How do you establish credit without credit?

While the entire world is talking about going “debt-free” which I admire, the fact of the matter is unless you never intend on purchasing a home or any other high dollar item, and you are not independently wealthy (in which case creditors will offer you all the credit you wish) you will need to establish credit at some point in your lifetime…  duh!

Sorry, that last just slipped out.  I have as many referrals come from broker’s whose clients are denied because of lack of credit or payment history as I am for “credit restoration”.

Many people are also looking to re-establish credit after a bankruptcy, short-sale or divorce or short-sale.

Yikes, so where do you start when nobody is willing to take a chance on you?  As anyone that hasn’t been living under a rock for the last 5 years can attest everything we used to think we knew about credit no longer exists.  We will pause here while this sinks in…continue when ready.

It’s a good thing that I have been doing this for long enough to have learned a thing or two.  Yes, even getting the “starter” store credit card is crap shoot and one that has very little chance of succeeding. I never recommend that clients have store credit cards anyway unless they have them when they enter my program.  They usually have higher interest rates, they can be used at only one place and little known fact, but they don’t appear to garner as many points as “bank issued” credit cards.

There are several different types of credit but for our purposes and for most people we are looking for installment loans and revolving credit trade lines.

Examples of installment loans would be a car, mortgage, furniture purchase (unless on a store credit card), payday loans (eek!) and a personal loan.  These are loans which have a fixed interest rate and have a set monthly payment.

Examples of revolving credit are credit cards or perhaps a HELOC or line of credit where the interest rate is set but your payment amount depends upon the amount that is outstanding at the time of the statement date.

Every person should have both.  I am not advocating for going out and applying for every loan possible…in fact the exact opposite is true.  However, it is important to know that many people that have lived “off the grid” and not thought much about their credit or established credit… these same people are usually surprised to see that when they receive their credit report it is nearly made up of entirely negative accounts.  This is because early on creditors realized that in order to collect monies from you, they could use the whole “pay or we’ll ruin your credit” gambit and people usually paid (whether their account or whether accurate or not).  The other problem for those that have been very lucky and never owed a debt is that there is simply not enough information to provide the FICO scoring models enough data to generate a score for you, so a lender simply cannot make a sound judgement for a high ticket item.  (Yes, your utility provider will place your account on your credit report if you move and forget to pay your last bill, but they don’t put the 15 years of on-time payments on your credit report!)  Definitely wrong, (on so many levels) but there it is.  The system is broken so we have to work within it.

Generally, I have discovered that it takes at least 4 current trade-lines (preferably positive) to generate a FICO score.

Now, you may be asking what are your options?

Well, there are a few.  It used to be quite simple.  Walk into the GAP or JC Penney’s and they would fall over themselves to give you a credit card.  Another option, visit a college campus.  No job, no problem.  As you have probably realized the world and credit have changed a bit.  No longer are credit card companies allowed to solicit on college campuses and apply for credit for that extra 10% off on your initial purchase at your own risk.  These are no longer considered “starter cards”.

Instead the reality, as hard as it is to swallow may be…(gulp) the secured card, the authorized user, the secured line of credit or the dreaded, absolutely last option “sub-prime” credit card lender.

How do they stack up against each other, you ask?  And a darn good question indeed.

Well let’s start with the obvious a credit card – without a co-signer the chances of someone with no credit getting an unsecured card from a bank are credit union are somewhere around the chances of me being picked for “America’s Next Top Model”.  Although it could happen (in an alternate universe where everyone drinks copious amounts of alcohol and fashion is designed for 5’4″ women) it is highly unlikely. So your options for a credit card come down to these: secured, authorized user, or sub-prime.

Although secured credit cards do not garner as many points in your FICO scoring model, consider this “training wheels” for how to responsibly use credit.  After all, it is your money.  Once it is your money and not some faceless bank (or the millions of taxpayers that bail it out) it becomes a little more real.  We will talk about the best use of credit cards to garner points in another post.  This is my recommendation for all clients starting out.  If you keep in mind that credit was never meant to be used for “I want” purchases you can start to use credit wisely.

Second is the “Authorized User”.  Although in 2009 FICO was to role out a new scoring system FICO 08 (in ’09) but alas, I have yet to see any of the lenders that I work with using it.  This would have severely limited the use of the “authorized user” ability for persons trying to establish credit.  My thoughts are these with regards to “authorized user” accounts… for a child it is a great way for them to begin using and understanding credit.  For a spouse that may not have their own credit again, a good way to begin using and understanding credit.  The thing that people need to keep in mind is that if you are an authorized user on an account, your payment history will be exactly that of the primary card holder.  Therefore, if they go skiing and run into a tree and miss a payment it is going to show on your report, too.  Guess what?  The bureaus don’t care that you are only and authorized user.  So use this option wisely.

A third option may be a secured line of credit or a secured CD offered by many banks and credit unions.  These report as installment loans on your credit report and as we said earlier you should have a mix of both installment and revolving credit lines. My understanding is that it works much like a secured credit card except that you place the money into a CD or line of credit and borrow against the money.  You pay the money back monthly, therefore establishing a positive payment history (right?…on time payments required).

And last and certainly least is the “sub-prime” credit card.  Now I know that they serve a purpose…opening doors for b&e crews, drinking games at parties (or so I’ve been told) etc.  However, I find little use for them for people that are serious about establishing credit.  Many have avoided restrictions imposed by the Credit Card Consumer Bill of Rights and the C.A.R.D. Act by raising their interest rates (some as high as 79.9%), doing away with grace periods, etc..  I find that although they may many times be easier to acquire the penalties are severe so I don’t recommend these unless you have a full understanding of how credit cards work.

Okay, so those are several options to start to establish trade lines (just the minimum) so that you can at least generate a score, just in case you decide one day to purchase a home, car or any other high dollar item.

For this and other strategies for building positive credit, visit www.CreditAgenda.com or call (800) 811-3078