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Unless you’re filthy rich and can pay cash for all of your belongings, chances are you will need to borrow money from a lender at some point in your life.
Whether you’re ready to purchase your first home or a new car, those three digits attached to your name start to hold a lot of weight.
Your credit score not only shows lenders your likeliness of repaying your loans, but it also determines the amount of your loan and interest rate.
So, what happens when you have no credit?
Unfortunately, you’re seen as a risk. Lenders are unable to predict how likely you are to pay your bills so your applications are typically denied.
If you’re approved, you could be stuck with a high interest rate and a ridiculous monthly payment. I know, I’ve been that person.
Using a credit card is one of the quickest ways to build credit, and it’s not as difficult as you may think!
WHAT MAKES UP A CREDIT SCORE?
Your credit score is made up of a number of different components that include:
- Credit usage- 30% impact on score. This is the amount of credit you are using against what is available. According to Credit Sesame, lenders and creditors typically like to see around 5-7% being used.
- Credit age – 15% impact on score. This is how long your accounts have been open. An average of 5 years is a favorable amount of time.
- Account mix – 10% impact on score. Creditors and lenders favor those who show they are able to manage a mix of accounts such as:
- Credit cards
- Auto loans
- Home loans
- Student loans
- Payment history- 35% impact on score. Obviously, this is the biggest component of your credit score so making payments on time is one of the most beneficial things you can do.
- Credit inquiries – 10% impact on score. Credit inquiries are applications you put in for credit, such as applying for a credit card. A hard inquiry is placed on your credit report when it is actually pulled by a lender but is only factored into your score for 12 months.
When you do multiple applications within a short period of time, it can negatively affect your credit score. This signals to lenders that you’re desperate for credit and that your finances are unstable, although that may not be the case.
PERKS OF A GOOD CREDIT SCORE
Although different lenders may have their own requirements for what scores they will and will not accept, a score of 700 or above is typically considered good.
The perks include:
Loans with lower interest rates. Interest can be the silent budget killer, but with a good credit score, you can avoid getting eaten alive in interest charges.
A low interest rate not only lowers your monthly payment but also allows you to pay your debt off faster because more of your payment is being applied to the principal balance.
As an example, let’s say Samantha finances a $25,000 car with a 9% interest rate. She settles for a 36-month term, making her monthly payment around $795. This means that she will be paying out $3,620 in interest over the life of the loan.
Jennifer finances the same car but with a 4% interest rate. Her monthly payment is $738, and she will only pay out $1,572 over the life of the loan. That’s $2048 less than Samantha.
Waiver or reduction of deposits. Certain utility companies will waive or reduce the amount of a deposit for those with good credit. Personally, I’ve had my security deposit waived by my electric company and even had the amount of a security deposit reduced for an apartment!
Better credit card deals. With better credit, comes better deals. This includes credit cards with low APYs and rewards.
First dibs on the apartment you want! This is one of my favorite perks! When you have good credit, you move to the top of the list when applying for rentals/apartments.
This is because landlords can see that you have a good history of paying your bills on time so they’re less likely to deal with late payments and evictions.
Since moving out on my own, I’ve always beat out other applicants!
CONS OF BAD CREDIT/NO CREDIT
Denials, denials, denials! Whew, I remember these days. With bad credit or no credit, you’ll find yourself getting a lot of denials from lenders. Whether it’s a credit card or an auto loan, your low score sends out a big red flag that may bar you from certain deals.
High-interest rates. If you find a lender who will accept your credit score, chances are you’ll be paying a butt load in interest charges. Think about it, what incentive do they have for giving out low-interest loans to those with bad or no credit?
The way they see it, if they’re taking a risk by lending you money then you’re going to pay out extra to make the transaction worthwhile.
Difficulty finding a place to rent. Even though it may not be necessarily true, bad credit indicates that you are not responsible financially and no credit could mean that a cosigner is required.
Why is having no credit almost as bad as bad credit?
As I mentioned before, lenders cannot determine the likeliness of you paying them back if you’ve never borrowed money.
For example, let’s say you have a friend that needs to borrow $100. You’ve given her money before and she always pays you back in full so you’re confident you’ll get your $100 back.
Had this been your friend’s first time borrowing, you would be more likely to proceed with caution.
Posts to check out next!
How to build credit using a credit card
Apply for a credit card
In order to build credit with a credit card you obviously need one! In order to increase your chances of getting approved, apply for a secured or starter credit card.
