Credit is one of those tricky thangs like landing your first job. All jobs want you to have experience… but how do you have experience without ever having a job? Likewise, it takes thangs like credit cards or loans to get credit… but how do you get these without having any credit in the first place?
Some Important Definitions
Co-signer/ Joint owner* – A co-signer and joint owner are pretty similar, but exact definitions vary depending on the lending institution. The co-signer is fully responsible for any money owed, even if they were not the ones who made the charges. This is mostly used for couples who share assets, although can be used in other situations like parents or friends. Social Security Numbers would be used in this case to assign financial responsibility.
*I personally don’t like this one, because money can make people weird and a potential risk to each other. Once you sign the papers you are stuck together (unless they are removed from the account later, which isn’t easy and will require lender approval /additional review of your credit to see if you qualify alone)! I would avoid unless absolutely necessary.
Authorized user – this is a funky one. Authorized users are individuals who can use the credit without signing up for it themselves- they basically piggyback off someone else’s credit (usually their parents or a friend). Authorized users get their own card, but usually are not responsible for paying the bill. Your Social Security Number may or may not be used in this situation. Authorized users can damage the original card holder’s credit if they abuse the privilege.
Collection – Collection here refers to a collection agency. If you fail to pay your bills (utilities, medical, credit card etc.), the your “bad debt” is sold to a collection agency. The agency will then annoy you constantly to get the money back- that’s how they make money. This really only happens if you don’t pay anything for a long time (~180 days, but it’s up to the individual lender).
Credit Utilization Ratio – CUR sounds scary, but is pretty simple. Basically shows how much of your credit you use. If your credit card limit is $1000 a month and you use $500, your CUR is 500/1000 = .5 or 50%. Even though $500 is not that much, using 50% of your credit looks bad. If you had a $10,000 limit and spent $500, your CUR would be 500/10,000 = .05 or 5%, which is very good. The actual amount spent is the same, but the percent of total credit used is very different. Think of this as the “self-control” ratio- i.e. even though I am allowed to spend this much, how much of it did I actually use. The lower the better.
Interest: a percentage fee the lender charges you when you borrow the money- why else would they give you $$ if they weren’t going to make $$ back? Simple example, if your original loan amount from the bank (aka principal) is $100 at 5% per year, next year you will obviously owe the $100 but also $5 more. If you don’t pay back the loan for 2 years, you will still owe $100 but now $5 + $5 more. You don’t have to be good at math to see that the longer you wait, the more you owe.
Ways To Get Started With Credit
Option 1: Getting A Small Loan: 18 & Up
Getting a loan should not be your go-to strategy for building credit unless you need it for something specific like tuition, a car or starting a small business.
Pros: If you need to borrow money anyway, this is a great place to start. The percent interest will be much lower than putting this debt on credit card. I.e. if you need $5000 for tuition, you’re better off paying a 6% student loan* than 20% on a credit card bill (think $300 vs. $1000).
Cons: Unlike some credit card options- all loans will cost you money. There are certain fees you must pay to get a loan plus you will pay interest until you pay off the principal. There is a bit of paper work to do, and you’ll need to prove you are worthy of the loan, what you will use it for etc.
Loans vs. Cards: once you pay it off, the loan stays on your history but not forever. On the other hand, if you keep a credit card open, the card will continue to build your history- even if you hardly use it! So remember, loans are short term.
*Student loans are a whole separate mess to discuss later
Option 2: Getting on Mom & Dad’s Credit Card as an Authorized User: Any Age
Pros: May help establish credit if account is always paid on time, and has high limit-low balance aka low Credit Utilization. A good option if you have a good relationship with your family or friend and there is mutual trust not to mess things up.
Cons: Could hurt your score if something happens to the account owner and the bills aren’t paid, or there is a high Credit Utilization. In most states an authorized user should not be penalized if this happens, but it may hurt your score without you noticing. You can call the credit bureaus to remove the negative information, but that can be a pain.
