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Feb 2018

Building Credit From Scratch

When you get a mortgage loan, there are many factors that effect your credit score: debt-to-income ratio, credit score, employment history, and savings and investment accounts. Your credit history is one of the most important considerations, and is summed up in your credit score.

What makes up your credit score?

FICO® (Fair Isaac Corporation) is an independently operated company, separate from any credit bureau. Although there are many different credit score models, the FICO score is used in about 90% of lending decisions. So it’s very likely that the score your lender uses to determine your creditworthiness comes from FICO one way or another. They have a formula that calculates a consumer’s credit score based on a variety of factors. Your three-digit FICO® score shows up on the credit report that your lender sees, and your score is calculated based on the following factors:

  • 30% Debts Owed

  • 10% Any New Credit- number of credit accounts recently opened

  • 15% Length of Credit History

  • 10% Mix of Credits: credit cards, loans, retail accounts, etc.

  • 35% Payment History

Credit scores range from poor to excellent, 300 to 850.

Tip: Different lenders use different scoring models to determine their risk in lending to you, and they vary from industry to industry. For example, an auto lender may pull a different score than your mortgage lender. If you’ve gotten your credit score online or from a different lender, you have a general idea of where you stand, but remember that it might not be the same score your mortgage lender will use.

What if you don't have any credit?

In order to even have a FICO® score, you generally need at least one credit account that has been open for six months or more and at least one creditor who has reported your financial activity to the credit bureaus in the last six months. This could be an auto loan, student loan, credit card accounts etc. Having no credit may affect your chances of getting a home loan, and it can also impact other things. For example, many landlords will check your credit score before they let you sign a lease, and credit card companies pull your credit score before they approve you for a card. With a credit score as a requirement for so many things, where do you start when you’re building from nothing? Don’t worry, it may be simpler than you think. After all, everyone started with no credit at some point.

Apply for a secured credit card

A good way to start establishing credit is by applying for a secured credit card. This is a credit card that is backed by a savings account. How does it work? You deposit money into an account, which the creditor holds as collateral to secure your card. Get it? A secured credit card. This may sound a little bit like a debit card, but it’s not — the money you deposit becomes the credit line for the account, it simply protects your creditor incase you become unable to pay your credit card bill. Your credit limit on this account will not be reduced as long as you make your credit card payments on time, and you get your deposit back when you close the card. Your secured credit card limit will be based on your credit history (if you have any) and the amount of money you deposit into your account as collateral. For example, if you put $1,000 into your account, your limit will be $1,000 in most cases. Some secured credit providers may allow a percentage more than what you deposit into your account, but there’s typically a minimum deposit requirement for this option.

Apply for a credit-builder loan

This is exactly what it sounds like — a loan with the sole purpose of helping you build credit. It’s kind of like a forced savings program, where the money you borrow is frozen in an account until you repay the full amount. Once you repay the loan, you get the money. How does this help you establish credit? As you make payments on the amount every month, your lender reports them to the credit bureaus. Therefore, if you make your payments on time, you will establish credit and your score should increase. Let’s say you get a credit-builder loan for $2,000 to be paid back over a year. This makes your monthly payment $166.67. If you make your payments on time and in full each month, at the end of the year you will get the $2,000 and have established or increased your credit score. Credit-builder loans are a good choice if you’re trying to establish credit but don’t have the money for a deposit on a secured credit card. These loans often require no money upfront and no deposit.

Get a co-signer or become an authorized user

By using a co-signer, it’s possible that you can get a loan or other line of credit without having credit yourself. It’s important that both you and the co-signer understand that by co-signing, the co-signer is just as responsible for repaying the loan amount or monthly debt as you are.

For example, your father could co-sign your car loan. Many lenders may allow you to get a car loan without having a credit score if you have a co-signer with established credit. However, should you make a late payment or become unable to pay your loan, your co-signer would be responsible.

You can also become an authorized user on a family member’s credit card. Becoming an authorized user means that you have access to a line of credit that you’re not legally responsible for paying back, but it will affect your credit score.

For example, let’s say your mom adds you as an authorized user of her credit card. This means you get your own copy of the card, often times with your name on it, that you can use (probably with agreed upon limits between you and your mom). As long as your mom makes her credit card payments on time, this should help increase your credit score. There is possible downside to becoming an authorized user. If, for some reason your mom became unable to make her payments, this would affect your score, and hers, in a negative way.

Create good credit habits

Once you establish credit, building your credit score takes some time. Continue building your credit by creating good credit habits and sticking to them. Once a year, you can go to to pull a credit report from each of the three credit bureaus for free.

Many things you do will require a credit score — getting a home or car loan, opening a credit card, renting a new apartment, etc., but don’t worry if you don’t have established credit yet. It’s possible to build your credit from nothing, and there are many tips and tricks to continue improving your credit score once your credit is established.