New To Credit Guide
A person is considered to be “new to credit” if they’ve had their own loan or credit card for less than three years (or have never had one at all). This term is typically used to describe college students, recent immigrants, young adults, and recently divorced or widowed individuals who’ve had no credit under their names in the past 10 years.
While it is very important for anyone with limited or no credit history to begin their credit careers on the right foot, personal finance – and the credit card industry in particular – can be extremely confusing to navigate. We’ll therefore answer some of the most common questions from people who are new to credit below in order to ease your transition into credit management.
Having no or limited credit isn’t necessarily a bad thing, considering that everyone must start somewhere. However, having no or limited credit and not doing anything to change that is a big mistake.
Why? Well, a consumer’s credit standing is extremely important both to their bottom line and from a logistical standpoint in our increasingly digital, interconnected personal finance landscape. While having a good or excellent credit score will save you a lot of money on financial products ranging from credit cards to insurance policies as well as make it easier to get a loan, find certain types of jobs, rent an apartment, lease a car, etc., limited or no credit history is simply a recipe for increased costs and hassle. More specifically, good credit can save you more than $1,000 a year on your car loan and more than $2,000 a year on your mortgage relative to bad credit. Without a track record of responsible financial management, financial institutions and other decision makers will have little reason to trust that you will pay your bills on time.
In short, building above-average credit will simply make your life much easier.
The easiest way for most people to build credit is to maintain one or more credit card accounts in good standing. Whether you lock your card in a drawer or use it responsibly (i.e. pay your bill on time each month, minimize unnecessary debt, and maintain low credit utilization levels), your creditor will relay positive account information to the major credit bureaus each month, thereby beefing up the files on which your credit scores are based. The other great thing about a credit card, compared to a loan, is that you won’t have to pay any finance charges if you pay your bill in full every month.
Keep in mind, however, that if you’re new to credit it’s going to be difficult for you to get a regular credit card because lenders have little way of knowing whether or not you are a trustworthy candidate. You can prove it to them by getting a secured credit card for which your deposit acts as collateral against your credit limit. Once you have shown that you can manage a secured credit card responsibly for about a year, it is likely that your credit card company will offer you a chance to apply for a regular credit card.
You can learn more about credit building in WalletHub’s Guide to Credit Score Improvement.
While you can’t garner approval for your own credit card account until you turn 18, that doesn’t mean credit building efforts must be put on hold until then. Rather, you can ask a parent or guardian to add you as an authorized user on one of their accounts. Assuming you and the primary accountholder employ responsible spending and payment habits, you will benefit from modest credit score gains that may enable you to get a better starter credit card when you first apply on your own.
You can learn more about the pros and cons of such an arrangement in WalletHub’s Authorized User Guide.
Before you start considering specific credit card options, you should know that the Credit CARD Act of 2009 instituted new ability-to-pay rules that may affect your ability to obtain credit, particularly if you are of college age.
More specifically, applicants must now be able to demonstrate the shared or independent income necessary to pay at least a credit card’s required monthly minimum payment. The other alternative is to have a more financially-established friend or relative cosign on your credit card account. This person must be at least 21 years of age and have the means to repay any debt that you may incur. Because this person will assume joint liability for your credit card debt, it’s best to choose someone with whom you share mutual trust and that you can get ahold of easily if the need should arise. For example, if you have opened a credit card account with a cosigner and want to increase your credit limit, your cosigner must agree to the increase in writing.
Once you’ve either identified a cosigner or garnered the necessary income, it’s time to choose a credit card.
When you’re new to credit, the particular credit card options that are at your disposal depend on a number of different factors, including your age, the extent of your credit history, how much money you make, and whether or not you’re still in school. That information will dictate whether you should get a student credit card, an unsecured credit card for limited credit, or a secured credit card – the three types of cards targeted to inexperienced consumers.
Choosing between these card types is rather simple. If you’re currently a student (or your university e-mail address is still active), go the student credit card route. Credit card companies tend to offer college students more attractive account terms than their credit standing would ordinarily merit due to their above-average earning potential and the years of financial independence (i.e. years of revenue-generating opportunities for banks) that lie before them.
