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Lesson 4: How To Build Good Credit

Summary:

Learn how the system works, then make it work for you
It is easier now more than ever before to build good credit, even when starting with bad credit
When starting with no credit, you will likely have a N/A or “No Score” instead of a “Zero”
A “Thin File” is when you do not have many accounts on your credit report
A good way to begin building credit is to have two term-loans and three revolving accounts (credit cards)
There are non-qualifying loans available that allow you to receive the loan proceeds when you are done paying off the loan, but it builds your credit while you pay the loan
Two term-loan companies you can use are Self.Inc and CreditStrong
There are credit card companies that offer low initial despot requirements for secured cards to people with bad credit history
Several options for credit cards (revolving accounts) are Capital One, Discover, Credit One and Blue Sky
While building your credit, several good options for store cards are Khol’s and Firestone
If you have someone willing to make you an Authorized User, the account should report all their history to your credit, which would give you that credit history and benefit your credit report
FICO® does not calculate a score for you until you have 6 months of credit history
VantageScore will calculate a score for you almost immediately after any credit is established
Starting with no credit, the strategy of getting two term-loans and three revolving accounts will likely bring your FICO® Score up to 650 after six months, and close to 700 after one year

Wise Credit Management is a free Bible-based class that teaches how credit really works by showing factual information directly from the Credit Bureaus and FICO, and simplifies the subject to show everyone how to build good credit or handle bad credit. The class is fairly comprehensive and focused on getting good credit to qualify for a good mortgage rate and terms. WiseCreditManagement.com is a free community for members to take the class, join local groups (online or in person) for mutual support, and to find local professionals who volunteer to use their skills to assist members to success.

I am not a lawyer or Credit Repair Organization.

Home ownership is the way most Americans build wealth and a lack of education about credit is a huge contributor to the growing “Wealth Gap” in our country. Wise Credit Management is focused on teaching how to get good credit and qualify for a good mortgage rate and terms.

My work is protected by the “fair use” section of U.S. Copyright Act.

Luke 16:10 ~ He who is faithful in what is least is also faithful in much… ~

Building good credit is a journey that takes time. If you start small and show that you will be responsible with small amounts of credit, you will be trusted with larger amounts of credit later.

On your journey to where you want to be, you must begin wherever you are and start small in order to build something big. The FICO® Scoring algorithm does not seem to care if your line of credit is $100 or $1,000,000 as long as your Utilization Ratio (as discussed in Lesson 3) is low. As we will see in Lesson 5, many people who are not “millionaires” have perfect 850 credit scores. Be faithful in small things and that will show you can be faithful in big things, like a loan for your home.

I try to teach the easiest and most simple way to do things while avoiding unnecessary expenses. It is possible to build your credit from nothing to great for free. However, it helps to invest some money in your score now to get where you want to go faster. This is the Lesson where you really start to work on making your credit better. Take ownership of your credit report and manage your credit wisely.

What age should you start building credit? As soon as you can learn to be responsible with money. You have to be at least 18 to enter into a legal contract for credit and the Credit CARD act of 2009 requires anyone under 21 to have a co-signer or independent income. So, my honest answer would be to start building credit as soon as you turn 18 and have a job. Start small and learn responsibility early.

Lines of Credit

There are several different types of credit and there are subtypes of those types. To keep it simple, we will discuss the basics of each type so you have a general understanding of each.

Term loans are usually mortgages, auto loans and student loans. They have a beginning balance, a set length of time (term) to repay the loan, the monthly payment is fixed and the interest rate you pay is usually fixed but can be variable.

Revolving lines of credit are usually bank issued credit cards, store cards or gas cards and home equity lines of credit. Revolving lines usually have a set limit (if you have a “Black Card” with no limit, good for you), your balance is pretty much whatever you spent minus whatever you paid back, your minimum payment is usually 1% to 2% of the balance or $25, the line is usually unsecured but it can be secured by something like a house in a Home Equity Line Of Credit (HELOC), sometimes there is an annual fee and sometimes there are fairly good rewards for using the card such as free travel miles or “Cash Back”.

