Ask an Expert: How Do I Build Good Credit From Scratch?

February 6, 2021CreditBy toptierfinancial

The NFCC often receives readers questions asking us what they should do in their money situation. We pick some to share that others could be asking themselves and hope to help many in sharing these answers. If you have a question, please submit it on our Ask an Expert page here.

This week’s question: I need some advice in regards to my credit report and good ways that I can begin to build up my credit. I have no credit at all. Eventually within five years once I’m out of school I want to buy a house.

Building credit from scratch will take some time and effort, just like getting a job after graduating from school. You can think about good credit as a means to an end: you need good credit to finance big purchases and get the best interest rates and repayment terms on loans and mortgages. So, getting your credit ready is an excellent start to buying a home in the near future.

What is on Your Credit Report? 

Your credit is a record of your monthly financial credit transactions. Your creditors report your activity to the three credit bureaus, Equifax, Experian, and TransUnion, and they use that data to generate a credit score. Your credit report also includes your personally identifying information such as your name, addresses, social security, and some public records such as bankruptcies and judgments and tax liens, if you have any. To start generating data for your credit report, you need to get a credit line. The easiest way to do that is to get a secured credit card. Many banking institutions issue secured credit cards, and they work pretty much like a regular credit card. The main difference is that these cards are backed by a cash deposit, which usually corresponds to the card’s credit limit.

Be Strategic

Learning how to use your credit card strategically is equally as important as getting that credit line. Your credit score takes into consideration several factors. The factor that influences your score the most is whether you pay your accounts on time and as agreed. Late or insufficient payments are very detrimental to your credit history. So, you should plan to pay in full and before your due date. Another important factor is your utilization ratio, which is how much you owe compared to your available credit. To have a balanced ratio, experts recommend that you use only 30% or less of your available credit in every billing cycle. For instance, if you have a $500 credit limit, you should be using less than $150.

Yet another factor is the age of your credit history. The older your credit history, the more history and data you’ll have to establish a solid credit history. Achieving this will just require time and your continued effort. The other two factors to keep in mind are the mix of credit you have (credit cards and loans) and how often you ask for new credit. Too many new credit inquiries reflect negatively on your score, so it’s important that you only apply for new credit sporadically. In your case, you should keep your secured credit card for at least a year before applying for a regular credit card. In some cases, your creditor may even upgrade your secured credit card to a regular one and return your cash deposit.

It’s never too soon to start building your credit. And once you learn healthy credit management habits, it will be very easy for you to manage your credit and use your credit cards responsibly on a daily basis. If you feel you need additional guidance or personalized help to get you started, you can always reach out to an NFCC Certified Financial Counselor. They are ready to help over the phone, online, and in-person if it’s available in your state. Good luck!

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Credit-Builder Loans: Can They Help You?

October 31, 2019CreditBy toptierfinancial

What Is a Credit-Builder Loan?

If you have bad credit or no credit at all, you’ll likely have a hard time getting a loan. After all, the paradox of credit is that it’s hard to get credit without already having a credit history, much like trying to get a job without any work history.

A credit-builder loan can be a good option for those with no credit or bad credit because credit-builder loans do not require the borrower to have good credit to get approved. However, you will need to show that you have enough income to cover the monthly payments.

Just like a traditional loan, your payment history will be reported to the major credit bureaus. That means you need to make all of your payments on time if you want to build up your credit score.

How Do Credit-Builder Loans Work?

Credit-builder loans, also sometimes called “fresh start loans” or “starting over loans,” are set up differently than traditional loans in order to minimize risk for lenders. 

These loans are typically small amounts, such as $500 or $1000. In addition, unlike other types of loans, you do not receive the money upfront and pay it back later. Instead, this process is reversed.

The definition of a credit-builder loan is a loan where you make the payments first and receive the funds after you have finished paying off the loan. The lender deposits the amount you are borrowing into a savings account or certificate of deposit that will be held for you until you finish making all the payments. Until that point, you can’t access the funds.

Do You Need a Credit Check to Get a Credit-Builder Loan?

Because credit-builder loans are low-risk, in many cases, you can apply for credit builder loans with no credit check. You’ll likely just need to provide your income to prove that you can afford to make the payments.

Banks That Offer Credit-Builder Loans

Most of the big national banks, such as Chase, Bank of America, and Capital One, do not typically offer credit-builder loans, although Wells Fargo offers secured personal loans.

The best credit-builder loans can often be found at local banks and credit unions or through online lenders.

Payment history makes up 35% of your FICO score.

Payment history makes up 35% of your FICO score.

Are There Downsides to Getting a Credit-Builder Loan?

With a “fresh start” loan, as with any loan, it can hurt your credit score if you miss any payments. Remember, payment history is the biggest contributing factor to your credit score, weighing in at 35%. So when it comes to building credit, you need to be prepared to make every single payment on time.

In addition, you will be paying interest on the loan and potentially an application fee or other fees, although some lenders may partially refund the interest if you pay the loan back on time.

