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What’s the best way to build credit? Credit cards, co-signers and more

There’s no shortage of options to help you build credit.

Justin Cupler

Contributing Writer at Tally

July 7, 2020

From getting approved for a new cell phone plan to getting the best car insurance rates, your credit report and credit score are ingrained in day-to-day life. Even a lack of credit can haunt you when applying for loans or credit cards. 

Fortunately, there's a long list of credit-building methods that can help you build the credit score you need to meet your financial and life goals. But, before diving into building credit, you'll need a firm grasp of your credit report, credit score and how they work together. 

Understanding your credit report

You have numerous credit reports, but the three that matter most are from the major credit bureaus: Experian, Equifax and Transunion. 

Your credit report acts as a financial report card that shows how you've managed debts over the past 7-10 years. It also lists other financial data lenders will use to determine your identity and creditworthiness. 

The details you'll find in your credit report include: 

  • Personally identifiable information, including known names, known addresses, Social Security number, date of birth and known employers

  • Credit accounts, including loans and credit card accounts, and their respective balances,

    , open dates and payment histories

  • Public record and collections, including unpaid bills sent to collections, wage garnishment for unpaid debts and bankruptcy

  • Hard credit inquiries

Understanding your credit score

Your credit report and credit score are closely related. Lenders and other companies you have financial relationships with report information to your credit report. Your credit score is a numerical value calculated using what's in your credit report. 

When determining your creditworthiness, lenders will look at your credit report and credit score before deciding to approve or deny your application. This is why it's critical to understand and monitor both. 

From credit report to credit score

To build your credit score, companies develop scoring models that process the financial data on your credit report and assign a numerical value to it. There's a wide range of credit scoring model, but the one most lenders use is the FICO score. Making things more complex, FICO has several industry-specific scoring models, including FICO Auto Score, FICO Bankcard Score and the base FICO Score. On top of that, there are multiple versions of each industry-specific score. 

When speaking about the broad term "credit score," it generally refers to the base FICO Score model. Your base FICO Score is calculated using five main categories of financial data found in your credit report. To calculate your credit score, the FICO model weighs each category differently, so certain categories have more impact than others. 

The categories and their weights include:  

  • Payment history: makes up 35% of your FICO credit score and shows whether you pay your debts on time or have some late payments.

  • Amounts owed: makes up 30% of your credit score and considers your total debt balances, the amount you owe on various types of debts and your

    on revolving debts.

  • Length of credit history: makes up 15% of your credit score and considers the age of your oldest and newest accounts, the average age of all your accounts and how long certain accounts have sat dormant.

  • Credit mix: counts for 10% of your FICO Score and considers the mixture of different types of debts you have, including revolving accounts, mortgages, installment loans and more.

  • New credit: makes up 10% of your FICO Score and considers how many new accounts you've opened, how many hard inquiries you've had on your credit and how long it's been since you've opened a new account 

As for the scores themselves, the base FICO Score ranges from 300 to 850, and within that range are categories: 

  • 350-579: Poor

  • 580-669: Fair

  • 670-739: Good

  • 740-799: Very Good

  • 800-850: Excellent

Those scores give lenders a way to judge your creditworthiness quickly, but if you have no account on your credit report — no loans, credit cards or anything — your credit score will read "insufficient credit history." 

There are a few times when you may end up with an insufficient credit history. The most common time is when you first turn 18 and attempt to get a loan or credit card, or attempt to check your own credit score. The less common time is when it's been over seven years since you closed your last credit account, so you no longer have any accounts showing on your credit report. 

If you see "insufficient credit history" on your credit report, it's time to start building credit. There are many credit-building methods available, and the best way to build credit depends on what credit accounts you're eligible for and what fits your financial situation.

The best way to build credit

There are several ways to go from no credit to good credit with relative ease. The key is finding the process that best suits you. Here's a look at your options. 

Get a credit card

You may think it's impossible to get a credit card while building credit, but there are plenty of credit cards on the market designed for people with credit issues. 