According to Experian, Authorized User accounts are set up as secondary account holders for an account and usually occur with credit cards. It should be someone who is trusted by the primary account holder to make purchases and be responsible with spending the money, because the Authorized User is not responsible for paying the money back. The Authorized User will get the line of credit reported to their file with the AU designation and as we will see in Lesson 5, the account does not count toward the “Length of Credit” factor in determining the Authorized User’s credit score. The “catch” is that the Authorized User gets any bad credit for that account reported as well. If there are late payments or if the Utilization Ratio is high, that could actually bring the Authorized User’s score down. If you become an Authorized User on someone’s account, make sure they manage that account responsibly.

According to myFico.com there are other (Alternative) lines of credit such as rental history and utility payments that are becoming more prominent on credit reports. These accounts will give you a line of credit that a potential lender will see and evaluate along with your score. They can help you show some level of responsibility even if you do not have traditional credit history. Please note that most of these alternative lines of credit do not affect your mortgage FICO® Scores even though they may be reflected on the newer scoring models.

If your credit history is not several years old, it will be considered short. The average age of your accounts, the age of your oldest account and the age of your newest account are all factors in whether or not your credit history is considered short. A short credit history usually makes lenders reluctant to lend because you haven’t established a long and proven track record of repaying your debts. Short credit history is only overcome by establishing credit and doing the right thing for a long period of time.

If you do not have many accounts and especially if you only have an Authorized User account you will be considered to have a Thin Credit History. Experian says that thin credit has only one to four accounts and are typically young people or new immigrants. I would also add that some people like to be cash only and one credit card is fine for them, but it is still “Thin”. It is difficult for the scoring algorithm to calculate a high score because a thin file with one account only has a few months of history, or maybe it is not used very often, etc.

According to Experian.com, FICO® Scores need at least 1 open line of credit with 6 months of history before it can calculate your score. When you first start, you won’t have a FICO® Score. However, VantageScore will calculate a score for you almost immediately. In my experience, VantageScore begins at 600 and goes up (or down) from there.

If you currently have a credit score and open a new account, your credit score will almost certainly dip for several months before recovering and probably going higher. New credit hurts until it becomes established credit.

Principles For Building Credit

You should try to have 2 to 5 term loans and 3 to 6 revolving accounts. Don’t borrow just to have credit. Use credit cards to pay necessary expenses, but not anything you wouldn’t spend money on anyway. Just put everyday bills and necessary expenses on your cards. Be careful about applying for too much credit too soon because you could be denied simply for having too many inquiries. You can find a pre-qualification application on the website of most major lenders so you should pre-qualify before you apply. I do not suggest using the Experian or CreditKarma App’s pre-qualification offers. Make sure the account will report to all 3 major bureaus. Also, know that credit card companies will use existing limits on your credit report as an indication of how much credit they should extend you, but your scores do not care about how high your credit line is, only the Utilization Ratio, payment history and length.

It is definitely possible to build credit without debt. Secured cards will build your credit over time without the need for term loans. However, I include term loans in the class because they will build your credit score higher and faster than only having secured cards. This class is for informational purposes, you should always take the information and use it according to your needs.

Suggested Companies

For term loans, you can go to a bank and ask for a secured starter loan that has virtually no credit requirements and does not even have a “hard” credit inquiry. The premise is that the money they lend you is secured by a deposit you made in their bank until you pay off the loan, at which point they will give you back your security deposit. So it’s like having a bank lend your own money back to you (and charge you interest for it). Most banks will give you this type of loan if you bring the money to use as a security deposit for the loan, but that means you must have the money already saved to deposit it into the bank. But there is another way. At least two banks will lend you the money and keep it on deposit while you pay the loan off. This means that you do not need to have the security deposit already saved to deposit in an account. You make monthly payments over the term and at the end you will get the original loan amount. It could be compared to a savings account that costs you a monthly fee and reports the savings to your credit. And yes, these loans are factored into your mortgage FICO® Scores. There are fees and interest charged for these loans, but the way I see it is that you are paying a small amount of interest on a small loan so you can qualify to purchase a home in the future for a lower interest rate. Building credit now will literally open doors for you in the future and lower your mortgage interest rate because you have a good credit score.