These cards are designed for those with bad credit or no credit history so getting them is fairly easy.
What is a secured credit card?
A secured credit card requires you to make a cash deposit. So, unlike an unsecured credit card where you have access to a credit line with no money down, you will typically have to deposit the credit limit of the card.
This helps to mitigate the lender’s risk of you missing payments because if you default on payments your deposit is used to pay your bill.
Will I ever get my deposit back?
Yes, when you close out the account or build enough credit to upgrade to an unsecured credit card you will receive a refund of your deposit.
Best starter credit cards:
Capital One Platinum – This was the only credit card I was approved for when I lacked credit history and I still have it to this day! There is no annual fee.
Citi Secured Mastercard – This secured credit card requires a minimum deposit of $200. There’s no monthly or annual fee.
Capital One Secured Mastercard – This secured credit card requires a minimum deposit of $49, $99, or $200.
Petal Cash Back Visa Card- This card offers 1% – 1.5% cashback and has no annual fee.
Use your card regularly
You can opt to put an expense, such as your cell phone bill, on your credit card each month and pay it in full before the due date. When I got my first credit card, I used it strictly for gas and paid off the balance every time I got paid.
Keep your credit card utilization low
A good rule of thumb is to keep your credit card utilization under 30%. This means that the amount you have used against the available credit should be no more than 30%.
Going over that percentage could negatively impact your score because this indicates that:
- You may be too heavily reliant on the credit you have available.
- You may be irresponsible with your credit.
Pay your balance in full each month
Like with any bill, your credit card will come with a monthly payment amount and a due date. This payment amount varies, depending on your balance and billing cycle.
The best thing to do is to pay your balance in full before the statement cut-off date. I did this and it helped me increase my credit score 100 points in just one year! This is because your credit card company will report your balance to the credit bureaus shortly after the statement cut-off.
Also, some credit card issuers have a grace period for those who pay off their balance. You’re not charged interest so you save money and boost your score!
What is an interest-free grace period?
This is the time between the end of a billing cycle and when your payment is due. Paying off your balance in full during the grace period keeps you from paying interest on any charges made during that billing cycle.
Exceptions to the grace period include cash advances and checks.
If you can’t afford to pay your balance in full, you can still save money by paying as much as you can before the due date. Preferably, pay more than the minimum payment.
Typically, you’re charged interest by your average daily balance during each billing cycle. By making a payment before the due date you reduce your daily balance and therefore incur fewer charges.
Some credit card companies, such as American Express, make it easy to pay by offering auto-pay. You can choose to pay a fixed amount, the total balance, the minimum payment, or the adjusted payment.
To save even more money, make multiple payments versus just one. If you’re paid bi-weekly this can easily be done by dividing the balance between paychecks.
Instead of carrying the same balance up until your monthly payment, your average daily balance is reduced earlier on by the first payment.
Finding the statement cut-off date
The statement cut-off date will come before the payment due date. This is why, even though you paid the card off on the due date, you'll see that a balance was reported.
To find the cut-off, look on your statement for “closing date.” Depending on how many days are in a month, the date may differ by a day.
For example, my closing date was 09/24 in September but 10/25 in October since there are 31 days in October.
MONITOR YOUR CREDIT WITH CREDIT SESAME
In order to build credit with a credit card, or not, you have to have a good understanding of what affects it. Plus, watching your score rise is like a guilty pleasure.
Credit Sesame is a free ee personal finance credit and debt management tool that not only allows you to monitor your score but also breaks down each component to help you see where you stand and what needs to be improved.
There's no credit card required or trial period.
Whatever your reasons are for wondering how to use a credit card to build credit, with discipline and good financial habits it’s pretty simple to do.
Although it’s nice to have a high credit score, your score represents your “borrowing” power. The more you borrow, the more debt you’ll be in. Only apply for what is necessary, and remember that actually having true ownership is way more important than obsessing over how you appear on paper.
OTHER RESOURCES TO CONSIDER:
Self. Self Lender offers an accessible way to establish payment history and build credit, while saving money, through a credit-builder account. It’s a small installment loan, but the money is yours, securitized by a CD. No credit score is needed to get started! In the end, you get your money back with established credit history! Check it out here.
Credit Money. Credit Monkey increases your score by removing negative items and setting you up with credit monitoring tools. You can follow your credit repair process in real-time, by seeing their scores, graphs, information, and more on any Internet-enabled device, (iOS & Android ). Learn more here.