How To Build Diversified Personal Credit Profiles
It is extremely important to understand the credit scoring landscape in order to have the most opportunity to achieve financial success and freedom.
In the credit and lending sphere, your credit profile/score is a direct reflection of your creditworthiness. Typically, it is difficult to attain a line of credit or a loan offering the best pricing without establishing a robust credit profile, first. Those with limited credit, who do gain approval for a credit card or loan, will find themselves paying much higher rates and pricing due to their greater risk of default.
But how do you build credit, when you don’t qualify for credit?
Here are the top 5 vehicles consumers can use to drive them towards well-established credit:
- Apply for a secured credit card.
If you are having trouble getting approved for a standard unsecured credit card, there is the option to open a secured credit card. With a secured credit card the individual must leave a deposit which is used as security and protection against default. Most secured cards have higher fees and penalties due to the higher potential risk of the user. This is a viable option for some individuals who are looking to grow or fix their credit score. Make sure the secured credit card you apply for reports to the credit bureaus. After having the card, and using it wisely for 6 months you should have a credit score.
- Become an authorized user.
Becoming an authorized user on an aged and healthy account, can improve your creditworthiness. The reason for this is that the older your average age of credit the better it is for credit scores. Old credit will make the average age of credit older therefore increasing the scores. If the primary card holder lists you as an authorized user, their good credit will be reflected on your credit score.
It’s important to mention that becoming an authorized user will only help your scores if you already have some primary credit in your name; if you do not the bureaus will disregard the authorized user account until you open a primary line.
Authorized users do not have the authority to close accounts and cannot be held liable for any debts. The authorized user also does not have to use the card, all they need is to be listed as an authorized user and the account holder’s account open date and payment history will reflect.
Make sure to use this strategy with any credit cards other than American Express. American Express updates the date the authorized user was added as the open date which will not age the credit.
- Apply for a retail credit card.
Consumers often find it easier to qualify for a retail credit card than another form of credit. Retail cards usually offer lower limits and very high interest rates, so be aware of this when using them. If used responsibly, a retail card can be very helpful in developing a credit profile because retailers report directly to all three credit bureaus.
- Apply for a credit builder loan.
A credit builder loan is a small loan extended to an individual by a credit union. The amount allotted is usually between $500 and $1,000 dollars and the term to pay off the loan is typically no longer than a year. Interest rates on credit builder loans are very low, which is also a plus. The credit union or lender will take the money from your loan, and put it into an interest-bearing account. The sum accrued by the account will belong to you, but you cannot access it until the loan is paid in full. Your payments will be reported to the three credit bureaus and at the end of the term you will receive the dollar amount that was accrued on the account in full.
- Get a co-signer or become a co-signer.
I do not recommend this option as a first step for building credit. It’s riskier than the other options. As a co-signer, you’re jointly responsible with the other co-signer for a sum of debt over an extended period of time. Co-signers typically apply for auto loans, mortgages, or large personal loans; it is important to understand that these loans can take decades to pay off. If you are considering this option, you need to think about your relationship with the person you are applying with, your ability to make payments over a long period of time, and how it can affect future financing needs.
Prior to application, individuals should make sure once the loan is approved they will have equal access for making timely payments. If either party pays late it will impact both credit scores negatively. Also, understanding the new debt-to-income ratio the loan will cause and how that will change their ability to gain future financing, will help make educated decisions on whether this type of credit is worth having.
There are a variety of options available that are designed to help individuals with poor or minimal credit begin building a good-standing credit history.
Add a little variety to your credit.
While you’re building credit, it’s important to consider the complexity of credit reporting and the importance of credit age and diversity.
Revolving, installment, and mortgage accounts are used in calculating credit scores, having a healthy number of these accounts in good-standing is what builds strong credit.
- Revolving credit account balances such as credit cards, overdraft on a checking account, and certain types of lines of credit have the most dynamic influence on scores.
- Installment credit which can include student loans and car loans / leases, have a set monthly payment and needs less decision making or management skill.
- Mortgage accounts are installment loans but I always add them to a separate category because they are the hardest type of credit to qualify for and more points are added to scores once these types of loans become seasoned. Once you get approved for a mortgage and your account ages for about 6 months to a year on your credit profile it can lead to a substantial increase in your credit scores. Since mortgage credit is so difficult to qualify for, your score increases much more than it would with other loans. Mortgage credit also adds to your variety of credit which accounts for a portion of your credit score. With a nice variety of credit your score increases because it reflects your ability to juggle varied types of credit.
In addition to variety, credit history is a major component in the calculation of credit scores, staying on time and using strategy when opening credit while using excellent management skills can build a great credit history.
Consumers need to start to build and expand their credit in preparation of loan shopping. Building credit does not happens overnight and the last thing any prospective buyer wants to find out is that they were denied based on limited credit. However, it’s important to beware of opening other accounts within a short period of time after your mortgage becomes active since this may drop credit scores substantially. This is due to you reducing your average age of credit by opening many new accounts within a year as well as adding more accounts that you don’t have experience juggling, and it ultimately makes you appear as a high risk borrower to lenders. Being late on a mortgage can drop scores significantly and take many years for recovery. A 30 day late payment on a mortgage can drop credit scores by 100’s of points and take up to 3 years to naturally recover. A 90 day late payment can drop scores even more and take up to 7 years to naturally recover.
If you have any credit questions about credit improvement or building feel free to reach out to us for a free credit review.