Disclaimer: The companies mentioned here are just a few examples, and there may be other lenders offering similar secured loan products. It’s important to compare loan terms, fees, and interest rates before making a decision. Be sure to do your own research to find the best option for your situation.

Credit Strong has a credit builder loan that I recommend and use personally to have a term loan (I have no mortgage or auto debt so these loans work for me). For as little as $15 you can establish credit and save $1,000 over the life of the 10-year term of the loan. One additional benefit is that it gives you your free FICO® 8 score from TransUnion. From a purely practical point of view, it costs a few dollars per month in interest to establish your credit line and raise your score which will reduce the interest rate you pay on a $300,000 mortgage when you purchase a home. Credit Strong also has a way to establish a revolving line of credit for $500, but costs $99 per year extra. So with this one company, you could establish a term loan and a revolving line of credit. However, the $99 fee sounds a bit much.

I also suggest the company that used to be known as Self Lender, now simply Self.inc. It has a similar starter loan, but its benefit is the money you save can be used to open a secured credit card with a $25 annual fee. After several months of making payments on your secured loan, you have saved enough to be issued a secured credit card, so you actually have the ability to open two accounts within about 3 months. It’s a good way to get started. And yes, the accounts from Self.inc and Credit Strong both count toward your mortgage FICO® with very little monthly obligation.

If you use both companies to get starter loans and get the secured credit card with Self you will be paying about $40 per month for your two term loans and $25 per year for your secured card. But where do you go for two more credit card accounts?

Capital One offers a starter credit card and has a reputation for giving people with no credit history a $200 unsecured line of credit to begin with. I suggest using Capital One for one of your first credit card accounts, and I use their affiliation with Walmart to get 2% cash back on purchases there. It works for me. If you have bad credit, Capital One will likely approve you for a secured card, but you have to begin with a $200 deposit. Sometimes it’s the cost of having bad credit (aka. a bad credit “fine”).

Discover also has good starter credit card options. They offer a student credit card and a secured card with a deposit of $200. These two companies have the lowest security deposits I know of and will establish your credit very quickly.

Credit One is a good option to use if you are trying to overcome past mistakes. They offer a $300 unsecured limit to start, but with a $75 fee and $8.25 per month after the first 12 months. If you have bad credit in the past, it is a good way to build unsecured credit so you can qualify for better credit cards in the future.

Try to get unsecured store credit to further establish your credit and improve your chances of getting approved for bank issued credit cards later.

Kohl’s is a good company to go to for an unsecured store card. They will approve applicants with collection accounts and might approve people with scores as low as 570, but typically look for 640. This will give you one more tradeline.

Bridgestone Firestone is also a good company to apply with. Typically, you need to have a score of at least 630 and will approve applications with collections.

You can have your rental payments put on your credit report. eRentPayment.com is one company that, with your landlord’s cooperation, will report your rent history as a line of credit to Experian and TransUnion for a $3/month fee. However, this payment will not count toward your mortgage FICO® Scores.

A mortgage company might ask for a Verification of Rental history (VOR). If you are not making your payments through an automated system, I strongly suggest you make your rental payments with a handwritten check out of your checking account that gives you a copy of your canceled check. That is the strongest VOR you can have. Talk to a mortgage professional about getting pre-qualified and see if they will need a VOR before you start to stress over this.

When building or rebuilding your credit, you should try to get several lines of positive credit established on your credit report because automated approval systems see positive tradelines as good indicators of creditworthiness, regardless of whether or not they affect your credit score.

Services that report utility payments to the credit bureaus are a good example. Experian Boost will use your bank account to verify certain types of payments and report those as a revolving line of credit. They do not affect your Mortgage FICO® Scores, but they do add a tradeline to your report which could help an otherwise thin credit file.

Step-By-Step Plan To Establish Credit

What is a good way to establish credit with no credit or bad credit? First you should get the starter loans from Credit Strong and Self.inc, then get the secured card from Self.inc. You should be approved for these accounts no matter what your credit looks like. New accounts hardly ever report immediately so you might have to wait 30 to 45 days to even see these accounts on your report. The net out of pocket to you will be about $40/month for the first 3 months before you are eligible for the secured credit card from self.inc.