Unsecured credit card

Because this is an unsecured card, there is no security deposit. Plus, an unsecured credit card generally carries the Visa, Mastercard, or Discover logo, so you can use them at most retailers. An unsecured credit card is what comes to mind when most people think of a traditional credit card. 

Most unsecured cards have tight creditworthiness requirements, and someone still building their credit likely won't meet the requirements. 

There are, however, unsecured credit cards designed specifically for people with less-than-ideal credit situations, including bad credit or no credit. 

Like most other credit cards, these credit-building credit cards report to the major credit bureaus. This means they can help you build credit by making on-time payments and keeping your balance below 30% of the credit limit. 

Unsecured credit cards are a good way to build credit without a security deposit, but there are some downsides to them, including:

  • They may have a higher-than-average interest rate

  • Credit-building unsecured credit cards are not as abundant as credit-building secured credit cards

  • They may have an annual fee

  • They may have additional requirements in lieu of good credit history, including:  

    • Being a student

    • Having an account at the credit card issuers bank

    • Authorizing automatic direct debit

Secured credit card

A secured credit card works the same way as an unsecured credit card: You can use it virtually anywhere to pay for goods and services, you receive a monthly bill and you pay interest on the balance unless you pay it off each month. But a secured credit card differs in its looser creditworthiness guidelines and security deposit.

When you receive a secured credit card, you will pay a security deposit that's generally the same amount as your credit limit. The credit card company places this refundable deposit in an account and uses it to pay off the credit card if you fail to repay the debt. 

With the credit card company's financial risk offset by the security deposit, it can approve people with all types of credit, even those with no credit. This easy approval makes a secured card a common first credit card for people looking to build credit. 

Like traditional credit cards, the credit card issuers typically report your account details to all three major credit bureaus. To maximize the positive impact on your credit score, always make on-time payments and keep your credit card balance under 30% of your credit line.

Secured credit cards are good credit-building options, but they aren't perfect. Some downsides include:

  • They require a lump-sum security deposit

  • They have a higher-than-average

  • They offer a low initial credit limit

  • They often charge monthly and annual fees. 

Become an authorized user

Credit card companies often allow the main cardholder on a credit card account — the one whose name the account is in — to add trusted third parties as authorized users on the account.  

An authorized user typically receives a credit card attached to the cardholder's account but doesn't have access to sensitive data like the cardholder's Social Security number, address and other information. The authorized user also can't make changes to the account or add new authorized users. 

Many credit card companies report authorized users to the credit reporting agencies, so you can start building good credit if the main cardholder is responsible with their credit card use. 

Once you find someone willing to list you as an authorized user, completing the process is easy and application free. The main cardholder calls the credit card company with your information, including your name, address, date of birth and Social Security number, and the credit card company adds you to the account. Though the credit card company has your Social Security number, there is no credit check involved to be an authorized user. 

There are a few downsides to being an authorized user, including:

  • The main cardholder can delete you any time

  • The main cardholder may be able to limit your spending

  • Not all credit cards report authorized users to the credit bureaus

  • If the main cardholder has a late monthly payment or defaults, it can hurt your credit score

  • Finding a cardholder willing to add you as an authorized user may be hard

Becoming an authorized user is all about mutual trust. You must have a friend or family member who trusts you not to make big charges on their credit card account, and you must trust the main cardholder not to miss payments.

Take out a student loan

If you're a college student or considering going to college, a federal student loan is a great way to build credit. What makes federal student loans so ideal is that they have no credit requirements. 

Whether you have good credit, bad credit or no credit at all, a federal student loan is virtually guaranteed if you meet a few criteria: 

  • You have a high school diploma or GED

  • You're enrolled in an eligible college or university

  • You complete the Free Application for Federal Student Aid

  • You're in good standing with past federal student aid

  • You have maintained a cumulative 2.0 GPA or higher in college

  • You're at least a part-time student

On top of being a near sure-fire approval, federal student loans have many perks, including payment deferral while in school, relatively low interest rates, loan forgiveness programs and more.   

