Building Credit When You Have None

Bright red. Awesome stereo. Plenty of room for all your BFFs. That used car on the lot is one hot ride, and the price is right. You’re a young adult with a pretty solid job, and it fits your budget, so finances shouldn’t be a problem. If only someone would extend you credit.

The truth is, you’re young, a relative newbie in the world of finance, and unfortunately it shows. You have no credit history. No matter how responsible you are, if there’s no financial record of it, getting credit could be difficult.

When lenders look at you, how do they decide if you’re worth the chance they’ll take by lending you money? They start with the Five Cs of Credit:

1. Character—Are you a person of your word? Do you take promises seriously, especially when involves paying back borrowed money?
2. Capacity—Is your financial situation such that you’re able to make prompt payments on a loan?
3. Collateral—This is something of value that you own that’s used to secure a loan. If you fail to make your payments on time, the lender has the right to confiscate your collateral as a way to pay off the loan, which will have devastating effects on your credit. And frankly, you don’t want the repo man knocking at your door.
4. Capital—These are your assets. Assets include such things as a home, vehicle, bank account, etc., and are used as an indicator of your ability to repay a loan.
5. Condition—How’s the economy? Current economic conditions could affect your ability to make timely loan payments.

The first two points are within your grasp. You’re responsible and have a job. The remaining three points are tougher. You’re not old enough to have acquired much collateral or capital, and the economic condition is out of your control. So how do you convince lenders you’re a good credit risk? You’ve got to take the right steps to establish a good credit history.

1. If you haven’t already, open a checking and/or savings account. Accounts like these signal financial stability and show lenders you’re able to handle financial affairs in a responsible way.
2. Use what credit you can. A good place to start is with a credit card from a department store or gas station. Apply for a card from Macy’s, Sears, Kohls or some other such store. Also try BP, Mobil or another oil company. These credit cards are usually easier to obtain than a Visa or MasterCard. Be sure to use the cards responsibly and make prompt payments to build a solid credit history. But make sure not to take on too much revolving debt, which can lead to a negative credit rating.
3. Take out a small loan, even if you don’t need the money. To offset the interest on the loan, you could put it in a money market account or certificate of deposit (CD) and earn interest from these investments. Once again, be sure to make prompt payments on the loan. The idea here is to show lenders you’re a responsible person with your finances. Tend to a smaller loan responsibly, and lenders will be more willing to take a chance on you for larger loan amounts in the future. Just be sure NOT to open any payday-type loans as these will have a negative impact on your overall credit score.
4. Look into a secured credit card. These cards are much like a regular credit card, but are “secured” with a deposit, usually an amount equal to the credit limit. So you put up $500, and you’re issued a card that looks like any other credit card but has a $500 limit.
5. A co-borrower on a loan is another option. A responsible, qualified co-borrower with a good credit history can help a person with little credit take out a loan; however, the co-borrower also shoulders the burden of paying back the loan if the primary borrower defaults. This shields the financial institution from much of the lending risk but puts the co-borrower in a bad position if the primary borrower shuns responsibility. If you use a co-borrower, be sure you don’t leave him/her in a bind by not making timely payments.

It’s important to remember that credit can be a good thing if used responsibly. Never get in over your head and always make timely payments. Failure to do so can create problems within your financial life that will add headaches to your life in general. Use credit responsibly, and it can help you deal effectively with financial situations all through your life.