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How to Build Credit from Scratch


This article was written by John Ulzheimer, credit expert for CreditSesame.com.

There are three types of consumers as it pertains to credit reports: those who want to build a credit report, those who want to rebuild a credit report and those who want to maintain an already impressive credit report. Building credit is not the same as rebuilding or maintaining credit, and the strategies for each are very different. Still, when building credit and establishing a credit report from scratch, there are four generally recognized methods for doing so.

1. The credit builder loan. A credit builder loan is a loan extended by a credit union for a very small amount of money, normally no more than $1,000. The pay back terms are also very short, normally 12 months or less. For these types of loans, rather than giving the money to the borrower, the money is placed in an interest bearing account.

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As you make your payments to the credit union, they will in turn report your payment activity to the credit reporting agencies. After fully paying back the loan the funds plus any interest accrued are released to the borrower. You’ll also have 12 months of on-time payments that have been reported to the credit reporting agencies, effectively establishing a credit history in your name.

2. Secured credit cards. A secured card is a very common credit-building tool and can work quite well for those that are looking to establish credit on their own for the very first time. You make a deposit with a financial institution and they will in turn issue you a credit card with a credit limit equal to (or close to) the credit limit. For example, if you make a cash deposit of $500, the bank or credit card issuer will issue a credit card with a credit limit of $500.

Secured cards, which are NOT the same as prepaid cards, function exactly like any other unsecured credit card. You can use it wherever credit cards are accepted. You can incur a balance, interest and fees. And, you have a due date and a grace period. Your payment activity is reported to the credit reporting agencies but you’ll want to choose a card that reports to all three – Equifax, Experian and TransUnion.

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3. Authorized user credit cards. An authorized user is someone who is added to the credit card account of another person – a parent or spouse for example. The authorized user gets a card issued with their name on it and can use the card just like the primary cardholder. Unlike the primary cardholder, however, authorized users are not legally liable for the balance or the payment on the account.

The reason authorized user cards are a great credit building strategy is because the history of the card is normally reported to the credit bureaus. If the card is old, has a low balance relative to the limit, and has always been paid on time, you will benefit from all of these positive attributes.

The authorized user strategy is very common among young people because they can get themselves added to one of their parent’s credit cards. There are also several credit card issuers that no longer open joint credit card accounts, which makes the authorized user approach not only a tool for credit building but also a common occurrence when a husband and wife want to open a credit card in both names.

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4. Retail store credit cards. Retail store credit cards are cards issued with a store brand or logo and can only be used at that particular chain of stores. The Home Depot card, Gap card, Macy’s card, and the like are all examples of retail store credit cards. Retail store cards are normally easier to get than general use credit cards, like Visa, MasterCard, Discover and American Express. As such, retail credit cards are a common tool used by people who are looking to build and establish a credit report for the first time.

Retail store credit cards almost always have a combination of low credit limits and high interest rates. This makes them a more expensive credit card option, which is why they are easier to get, even for people with little credit experience. The drawbacks to a retail card is that their APRs are almost always in the mid to high 20 percent range, which is considerably higher than their non-retail peers. And, their credit limits are almost always very low, which limits the card issuer’s downside financial risk.

All in all, the retail store card is a perfectly fine tool for credit building. But, you have to be cognizant of the fact that if you’re carrying a balance from month to month, it’s going to get expensive.

John Ulzheimer is a nationally recognized expert on credit reporting, credit scoring and identity theft. He is twice Fair Credit Reporting Act certified by the credit industry’s trade association and has been an expert witness in over 140 credit related cases to date. Since 2004 John has been interviewed and published over 3,000 times on the topics of personal finance and consumer credit. Formerly of Equifax and FICO, John is the only recognized credit expert who actually comes from the credit industry.

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