How to Establish Credit

Repairing your credit – getting rid of the negative credit report information and caught up on past due bills – will raise your credit score some. To raise your score to a level high enough to get loan approval and better interest rates, you’ll have to rebuild your credit – prove that you can handle credit responsibly. Getting started might be difficult, but once you begin to build momentum, you’ll be coasting your way to a good credit score.

Get a CD Loan

Here's how it works:

• A simple Certificate of Deposit allows the owner to deposit a certain amount of money, (usually a minimum of $1000) as an investment for a fixed length of time, ranging from three months to five years. CDs are federally insured and pay higher rates of return than simple savings accounts.
• The depositor can take out a loan for up to 100 percent of the CD amount, secured by the CD itself. Because the loan is secured by the cash in the account, the interest rate to the borrower is low -- typically the annual percentage rate of the CD plus some index the bank uses.
• The loan is paid back during the term of the CD, which can be up to five years. If the customer defaults on the loan, the bank can seize the money invested in the CD. If the loan is not repaid by the time the CD expires, the depositor can renew the CD to extend and refinance the loan.
• Rates vary, but typically, the borrower will pay a premium of several percentage rates to borrow their own money. In other words, if the CD is paying 6 percent, for example, the cost of borrowing might be 9 percent.
• The benefits of this loan are that it typically carries a low interest rate compared to an unsecured personal loan or credit card, and it allows savings to remain in place. Most of the time the CD continues to earn interest on a monthly or yearly basis, offsetting the interest charged on the loan so that, in many cases, the borrower is paying an even lower rate of interest. Depending on the bank, it may affect the outcome of the interest rate on the loan.
• Despite their low interest rates and generous repayment terms, consumer finance counselors advise borrowers to ask if the bank reports loan payments to any of the three credit agencies. If the bank reports loan activity, it can work in the borrower's favor if payments are made on time. Likewise, if the borrower defaults on the loan, that activity is also reported. Otherwise, it's a waste of time for borrowers looking to establish a credit history if the bank doesn't report any payment activity.

How does this loan work?

Loan proceeds are used to open a new certificate of deposit (CD) (They are NOT put into your checking account at this time.). You will repay the loan over two years. Over this time period of making the affordable payments on time every month, you are building/rebuilding credit history.

When the loan is paid in full as agreed, you will have:

• built up your credit history
• increased your credit score
• you will then have access to the funds within the CD for your personal use

Benefits of the Loan:

• Building Credit History
• Increasing Credit Score
• Low Interest Rate
• You save money by earning interest on the CD during the course of the loan
• Low, Fixed Payments that make budgeting easy
• Two Year term: ~ $43.00/month

 

Get a Secured Credit Card

Why open a secured credit card? Credit scores are a measurement of your ability to make payments on time, primarily over the past 2 years.  The more accounts you have open to demonstrate this, the better.  We recommend having 4 or more open reporting accounts to achieve the best score possible.

How much can opening a secured credit card increase a credit score? Generally speaking, adding a secured credit card account to your credit report can increase a credit score anywhere from 10 to 40 points.  For example; if you have 1 reporting open account now, and add a new credit card account, it can easily add 20 or 30 points to your credit score.

Knowledge is Power!

Undestanding how secured credit cards work, and how to use them correctly is vital to improving your credit score.  Take a moment to read the following information to increase your understanding of this effective method of building your credit. 

What is a Secured Credit Card

First, if you can open an “unsecured” credit card, then by all means, do it.   Secured credit cards are a good choice for consumers who are turned down for a regular credit card. 

A secured credit card is simply a normal credit card that is “secured” by a deposit you make in a savings accout with the bank that gives you the credit card account.  In most cases, the bank will  require $200 to $500 be deposited into a savings account for a credit card with a credit limit equal to the amount you deposit.  The deposit serves as collateral in the event that you default on your credit card.  This is not a pre-paid debit card, nor is the money available for making your payments.  If you don’t make your payments, then you will be reported late on your credit report and eventually the account will be “charged-off” as bad debt, and the deposit used to cover your defaulted balance.

Interest rates on secured credit cards are usually in the 14% to 24% range on outstanding balances.  Additionally, you will find that most banks charge an annual fee of $39 to $59 for these accounts.  A small price to pay for the benefit of improving your credit scores.

By using your secured credit card and making payments on time, you will find that eventually your deposit will be returned and you will graduate to an unsecured credit card, usually within 18 to 24 months after opening the account.

Getting Approved

Even though you deposit an amount of money equal to the credit limit on the card your receive, there are not “guaranteed approval” programs.  You have to pass the bank’s underwriting process.  While it is easier to get approved for a secured credit card than an unsecured credit card, banks vary in their underwriting guidelines.  Some banks are more willing than others to grant approval. 

Reporting to the Credit Reporting Agencies

Credit reporting is not done in “real time”.  In fact, creditors typically report data to the credit reporting agencies only once a month.  Usually, creditors report the previous month’s activity in the first part of the next month.  What this means is that it may take a month or so for the account to show up on your credit report.  A reasonable expectation is 30 – 60 days for a new account to show up on your credit report.

It is important to activate and use your new credit card immediately upon receiving it.  Sometimes a creditor won’t report an inactive account as soon as an account with activity.  Don’t just sit on the card once you’ve received it.  USE IT.

Properly Using Your Secured Credit Card

Once you've successfully received new lines of credit, it is important to have some activity going on each month. We don't suggest you pile up large debt – maybe $50 dollars or so in a balance. Buy a tank of gas, or some groceries.  Here’s the key… pay the balance off when the bill arrives. And pay it on time. This is what creditors want to see.

VERY IMPORTANT:  Do not use more than 30% of your credit limit at any time.  The balance that is reported by the creditor to the credit reporting agencies is taken from  a specific day chosen by the creditor.  For example; if you pay your balance off when it is due on the 10th, then run the balance up to where you are using 80% of the credit limit by the 25th of the month, and the creditor polls the data from all of their customers on the 27th of the month and reports this to the credit reporting agencies, this is the balance that will be reported… not $0. 

The key factor here is that if your “utilization ratio” on credit cards is above 30%, it hurts your score.  The higher the ratio, the worse the impact on your score… often dropping scores more than 50 points.  BOTTOM LINE: Keep your balance under 30% at all times.

Keep the Accounts Active

Once you've successfully received new lines of credit, it is important to have some activity going on each month. We don't suggest you pile up large debt-- maybe $50 dollars or so in a balance. If possible, pay the balance off when the bill arrives. And pay it on time. This is what future loan officers and other creditors want to see.

You need to display at least one year of positive credit history to be taken seriously, especially by a mortgage company.

Disclaimer: The information provided in this site is not legal advice. All information is general information, some of which pertains to legal issues involved in the subject matter. Credit Matters Inc. is not a law firm and is not a substitute for an attorney or law firm. Your access to and use of this site is subject to additional terms and conditions.

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