Establishing A Good Credit History Has Never Been As Important As It Is Today

It’s not just that you’ll need good credit to get decent rates when you’re ready to buy a home or a car. Your credit history can determine whether you get a good job, a decent apartment or reasonable rates on insurance. One seemingly minor misstep -- a late payment, maxing out your credit cards, applying for too much credit at once -- can haunt you for years.

If you’re just starting out, you have a once-in-a-lifetime opportunity to build a credit history the right way. Here’s what to do, and what to avoid.

Check Your Credit Report

You’ll first want to see what, if anything, lenders are saying about you. That kind of information is contained in your credit report at each of the three major bureaus: Equifax, Experian and Trans Union. By mid-2005 you should be able to get one report per year from each of these bureaus for free; until then, the cost is generally between $8 and $9 each.

Credit reports are used to create your credit score, the three-digit number lenders typically use to gauge your creditworthiness. Lenders also may look at the report itself, as may the landlords, employers and insurance companies who use credit to evaluate applicants.

Can you have a credit report if you’ve never had credit? Maybe.

Somebody else’s information could be mixed in with your report, either through a credit bureau mistake or because of identity theft; i.e. someone using your personal information to open bogus accounts.

If that’s happened to you, you’ll need to clean up your credit report before trying to apply for new accounts. The Federal Trade Commission has information that can help.

Establish Checking And Savings Accounts
Here’s a basic step that’s sometimes overlooked by people seeking credit. Lenders see these accounts as signs of stability.

Opening checking and savings account is also one of the few things you can do as a minor to start building a financial history. While you can’t get a credit card in your own name until you’re 18 and can be legally held to a contract, many banks have no problem letting you open an account.

Many, but not all. If your bank balks, you need to either look around for another bank or consider opening a joint account with an adult.

Understand The Basics Of Credit Scoring
For information on how credit scoring works, read “Beef up your credit score in 5 steps.” For now, though, you need to know that the two most important factors in your score are:

• Whether you pay your bills on time.
• How much of your available credit you actually use.

It’s essential that you pay all your bills on time, all the time. Set up automatic payments or reminder systems so that you’re never, ever late. All it takes is a single missed payment to trash your credit score -- and it can take seven years for the effects to completely disappear.

You also don’t want to max out any of your credit cards, or even get close. Keeping your credit use to less than 30% of your credit limits will help you get the best possible credit score -- and should help keep you from getting over your head in debt, as well.

Finally, you don’t need to carry a balance on a credit card to have a good credit score. Paying your bill off in full is the best way to keep your finances in shape and build your credit at the same time.

Piggyback On Someone Else’s Good Credit

The fastest way to establish a credit history can be to “borrow” another’s record, either by being added to a credit card as an “authorized” or joint user or by getting someone to co-sign a loan for you.

Having a co-signer can allow you to qualify for loans you might not otherwise get. The loan will show up on your credit report and, if you pay it off responsibly, will help boost your credit score.

If you default, however, you won’t be the only one who suffers. The co-signer has basically promised to make good on this account, so any delinquencies will show up on her credit report as well.

Being added as an “authorized user” has its risks, as well, for you as well as the person giving you access to the card.

If your father makes you an authorized user of his credit card, for example, his history with that account can be imported to your credit bureau file, giving you an instant credit record. If he has handled the account well, that reflects well on you. But if he hasn't, his mistakes would also become yours. Any late payments or other problems could make it harder for you to get future credit than if you’d established your history without help.

Even if you trust the person adding you to the card, you may not be able to piggyback on his or her credit. Some credit issuers won’t report authorized users to the credit bureaus, particularly if the user is not married to the original card holder. If the point is to give you a credit history, the person who’s adding you as an authorized user should call the issuer and ask how (or if) your status as a user will be reported.

Apply For Credit While You’re A College Student

Credit experts used to warn college students away from those booths set up on campus by credit card lenders -- the ones that promise free stuff for signing up. It turns out, however, that there’s no easier time to get a card than while you’re a college student, said Gerri Detweiler, author of “The Ultimate Credit Handbook.” Lenders are willing to take risks with you that they won’t once you graduate, probably because they know that your parents’ willingness to bail you out will end once you get your sheepskin.

You still have to exercise some caution, though. Look for a card with a low or nonexistent annual fee and low interest rates. For now, just get one: Opening a slew of credit accounts in a short period of time can make you look like a risky customer.

Apply For A Secured Credit Card

If you can’t get a regular credit card, apply for the secured version. These require you to deposit money with a lender; your credit limit is usually equal to the deposit.

You’ll want to screen your card issuer carefully. To be frank, there are a lot of bad guys in this particular niche of the credit world. Some charge outrageous application or annual fees and punitively high interest rates.

Your credit union, if you have one, is a good place to start looking for a secured card. You can also check Bankrate.com’s list of secured credit card issuers.

Ideally, the card you pick would:

• Have no application fee and a low annual fee
• Convert to a regular, unsecured credit card after 12 to 18 months of on-time payments
• Be reported to all three credit bureaus.

If the issuer doesn’t report to the credit bureaus, the card won’t help build your credit history.

Get A Finance Company Card

Gas companies and department stores that issue charge cards typically use finance companies, rather than major banks, to handle the transactions. These cards don’t do as much for your credit score as a bankcard (Visa, MasterCard, Discover, etc.), but they’re usually easier to get.

Again, don’t go overboard. One or two of these cards is enough. If you get many more, you may find that later in your life these accounts could prevent you from getting the highest possible credit score. That’s not a reason to avoid them completely, because right now they’ll do you some good. Just don’t apply for half a dozen.

Get An Installment Loan

To get the best credit score, you need a mix of different credit types including revolving accounts (credit cards, lines of credit) and installment accounts (auto loans, personal loans, mortgages).

Once you’ve had and used plastic responsibly for a year or so, consider applying for a small installment loan from your credit union or bank. Keeping the duration short -- no more than a year or two -- will help you build credit while limiting the amount of interest you pay.

Use Revolving Accounts Lightly But Regularly

For a credit score to be generated, you have to have had credit for at least six months, with at least one of your accounts updated in the past six months.

Using your cards regularly should ensure that your report is updated regularly. It also will keep the lender interested in you as a customer. If you get a credit card and never use it, the issuer could cancel the account.

Just remember the credit tips mentioned earlier:

• Don’t charge more than 30% of the card’s limit.
• Don’t charge more than you can pay off in a month. As mentioned earlier, you don’t have to pay interest on a credit card to get a good credit score, and it’s a smart financial habit to pay off your credit cards in full each month.
• Make sure you pay the bill, and all your other bills, on time.

 

Liz Pulliam Weston
is author of the upcoming book, “Your Credit Score: How to Fix, Protect and Improve the 3-Digit Number that Shapes Your Financial Future” (October 2004, Prentice Hall). She is a personal finance columnist for MSN Money and author of the question-and-answer column "Money Talk," which appears in newspapers throughout the country. Formerly a personal finance writer for the Los Angeles Times, Pulliam Weston is a graduate of the certified financial planner-training program at University of California, Irvine. She lives in Los Angeles with her husband and daughter. She enjoys hearing from readers, but regrets that she cannot respond to every email because of the volume of mail she receives. Mail Liz Pulliam Weston.

Liz Pulliam Weston's column appears every Monday and Thursday, exclusively on MSN Money. She also answers reader questions in the Your Money message board.