It happens to many people: they're ready to jump into a home mortgage, they submit their information for loan pre-qualification and they get denied on account of not having any credit history. Why is that? Why is credit so important?
There's nothing inherently wrong with having no credit, but financial institutions like to see that people to whom they lend money have a record of paying back their debts. If you don't have a credit history, you're not going to get a home loan. It's as simple as that.
But there's things you can do to get started on building healthy credit. Here are six simple steps you can take to help establish and build up your score.
The first thing you can do is to piggyback off of someone else's credit card. That is, to get yourself added as a joint account holder or as an authorized user. Each method of piggybacking has its pros and cons.
To get yourself added as a joint account holder, ask a person you trust and who trusts you — parent, sibling, spouse or friend. You will then reap the benefits, or, possibly, detriments, of that person's history with that card. It'll appear as if you've had the card the entire time. What you want is a credit card with good standing. Therefore, you should choose that person wisely.
That chosen person might not want to add you as a joint account holder, but instead as an authorized user. In this case, it won't count as an open and active line of credit for you and might not appear on your credit report, since as an authorized user, you are only being added as a signer and do not have financial responsibility for the account.
But, despite the limits of being an Authorized User, it still helps to build credit.
"Joint account holder is usually better for qualifying (borrowers) on a home loan, because it counts as an active open trade," Carla Blair-Gamblian, Veterans United Home Loan Consultant, said. "But honestly, authorized user is the 'safer' route all around."
An authorized user is a safer route because you're not responsible for the account and you can be taken off anytime.
In contrast, a Joint Account Holder is jointly responsible. Once you're added, you can't be taken off the account. So, if the primary holder defaults or makes a late payment, you're stuck and you will see the consequences with your credit score. Even if there is a break in the relationship, including divorce, death, etc., you are still responsible for the account.
Blair-Gamblian likes to use an analogy to explain how authorized user status works.
"I use a bar analogy," she said. "It's like one of your friends opening up a bar tab and telling you to put your drinks on the tab. At the end of the night, the bar isn't going to bug you for payment. They'll bug your friend and charge his card that is holding the tab. So, you get the fun of making the purchases without having to be responsible for the account."
But, you might ask, "If being an authorized user does not count as an active line of credit, what is the point?" Even if there's a chance that the account won't show up on your credit history, it often does and it helps.
Blair-Gamblian shared her experience as an authorized user.
"I've been a signer on my mom's Chase account since I was 16," she said. "The account was opened before I was born. The first time I applied for credit on my own, I had good scores and have never been denied. Bam, thanks Mom!"
So, if you would like to buy a home soon, becoming a joint account holder seems like the quickest way to build up a credit score. But, if you simply want to start establishing credit, then being an authorized user might be the more prudent route.
Your next move, and a very good one, is to get a secured credit card of your own.
To get a secured card means that you have to pay a deposit to a bank for it to open a line of credit for you — a $500 deposit gets you a $500 credit limit. After a year or so, you get your deposit back. When you've established enough credit, then you'll be able to get a card without having to put money down.
Blair-Gamblian thinks getting a credit card of one's own is a must for those beginning to build credit.
"Piggybacking is great to get started, but get an account of your own as well," she said. "If you piggyback, you should be able to get an unsecured credit card as opposed to a secured card, meaning no deposit and probably better rates and terms."
Even if you end up not carrying any debt on the credit card, you'll want to leave it open.
"The older the credit card, the better," Blair-Gamblian said. "Leave them open, do not close them."
Beware of your account closing because of inactivity. Therefore, it would be beneficial to charge something on your card every so often.
Tip: Charge a small balance and pay the card off every month, always keeping the balance lower than 25 to 30 percent of the limit.
Another move to make is to get a gas station credit card. Most of us always have to buy gas, so why not build credit by paying for it with credit.
Blair-Gamblian agrees that this is a good way to go.
"Gas station charge accounts are an excellent way to begin to build credit without creating unnecessary debt," she said. "Fuel expenses are a part of everyone’s budget so using a credit card for gas isn’t spending in excess of what you’ve already budgeted for. At week's or month's end, just pay it off."
When you've established a couple lines of credit through cards, it might be time to take out a small personal loan. It is good to note, though, that it takes time for a personal loan to boost your credit score.
"When it comes to personal loans, they can help but they need to hit maturity of at least 6 months, and preferably 12 months," Blair-Gamblian said. "If paid off too early, it does nothing for the score."
The credit bureaus reward longevity and a consistent ability to make on-time payments.
"Paying it off too fast sounds credit-worthy," Blair-Gamblian said. "But it doesn't show a pattern of consistent monthly budgeting for the long haul."
In short, personal loans can round out your credit report, but they don't do the financial heavy lifting that credits cards can do when it comes to your score.
The most important step in establishing and building up your credit score is making sure that you pay all of your bills on time. Bill payments make up about 35 percent of the score calculation.
Regular on-time bill payments — credit cards, utilities, telephone, internet, etc. — get reported to the credit bureaus. One missed payment can damage your credit significantly, while fidelity in this area helps to strengthen your scores.
After you've established and begun to build up your credit, it's time to keep an eye on it to make sure there are no errors in the report and to help you keep track of your financial habits.
Once a year, you are entitled to a free credit report from the three reporting agencies. Visit www.AnnualCreditReport.com to begin. This service is absolutely free and doesn't require you to sign up for any sort of monitoring service.
What is missing from your report, though, is your credit score. You will have to spend some money to access that.
Need help establishing or improving your credit? Give our VA home loan and credit experts at Veterans United Lighthouse a call at 888-392-7421.
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