Guest Article By: Alayna Pehrson – Digital Marketing Strategist at BestCompany.com
Obtaining a credit card can be an effective way to establish credit history and start building good credit. However, it’s not the only way to build your credit. For those who do not qualify for a card, or feel uncomfortable using one, there are alternative ways to build credit without a credit card. This article will examine the pros and cons of using a card to establish your score and explore other credit-building options available to you.
Pros and Cons of Building Credit with a Credit Card
A credit card is a tool, and like any tool, it can be used correctly or mishandled. Used correctly, a credit card can help you bolster your score, but when abused, it can have the opposite effect and hurt your credit score.
When you use your credit card responsibly, which involves making payments on time and not carrying a balance from month to month unless necessary, it helps to establish a good payment history, which is one of several factors that make up your credit score. As a cardholder, you may also have access to a great number of other benefits:
- Automatic documentation of purchase history for ease of tracking
- Fraud protection and the ability to dispute charges
- Easy completion of online transactions
- Optional perks and rewards such as discounts, travel miles, cash back, etc.
- Convenient purchasing without the need for cash
However, there can be plenty of disadvantages to obtaining and using a credit card as well. For one thing, it is much more difficult to obtain a credit card than it used to be. This is especially true for young adults. You have the legal capability to open one or more lines of credit at age 18, and it is to your benefit to start building up your credit profile as soon as possible. However, as of 2009 when Congress passed the CARD Act, anyone under age 21 who wants a credit card either had to show an ability to make minimum monthly payments, which can be difficult if you are a student limited to only working part-time, or enlist the help of a cosigner. Obtaining a credit card can also be difficult for people with low income or a bad credit score.
Problems can arise once you obtain the card, too. Another factor that plays into determining your credit score is credit utilization. Maxing out your credit card can lower your credit score, which is the opposite of what you intended.
While a credit card can be a useful tool, it can also be an irresistible temptation for some people. The following are situations in which obtaining a credit card may end up doing you more harm than good:
- The only cards you qualify for have very low credit limits, significant annual fees, and/or large interest rates
- The terms and conditions are incomprehensible to you
- The desperateness of your financial situation has driven you to apply for a card
- Your ability to make timely minimum payments is uncertain
- You plan to finance expenses you couldn’t afford otherwise
Tips to Build Credit Without a Credit Card
If for one reason or another, you are unable or unwilling to obtain a card of your own, there are still methods available for you to build credit. Here are four of the most common techniques:
1. Become an Authorized User on Someone Else’s Card
This is a good option if you are too young to obtain a line of credit on your own, if you don’t qualify under the CARD Act of 2009, or if you only qualify for high-interest cards. If someone else, such as a parent or spouse, adds you to his or her card as an authorized user, the account history can show up on your credit reports. In other words, if the account holder already has a good payment history, it will automatically apply to your profile without you even making a single purchase on the card. You don’t have to use the card at all to build credit in this way. In fact, if you do not expect to be able to handle the card responsibly, you may ask the account holder to restrict your access to it.
- Whether the account holder is trustworthy
- Whether the account holder already has good credit
- Whether or not you can remove yourself from the account if and when you choose
2. Pay Your Bills on Time
This includes your credit card bills but is not limited to them. Any bills that come due on a monthly basis, such as mortgage or rent, cell phone bills, student loans, utilities, etc., can help to bolster your credit score if you pay them on time. This simple step can help your credit score a great deal, as 35% of it is made up of payment history.
The potential problem is that some of these payments are only reported to the credit agencies in the event that you don’t pay on time, in which case you are punished for the payments you don’t make without being rewarded for those you do. However, in the interest of building positive credit, you may be able to make arrangements with your landlord, telecommunications provider, utility companies, etc. to have your payment histories reported to the credit bureaus.
3. Take Out a Credit-Builder Loan
For those looking to establish credit, or for those looking to repair credit that has sunk to the low end of the spectrum, a credit-builder loan may be a good option. There are online services that offer credit-builder loans, or you may be able to obtain one from a credit union or small community bank. However, national banks rarely, if ever, offer this type of loan product.
Ordinarily, it is difficult to borrow money with a credit score of 600 or lower, but since increasing your score is the specific purpose of a credit-building loan, the ordinary rule doesn’t necessarily apply. Every situation is different, and your results are by no means guaranteed, but over the course of a year with a credit-builder loan, it may be possible to increase your score by as much as 100 points.
A credit-builder loan is different from a traditional loan because instead of receiving the money up front and then paying it back, the amount that you borrow goes into a certificate of deposit account when you pay an initial fee. Over the course of a year, you make monthly payments that include an interest fee of 10% to 15%, plus a portion of the principle. At the end of the year, you will have established a decent payment history to help improve your credit score, plus you receive the money you borrowed free and clear by unlocking the CD.
4. Obtain Different Types of Credit
It helps if your credit report has different types of accounts on it, such as student loans or auto loans. However, don’t try to take out too many lines of credit at once because each one requires a hard credit inquiry that can knock your score down a few points.
Establishing new credit shouldn’t be too difficult, but repairing bad credit can be more of a challenge. Find out more about credit repair options from Lexington Law.