Building a credit score typically involves borrowing money, but you can build credit without accumulating a ton of debt. If you have no credit at all, there are a few ways to start building credit without diving head first into an ocean of debt.
Loan secured by savings: Borrow a small amount from a bank or financial institution where you have a checking or savings account. The Consumer Financial Protection Bureau encourages college students to open a bank account. The bank may agree to lend you a small personal loan that is secured by a deposit account such as a savings account. If you want to borrow $300, you would need to have $300 in your savings account to secure the loan. Make payments on the loan before they are due each month and pay more than the minimum payment. This will help you build good credit as your financial institution will report your loan and how it's repaid to one of more of the three major credit bureaus. You would pay interest on the loan until it is paid off, but paying more than minimum payments and paying off the loan early will reduce the interest you'll pay. MyFICO reports that payment history represents 35 percent of a FICO credit score. Don't rush to repay your loan; an important aspect of building credit is to establish on-time payments over a period of time.
Ask someone to co-sign a loan: This can be risky, as the co-signer will be held liable for repaying the loan if you can't repay it. It's a good idea to ensure that you can repay a co-signed loan in advance. For example, you could ask a parent or other family member to co-sign for a small loan, and show them that you have enough savings to cover the loan. Co-signing loans can lead to lost or damaged relationships, so do this only if you are positive you can repay the loan without help from your co-signer. By having enough cash on hand to repay your loan and its finance charges, you're protected from the consequences of not repaying a loan.
Building a Credit Score with an Education Loan
It's difficult to pay for college or a car in cash when you're just starting out, so borrowing student loans can be a good way to build credit when you're just starting out. Borrowing money for college is a fact of life for many college students. In general, students borrow loans from a financial institution or the U.S. Department of Education for each semester or quarter they attend college. If you don't need to borrow student loans for going to college, you can borrow for only one semester or quarter to help with establishing credit. The problem with using student loans to establish credit is that payments may not be required during the time you attend college, so it takes extra time to build credit with student loans. Lenders that provide student loans report payment information to credit bureaus. If you don't repay your student loans on time, you'll establish a bad credit history and have poor credit scores as well. Students who attend short-term degree or certificate programs can borrow and repay student loans faster. Talk with financial aid advisors at your school to learn more.
Tips for Success
- Avoid borrowing more than you need or can afford to repay: It's easy to get carried away and borrow more than you need to establish credit. If you borrow more than you can afford to repay, you risk going into default and establishing bad credit instead of good credit.
- Pay early and pay more than the minimum payment due: This is the best way to build a good credit score. If your payment is due on the 25th of each month, pay it on the 20th and pay extra. Doing this consistently will help you build an excellent credit score.
- Don't confuse payday loans with personal loans: Short-term loans such as payday advances carry high fees and interest rates. When seeking a personal loan, always ask the financial institution for an installment loan and verify the actual costs and interest rate before taking out any loan.
- Choose a co-signer carefully: Sure, your roommate might agree to co-sign a loan, but your friendship and credit scores will be in jeopardy if you can't repay the loan. Parents and family members may be more understanding, but there are no guarantees.
Before borrowing any type of loan, ask questions and ensure that you're comfortable with all terms and conditions associated with the loan. You don't need any surprises when you're starting to build a great credit score.