Finally, it may be several months to over a year before you finish paying off the loan and receive your borrowed funds. Building up a credit score by making payments on a loan takes a minimum of six months of payment history, according to FICO.

Other Ways to Build Credit

For those looking to build or rebuild credit, credit-builder loans are just one option. If you need to build credit fast, also consider one of the credit piggybacking methods we cover in “The Fastest Ways to Build Credit.”

By purchasing authorized user tradelines, for example, you can add seasoned tradelines with years of credit history to your credit report within just days.

Credit-Builder Loans: Can They Help You?

Conclusions on Credit-Builder Loans

For those who may be struggling to build credit due to bad credit or lack of credit history, a credit-builder loan represents one way to get a loan with no credit check and start building a positive credit history.

Just like other types of loans, credit-builder loans come with interest and fees, and the main downside of this type of loan is that you don’t have access to the funds until after you have made all the payments.

On the other hand, when you finish paying off the loan, you will have built up a record of on-time payments and you will have a chunk of savings to take home.

Credit-builder loans can also make a great complement to other methods of building credit, such as credit piggybacking.

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What’s the “Right” Number of Credit Cards?

July 11, 2019CreditBy toptierfinancial

How many times have you read a blog or heard some financial “guru” opining as to the mystical “right” number of credit cards to have in your wallet? Is the right number one, or two, or three? And what is the criteria for considering what is the right number versus the wrong number?

I’ll let you in on a little secret, there is no right or wrong number. It’s just an excuse to write a blog. If you are comfortable with one credit card, then one is the right number for you. If you need four to operate efficiently, then four is your right number. If you hate credit cards, then maybe zero is your right number.

When considering the right or wrong number of credit cards, nobody ever seems to focus on credit scores as part of their consideration. Well, that’s exactly what I’m going to do. And the reason I’m going to do so is because from a credit scoring perspective there actually is a right number of credit cards.

The Revolving Utilization Ratio

There is a metric in credit scoring systems called revolving utilization. Revolving utilization, often referred to as the balance-to-limit ratio, is the relationship between your credit card balances and your credit card limits, expressed as a percentage.

The ratio is calculated by dividing the aggregate of your balances by the aggregate of your credit limits, thus yielding a percentage. The higher that percentage, the fewer credit score points you’re going to earn from that metric. The lower that percentage, the more points you’re going to earn.

Reports about the optimal percentage are all over the place, with many of them being wrong. For FICO the optimal percentage is actually 1%, which is next to impossible to pull off. So, we have to go to the average percentage for the people with the highest average FICO scores, those with 750 and above. For those folks the average utilization ratio is 7%. For VantageScore the optimal percentage is anything less than 30%.

Now, that doesn’t mean you have to have 7% or 30% in order to have solid credit scores. You’ll just need to hit those targets if you want the highest possible scores, something that’s infinitely important right before you apply for a loan.

What Is the "Right" Number of Credit Cards? Pinterest graphic

Let’s go back to the topic of this blog, which is the right number of credit cards. The right number for you is going to be the number of cards necessary for you to maintain 7% utilization relative to your normal credit card spending patterns. That way you don’t really have to worry about your credit scores, ever. If you can hit 7%, or close to it, on a monthly basis then you’ll do as well as possible under both credit scoring platforms.

What you need to do now is download your credit card statements from the last 12 months. Add up the balances from all of the statements, and divide that number by 12. That will give you your average monthly amount of credit card debt appearing on your credit reports. Let’s say, for illustration purposes, your average monthly balance from all of your cards is $5,000.

Now we just need to figure out what credit limits you need from all of your cards in order for $5,000 to represent 7% of the aggregate credit limit. I’ll do the math for you…you’re going to need about $70,000 of credit limits for $5,000 to represent 7% of the limit because $5,000 divided by $70,000 equals 7.1%.

$70,000 sounds like a really large number, but in the world of credit card credit limits, it’s actually not that big of a number.  In fact, if you have two credit cards each with limits of $35,000, you’re already there. For many of you, however, you’re going to need more than two cards.

This becomes the answer to your question about the right number of cards. If it takes six credit cards for your average monthly credit card balances to equal about 7%, then six cards is the right number for you. If it takes ten cards, or 13 cards, or three cards…then those are the right numbers for you.

John Ulzheimer is a nationally recognized expert on credit reporting, credit scoring and identity theft. He is the President of The Ulzheimer Group and the author of four books about consumer credit. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry. He has 27+ years of experience in the consumer credit industry, has served as a credit expert witness in more than 370 lawsuits, and has been qualified to testify in both Federal and State courts on the topic of consumer credit. John serves as a guest lecturer at The University of Georgia and Emory University’s School of Law.

Disclaimer: The views and opinions expressed in this article are those of the author John Ulzheimer and do not necessarily reflect the official policy or position of Tradeline Supply Company, LLC.

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