I suggest making the first payment immediately after you set up your term loans and set up automatic payments so you never forget to make the payments. If you make your first payment before the term loans report for the first time, it should report as a new loan with your first on-time payment already made.

If you have no credit, you should be able to get an unsecured credit card from Capital One without a security deposit at the same time you set up your term loans.

If you have bad credit, you should be able to get secured cards from Capital One and Discover with a $200 deposit.

You can then wait for approximately 30 to 45 days until your new accounts are reported to your credit. You will know when they report because you established free credit monitoring as we covered in Lessons 2 and 3. At this point you now have a credit file with two or three new accounts. If you started with no credit, you will not have a FICO® Score, but you will have a VantageScore of about 600.

After 3 months you will be eligible for the secured card from Self.inc and you have an established payment history (about 2 monthly payments). You can consider applying for pre-approval for other cards. If a company is willing to pre-approve you for credit during this time it will probably be beneficial to you to apply.

If you started with no credit, you might want to avoid new applications until you hit your 6^th month and get a FICO® Score. After about one year of having the two term-loans and three credit cards, you should have a FICO® Score of about 700. You will have about 12 months of history over a mix of accounts, and you will be in a good position to apply for credit at lower interest rates. However, remember to avoid using your credit for anything that does not accomplish the end goal of owning a home and having a small “life jacket” just in case you need an emergency fund.

If you started with bad credit from the past, understand that it will take some time to establish a positive current credit history. Companies will be understandably reluctant to approve your application right away even if they do approve applicants with past collections. Reestablish your credit using the above steps, then begin to apply for unsecured accounts. Six months of positive history is a good place to get to before starting to look for unsecured accounts.

Manage Hard Inquiries While Building Credit

When a credit card company considers your application, they will run a “hard” inquiry on one of your credit reports. As we saw in Lesson 3, that could decrease your score on that bureau by 10 points during the first year and it stays on your credit for two years. Having multiple inquires on your credit report can be a reason a company denies your application for new credit.

Be strategic in your applications for new credit. Only apply for cards that have a pre-approval process to increase your chances of actually being approved. Remember, there are three bureaus and many credit card issuers choose one at random to check, but in my experience, Experian is the one most often used. So you might get more inquiries on your Experian credit report, which lowers your Experian score and decreases the chances of being approved by a different issuer in the next 2 years.

Zechariah 4:10 ~ Do not despise the small beginnings, for the lord rejoices to see the work begin. ~

This was a long and very important lesson. I tried to give you an exact formula to build or rebuild your credit and I used many of the companies I am recommending to you. (Who doesn’t like Kohl’s???) But the main takeaway from this lesson is that you have to make the choice to build or rebuild your credit. It won’t do it by itself. Careful management of your credit will literally help open the doors of home ownership while reducing the cost of necessities like insurance.

To Be Discussed In Lesson 7:

Can you dispute hard inquiries? Yes, but it’s much better not to apply unless you will get approved. Never dispute an inquiry from an account you were approved for because it’s like saying to a credit bureau, “Hey, I didn’t apply for that card that was approved and issued to me that I am using to pay for my Netflix account.” You’re basically saying that someone else submitted a fraudulent request for credit in your name and at your address. Disputing legitimate hard inquiries might do more harm than good.

Should you establish good credit while you have bad credit? How old is the bad credit? If it is past your State’s Statute of Limitations, the collector is unlikely to sue you for it. Will you need to pay off the collections before they “fall off” your credit 7 years after the last payment was made? Establishing new credit signals to a debt collector that your credit is important to you, and they might ask for more money to settle the debt. If you can, wait until the debt is automatically removed from your credit report, but remember that you still owe the debt to that company.

Establishing a Credit Strong account with a 10-year term loan will rebuild your credit and last longer than your collection accounts, so when those collections fall off your credit report, you will have a history of good credit. Secured cards can be used the same way. Open them now to have good credit waiting for you when your collections fall off.

We will discuss how to handle bad credit in Lesson 7 and there is a bonus DIY Disputing class at the end of the lessons.

Next: Complete the Lesson 4 Quiz (first make sure you completed the Lesson 3 Quiz)