The only drawbacks to student loans are: 

  • You must be a student, of course

  • They can add up very quickly while in school

  • Your credit score may not improve until up to six months after you leave school because you receive payment deferrals while in school and a six-month grace period after leaving school. 

You can, however, start repaying your student loans before the end of the deferral period, accelerating its impact on your credit score. 

Take out a credit builder loan

Credit builder loans are useful ways to build credit and they're open to nearly any credit type, even those with no credit or bad credit. 

A credit builder loan is for a small amount — generally between $300 and $1,000 — according to the Consumer Finance Protection Board

Instead of giving you the cash for the loan, the lender places the cash in a bank account while you repay the loan over the next 6-24 months. Once the repayment term is over, the lender sends you the original loan amount. In some cases, the lender may also send you back some or all of the interest the loan earned while in the bank account. 

A credit builder loan is a unique way to build credit, but there are a few drawbacks to keep in mind: 

  • The interest rate may be higher than average

  • It may charge an application fee, origination fee and monthly fees

  • You don’t receive the cash from the loan until after you pay it off 

Take out an installment loan

An installment loan, like an auto loan, may be another option for building credit. Installment loans come in two forms, a secured loan and an unsecured loan. Similar to secured and unsecured credit cards, the secured loan reduces the lender’s financial risk because there's an asset the lender can seize if you don't pay the loan. 

Secured loans have an asset to help reduce the financial risk to the lender. In an auto loan, for example, the bank retains the title to the vehicle until it's paid off. If you default on the loan, the lender repossesses the vehicle and sells it to recoup some of the losses. Because of the lowered risk, you may get approved for a secured loan when you're building credit. 

An unsecured loan, like a personal loan, has no assets securing it. If you default on the loan, the lender has no asset to immediately seize. Instead, the lender will have to sue you in court to get a judgment allowing it to seize assets or garnish your wages, but this can be a costly process that doesn’t always end in the lender’s favor. This risk makes it more difficult to get approved for an unsecured loan more difficult than a secured loan. 

An Installment loan is a good way to build credit because it won't impact your credit utilization rate. This allows you to potentially add other credit accounts, like a credit card, to enhance your credit mix and further boost your credit score.  

On the downside, because you're still building credit, you likely fall into a subprime lending category — a lending category reserved for borrowers who qualify for a loan but have credit blemishes that increase the lender’s risk — resulting in high interest rates and high monthly payments. You may also need a large down payment to get approved. 

Adding a co-signer

If you can't get approved for an installment loan, you can consider adding a co-signer. A co-signer is someone who shares the responsibility of the loan with you. They may not make the monthly payments, but the lender considers their credit history and income when reviewing the loan for approval.

While a co-signer may seem like a quick fix, you must consider that the co-signer is risking damage to their own credit to help you. If you default on the loan, the co-signer will also get a negative mark. This may make it tough to find someone willing to be a co-signer.

Get a boost from Experian

Experian, one of the three major credit bureaus, offers its free Boost service that may help speed up your credit-building venture. Experian Boost connects to your bank account and tracks payments to cell phone providers and utility companies. It then places these accounts on your credit report and records the monthly payments, potentially increasing your FICO credit score. 

Experian Boost is a good service with minimal risk, but there are some downsides to consider:

  • You must sign up manually

  • Not everyone will see a credit score increase

  • You may not be comfortable sharing your banking information with Experian

Build credit with confidence

Building credit may seem like an uphill battle, but with plenty of credit-building options available, it's easier than you may think. You can build credit by: 

  • Opening secured and unsecured credit cards

  • Being an authorized user on someone else's credit card account

  • Taking out student loans

  • Taking out an installment loan and using a co-signer if needed

  • Using new offers like Experian Boost. 

With so many choices, you can roll into the world of credit confident that you're in control of your credit score, credit history and financial future. 

Always remember that building credit takes time. Once you identify the best way to build credit, act as soon as possible so you can put your lack of credit behind you.