If you aren’t a student and you trust yourself to spend within your means, compare credit cards for limited credit in order to find an offer that meets your particular needs and submit an application. Should you not get approved for that type of account, simply place a deposit on a secured credit card rather than trying to apply repeatedly for an unsecured card in the hopes that you will eventually garner approval. Numerous applications within a short period of time may hurt your credit score, as they indicate desperation, and that will subsequently make it more difficult to garner approval for an unsecured credit card in the future.
Secured credit cards work just like regular credit cards and are reported to all the major credit bureaus. The only difference is that your line of credit (i.e. credit limit) will likely match the amount of your security deposit (a minimum of $200 is typically required). That’s actually beneficial to people who are new to credit, as it prevents overspending, precludes the need for issuers to charge high fees, and essentially guarantees account approval. What’s more, you can augment your spending power by adding to your deposit over time, which will in turn expedite your credit building efforts, considering the importance of available credit to credit scoring formulas.
You can therefore practice sound financial habits with a secured credit card at very low risk to both yourself and your credit card company. Once you’ve managed to pay your secured credit card bill on time for 6-18 months, you can switch to an unsecured line of credit and challenge yourself to not spend more than you should.
Regardless of the particular type of credit card you decide to apply for, make sure not to get distracted by interest rates and rewards at this stage in your credit career. Instead, strive to pay your bill in full every month and look for a card with no annual fees in order to minimize the cost of credit building.
Credit management can be both confusing and practically difficult. It’s therefore a good idea to keep the following tips & potential pitfalls in mind as you embark upon your credit career, particularly in light of the high stakes involved with your spending and payment habits.
- Automate Payments: Forgetting to pay your bill on time is one of the easiest ways to damage your credit score. You can eliminate that concern by setting up automatic ACH payments from a checking account. Depending on your preferences, you can choose to automatically pay your full balance, the required minimum amount, or a custom amount that is somewhere in between.
- Budget & Review: People have a tendency to overspend when paying for purchases with plastic, as the electronic nature of such transactions as well as the fact that payments aren’t due until the end of the month combine to make costs seem a bit abstract. The only way to truly ensure that you’re spending within your means is to figure out how much you can afford to spend and on what and then to regularly review your spending and payment habits to verify that they are sustainable. So, make a budget and stick to it.
- Leverage the Island Approach: The Island Approach is a segmentation-based credit card strategy that entails using separate accounts for different types of transactions. For instance, this might involve using one account for everyday purchases that you pay off in full within the billing period and another account for revolving debt. Doing so will enable you to get the best rewards on everyday expenses as well as the lowest financing rates. It will also reduce your interest costs and make it more obvious when you are overspending.
- Check Your Credit Reports: Consumer credit reports are a wealth of information. Not only do they enable you to gauge financial improvement, but they also make it easier to spot potential instances of fraud as well as credit bureau mistakes that may be depressing your credit standing. You should therefore avail yourself of your right to a free copy of each of your credit reports every 12 months and parse them for issues.
- Protect Your Account Information: Keeping your personal and financial information under wraps is necessary to minimize your chances of falling victim to identity theft and payments fraud. So, be careful about who you share your credit card information with, only submit payment information via secure websites, and shred sensitive documents before throwing them out.
- Not Comparing Offers: Direct product comparison is the only way to make sure that you find the best possible credit card for your needs. In other words, do your research – rather than simply applying for whichever card you see advertised on TV or you receive an offer for in the mail – before submitting any credit card application.You also shouldn’t let a credit card’s look and feel, organizational affiliation, or designation as being for business overly influence which offer you opt for. Focusing instead on the product terms that will prove most important to your day-to-day financial needs will surely pay off in the long run.
- Paying Unnecessary Finance Charges: Leveraging debt only for specific reasons and with a well-thought-out repayment strategy in mind will help you minimize the interest that you incur.
At the end of the day, being new to credit represents a great opportunity. You essentially have a clean slate – both in terms of preconceived notions and credit history – and can therefore exhibit responsible habits from the get go. Start by building up your financial literacy in order to get a grasp on the fundamentals of responsible money management. Once comfortable that you know what you’re doing, determine whether a student credit card, an unsecured credit card for limited credit, or a secured card is best for your needs, use it responsibly, and you’ll be well on your way to saving a lot of time and money throughout your personal finance career.
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