- Certain creditors also may not count this credit building tool as strongly because you are not generally responsible for the debt aka if the responsibility isn’t fully yours, you might not be helping your credit as much as you think
- But Pay Attention! As an authorized user, your SSN may or may not be requested- the bank usually just needs the name to be added. In this case, the creditor may or may not report your usage. They can try to match up by your name, address etc. but if you go this route and want to be 100% sure it is showing up (and helping) you will have to ask the bank if they report authorized users to the credit bureaus, and then get a credit report from one of the three credit bureaus to confirm. This can be tedious.
Option 3: Getting Your Own Credit Card: 18 & Up
Turning 18 is one of those American rights of passage. You can now buy cigarettes and porn- and then open up a credit card to pay for them! Well, kinda. As of 2009, the CARD Act made it much harder for the 18-21 crowd to get their own cards. Great protection for clueless college kids, but bad deal for educated readers of GUT. If you’re under 21 (or over but don’t have great credit) you may need a co-signer (which I don’t recommend), unless you can prove you have the income to cover your payments.
Pros: If you are able to qualify for your own card without a co-signer, great! You can start building credit. A secured credit card may be your solution here if you’re under 21.
Cons: You have to be diligent and exercise self-control! If you are a compulsive shopper you’ll need to be careful.
The most important things to look for in a card: low/no annual card fees and low APR. APR = Annual Percentage Rate and it is INTEREST. If you pay the cards on-time and in full (I can’t stress that enough!!) then you never have to worry about this. But it is good to have a card with low APR just in case you get in a pickle and need a little extra time to pay off this bill. Card rewards and points are more advanced thangs we’ll talk about later 🙂
Types of Credit Cards:
- For Students: Student Credit Cards ✏?✔
Student Credit Cards are a great way to get started. Lenders know that you have little to no credit, but if you’re going to school you’ll “supposedly” be more responsible than someone who isn’t so they have easier approvals. You probably won’t have that high of a limit (<$1000/month) but hey, gotta start somewhere! They generally have no annual fees, and may even have rewards these days! If you are good with the card (i.e low CUR and always pay it on-time and in full!) this may automatically roll over into a regular account, or you can request that it does after a few years. In other words- if you open when when you turn 21, you won’t still have the title of “Student Card” when you are 35. Avoid cards that require a co-signer unless you really understand what you’re getting into.
I personally started with a Bank of America Student Visa, and it was totally fine. It eventually rolled into a regular Visa. I also like this option because I connect it directly to my Bank of America checking account, so I never worry about missing a payment. If you already have a checking or savings account ask your bank, Google or check this site out for additional recommendations.
2. For People Who Lack Discipline*, Have Bad Credit, Are Under 21 or Not In School: Secured Credit Cards ?
A safe bet if you’re not sure if you can handle the excitement of buying cigs and paying for them later (cigs are bad, buy kale instead, ok?) Or maybe you’re not going to college and don’t qualify for a student card. Or your credit is bad (hopefully not if I catch you early enough!) Or the government decided you can smoke but not have your own card until you are 21.
These cards are “secured” by a safety deposit that you must make before using the card. It’s a concept similar to a “prepaid card” or gift card- but instead of draining the pre-payment and refilling it, you do still have to pay off whatever you spend each month (like a regular card), the deposit is there just in case you don’t pay that month. Your initial deposit may be your credit limit, but if you use this card well your limit may go above the original deposit. Ex: You deposit $500, so your monthly limit to spend is $500. If you only spend a few dollars each month and pay those balances without touching the original $500, you may be allowed to spend $750 next month. Here are some sample cards and more good info here.
*don’t lie to yourself
3. For People Who Qualify And Can Control Their Spending: Traditional Credit Cards ??
If you are out of school and have been working for several years, you may have enough credit history to qualify for a regular credit card. Traditional cards will typically have better rewards programs and allow you to have higher credit limits than student or secured cards. If you qualify, but are a little lacking in the self control department you can always freeze it:
I have a Cash Rewards Visa and American Express (with no fee-woop!) through Bank of America. They’re both great for me, but may not fit you if you want Frequent Flyer Miles or perks like concert tickets etc. Ask your bank or look it up to find your perfect card. If you find one with any signup bonus (cash, points etc.) power to you!
Want to Learn More?
Most importantly- be careful! Read the details! Yes, all of them, don’t be a bum. This advice is just a starting place for understanding, it’s up to you to check yoself before you wreck yoself!
Coming soon: How to Get Good Credit