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How to Build Credit the Right Way


on 9/6/2017

Young man paying billsWhen you’re just starting to make your way in life, it doesn’t take long to realize that credit is going to be necessary to financial survival. 

However, when you apply for credit, you may find that it’s hard to get approved if you don’t already have a credit history, leaving you wondering how to start building credit.

Check out these four options that may be your best way to build credit.

Savings secured loans

While you may not have established a strong credit history, you may have already developed good financial habits by saving.  If you have savings set aside for a purpose that you won’t have to touch for awhile, consider using those funds as collateral for a loan. 

Collateral is something that belongs to you that will be taken by the lender to pay off your debt if you don’t pay.  When your savings is collateral for a loan, you will not be able to withdraw funds from your account while you have a balance owing on your loan.

Why get a loan when you have money saved?  By taking out a savings secured loan (sometimes called a “pledge loan”), you will be more likely to be approved than other types of loans.  Then you can demonstrate your ability to make on-time payments on a monthly basis. 

Loans that require payment in full with monthly payments over time are called installment loans.  Establishing installment credit and showing a good pattern of on-time payments will show future lenders that you handle your financial obligations responsibly.

Here’s an approach to using a savings secured loan to start building credit.

  1. Save up funds that you will not need for the next year or two.  Start with something like $1,000 or $2,000.
     
  2. Apply for a savings secured loan with your credit union.
     
  3. When approved, put the loan proceeds in a savings account and don’t withdraw the funds.
     
  4. Make sure you make your monthly payments on time.  If not, your lender will withdraw funds from the savings account you used to secure the loan.  Don’t make the lender grab your payments from your savings.   Make the payments before they have to do this.  Better yet, arrange to have your monthly payments automatically withdrawn from the new savings account holding the loan proceeds.   Either way, make sure you make payments on time, or you will be defeating the purpose of getting the loan.

 

Secured credit cards

Like the savings secured loan, a secured credit card will use your savings account as collateral for your debt.  The difference with a credit card is that you will be establishing a different form of credit, called “revolving credit.”

Revolving credit is different from installment debt in that the account provides a pre-approved amount of credit (called a “line of credit”) you can activate by making purchases using your credit card or another method.  As long as you have your secured credit card account open, you will not be able to withdraw the amount equal to the approved credit line limit.

Here are some keys to establishing good credit with a secured credit card:

  • Use the card for small purchases.
     
  • Don’t let the outstanding balance remain over 30% of the total credit line for long.  Showing that your balances remain as a small portion of the available credit will boost your credit rating.
     
  • Try to pay your balance off in full each month.  If you can’t, be sure to pay more than the minimum required balance and keep that outstanding amount below 30% of the available line.

 

Co-signed loans

As a new borrower, lenders may ask if someone will co-sign for a loan with you.  A co-signer is someone with good credit who agrees to be responsible for your debt in the event you don’t pay.   

Unfortunately, too many family relationships and friendships have been spoiled when a co-signer ends up paying the debt of the primary borrower.  That’s why it’s usually only a very close relation who is willing to co-sign for a loan.  If you have to use a co-signer, don’t let them down by not paying off your loan.

One twist to a co-signed loan is to ask your co-signer to use their savings as collateral for your loan.  In this case, the co-signer continues to earn savings interest while you pay off the loan.  Many parents help their children establish credit in this way.

 

Starter loans

Many credit unions offer starter loans for new borrowers.  These can be first-time auto loans or small unsecured (no collateral) loans.  Starter loans can help you establish credit much like a savings secured loan. 

You will have to show that you have a steady income to get this type of loan.  Arrange to have your payments automatically deducted from your checking or savings account soon after your scheduled paydays to ensure that you are developing a good payment history in your credit report.

After getting the loan, develop healthy payment habits.

Getting your first loan or credit card takes you just part of the way to good credit.  To establish good credit:

  • Pay on time.
     
  • Don’t run your balances up, especially your revolving credit balances.
     
  • Don’t add too much credit too fast.  You may get a lot of credit offers.  More is not necessarily better.  Adding a lot of new credit accounts in a short time span will harm your credit rating.

 

Genisys Credit Union has a variety of credit options to help you to start using credit wisely.  (and so on…)  Would you like to learn more about credit? 

Download our FREE eBook: How Credit Works: Understanding It and How to Build Yours Right the First Time

 

© Genisys Credit Union and www.genisyscu.org, 2017. Unauthorized use and/or duplication of this material without express and written permission from this site’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Genisys Credit Union and www.genisyscu.org with appropriate and specific direction to the original content.

 

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