to go into debt
for something you don't absolutely need.
However, there is a safer option
to achieving a good credit mix.
- Credit builder loans are designed for exactly this purpose
to help consumers with no credit history
boost their credit worthiness.
They're like savings accounts
and installment lines of credit combined.
You choose your loan amount and term length,
but instead of giving the money to you,
the lender puts it in a special savings account.
Once you've paid it off,
you get the total amount of the loan
minus a small amount of interest,
kind of like a loan in reverse.
What's great about it is
that your monthly payments are reported
as traditional installment payments,
so you're building your credit history
and getting some motivation to save money.
- There is a bit of a shortcut
to building credit from scratch
and that's to piggyback off someone else's credit.
The official term is called becoming an authorized user,
which means they're allowing you
to use their line of credit
and your activity there will be reflected
on your credit reports.
You'll often see this with spouses
or other family members helping each other build credit.
If the person giving you a piggyback ride
has low utilization and a good payment history,
this can help your credit tremendously,
but they are risking their own credit score to help you,
so don't abuse that.
- Oh, there's one more component of credit scores
that we haven't discussed
and that's inquiries and new accounts.
Even though this factor is at the bottom of the totem pole,
it can make quite the difference if not managed properly.
Every time you officially apply for a line of credit,
your score takes a short-term ding,
whether or not you're even approved.
If you apply blindly to lots of lenders
in a short period of time, that can give the impression
that you're thirsty for debt,
and that's a huge red flag in lenders' eyes.
- [Philip] For someone with no history or a bad score,
the world of credit can feel like an exclusive party
that you're not invited to.
- But it is possible to get in,
you just have to prove you know the rules.
It takes time and discipline, but it's so worth it.
- And whether you're building credit history from scratch
or rebuilding from past mistakes,
understanding how credit reporting and scoring works
is an essential component.
- [Philip and Julia] And that's our two cents.
- [Julia] Thanks to our patrons
for keeping "Two Cents" financially healthy.
Click the link in the description to become
a "Two Cents" patron.
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- For a deeper dive on the subject, check out our video,
What Goes Into Your Credit Score?
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