How to establish a great credit score

People with very little credit information are said to have thin credit files.

Craig Watts, public relations director at Fair Isaac Corp., says that his company estimates that 22 million Americans have no credit record at all, and another 30 million have thin files.

Thin files contain not enough information with which to calculate a credit score.

"The common definition in the industry of a thin file is a credit report that has less than or equal to three trade lines," says John Ulzheimer, president of consumer education at Credit.com.

A trade line is basically an account, such as a car loan or a credit card account. The accounts must be on the credit report for several months before the account holder qualifies for a credit score.

"Just because you have a credit report doesn't mean you have a score. The account has to be on your report for at least three months before you start to qualify for a score," Ulzheimer says.

Once the file can be scored, the rules change a little for the borrower.

With excellent credit management -- keeping the balance reasonable in comparison to the limit and making payments on time every month -- "there is nothing to prevent a lender from offering more unsecured lines of credit," Ulzheimer says.

"That's less likely to happen now because of where we are right now. But there was a time when someone with a very thin credit report and a limited amount of information on the report was being offered pretty impressive lines of credit -- $5,000 or $10,000 lines of credit," he says.

Get around a Catch-22
Today's environment means credit issuers are less willing to grant large loans willy-nilly -- and they may be downright penurious when it comes to unknown borrowers.

That's because lenders don't want to be the first to lend money to a person with an unknown risk profile.

"It's the same situation as if you were asked by a stranger at a bus stop for $50 and they promised to pay your back," Watts says.

"You would want to know something about that person before you gave them 50 bucks. One of the things you would want to know is, have they borrowed 50 bucks from other people at a bus stop and paid them back reliably? It might make you feel a little better about parting with your hard-earned cash," he says.

Consumers in a thin-file predicament find themselves in a Catch-22 situation not unlike college grads who apply for jobs requiring experience. To build up a history, prospective borrowers need to get credit. But how can they get credit if they need credit to get it?

You can go about this in a few ways.

Go for retail or gas company cards
Most shoppers have participated in a transaction in a department store during which the clerk launches into a sales pitch for the store card. Most retail store cards, as well as gas company cards, offer some perks for signing up, plus they're somewhat easier to obtain than general-use credit cards.

"Typically those card issuers are more tolerant of thin-file people because their risk of exposure is so much smaller than the Visa or MasterCards of the world," Watts says.

One downside is these cards often sport higher interest rates, so it behooves borrowers to pay the bill in full each month. Another big drawback is that not all of these card issuers will report your on-time payments to the credit bureaus.

"You do want to make sure that they are reporting your payments to the credit bureaus," says Gail Cunningham, spokeswoman for the National Foundation for Credit Counseling in Silver Spring, Md.

"For instance, don't go down to the corner drugstore, which may have in-house charge accounts. They may set up an account but not report it," she says.

Consider secured cards
Another option for getting started with plastic is a secured credit card. A secured credit card acts like a regular, general-purpose card but is secured with a deposit, usually for an amount equaling your credit limit.

"You put up X amount of dollars, $300 or $500, and you're issued a credit card that looks like everybody else's credit card -- it's not stamped 'secured card' or anything so you're not embarrassed,'' Cunningham says.

"But the issuer has no risk as you charge and repay that debt each month as you build a positive credit history," she says.

Get a bank loan
Consumers with a thin credit file and a good relationship with a bank or credit union may be able to get a loan using their savings account as collateral.

"As you pay back the loan, the bank will report your good borrowing behavior to the credit bureaus, whereas they would never report your checking or savings account," Watts says.

Alternatively, borrowers who can't quite get a loan on their own could consider finding a co-signer. For responsible borrowers, co-signing a loan can be a great way to build credit. The key word is responsible.

In this borrowing scenario, instead of the bank assuming the risk of lending money, the other signatory shoulders most of the burden. Many a well-meaning co-signer has been burned by flibbertigibbets -- children, friends, boyfriends and other assorted associates whom they mistakenly thought would pay back the loan.

"If the primary borrower defaults, it will show on the co-signer's history and the lender is going to go to the cosigner expecting payment," Cunningham says.

"Frankly, on the other side of that coin, one of my recommendations is for people never to co-sign. It has to be on the table in this case," she says.

Try 'piggybacking'
Similar to co-signing, piggybacking has attracted plenty of controversy, though for different reasons.

The term refers to the practice of using someone else's good credit as a way of building up your own.

For instance, if a mother adds her daughter to her credit card as an authorized user, the credit card company will not check the daughter's credit history and the daughter, as an authorized user, assumes no obligation for the debt, but the credit card company will report the account on the daughter's file.

"It's not necessarily a positive way of doing it. Some lenders view that as being a little bit sneaky -- especially if you do it with someone that you don't have a defendable relationship with," Ulzheimer says. "(A) father and son, (or) husband and wife -- that is a different story than two complete strangers that are doing it. Lenders take a dim view of that."

How could a stranger be an authorized user on another stranger's credit card account? The phenomenon is a byproduct of our capitalistic system.

"The unscrupulous got ahold of the idea and started charging people with poor credit a fee to be added on to a person who has good credit. I am certainly foursquare against that, but as far as the legitimate use of piggybacking, I don't have a problem with it," Cunningham says.

The practice was due to be banned -- at least as far as the benefit to credit scores -- in the updated FICO 2008 scoring model. However, the change did not end up in the final design, so legitimate authorized users continue to benefit from the system.

Use alternative credit scores
In 2004, Fair Isaac introduced the Expansion score as an alternative to the classic FICO score to reach the unbanked market. It uses alternative payment data to compile a score for consumers.

"Instead of relying on one credit bureau's information, the Expansion score instead pings a number of small specialized credit bureaus that keep track of fairly interesting things -- but those things are usually not something that consumers are aware of being tracked by credit bureaus," Watts says.

For instance, the kind of information included could be gym memberships, payments to utility companies, or rental payments to a landlord or apartment management company.

(One such alternative credit bureau is PRBC, recently acquired by MicroBilt. Both companies cater to small and medium-sized businesses. PRBC compiles data provided by consumers, while MicroBilt receives trade line data directly from small businesses.)

Besides the Expansion score, there are other, similar, scores available to lenders, but so far none are as widely used as the conventional scoring models measuring traditional credit data.

"When you introduce any new technology or advancement for lenders, they spend a long time kicking the tires," Watts says.

"Some credit card issuers are using Expansion scores today, but the score hasn't really taken off with mortgage lenders," he says. The reason: Fannie Mae and Freddie Mac have had an enormous influence on the risk-management tools lenders use and require specific scoring criteria before purchasing mortgages.

Until the new scoring models are widely accepted, consumers with little to no credit may be able to benefit from them in building their credit histories, but they likely won't be offered a mortgage on the strength of that score alone.

However, over time, as the Expansion scores prove their predictive abilities, lenders will be more likely to use them.