RP Funding: Creating a Credit History

Picture two average, everyday millennials — the early thirties, decent income, both ready to become first-time homeowners. Now, imagine these individuals are in line at the local bank to inquire about a low-interest mortgage. One has always been a firm believer in the “always pay in cash” model of debt-free living, with only one emergency credit card to his name. The other has four credit cards, and, while he never misses a payment, the cards all carry balances ranging from low to moderate levels.

Which of these individuals is more likely to be approved for a loan?

As counterintuitive as it sounds, the debt-free applicant is going to have a tougher hill to climb. Why? Because his credit history is practically non-existent. Without a detailed history of regular payments, loan officers will continue to be wary of him unless he provides tangible, indisputable proof that he won’t take other people’s money and vanish somewhere in the Hawaiian Islands.

New Strategies for a New Generation

The saving tips of generations past no longer apply in today’s world. Long gone are the days where stuffing money in a mattress seemed better than accumulating IOUs. It sounds unfair, but an individual who lives “financially responsible” and pays for everything up-front will find it difficult to acquire a loan when it is most needed.

And it will be needed. Very few potential homebuyers can walk into a closing with a suitcase full of money, ready to make a full-offer purchase price entirely in cash. This is especially true of first-time homebuyers. To purchase a home in today’s world, going into some form of debt is a foregone conclusion.

To live comfortably and financially secure, it’s important to build a solid credit history. Understanding how to do that is the easy part: get credit! But getting that credit? This is where people struggle, and where one of life’s ugliest Catch-22s rears its head.

The First Steps

How exactly do you get a credit history? By securing a credit card. How do you get approved for a credit card? Well, you are going to need a credit history. See the conundrum?

Building a credit score worthy of securing a mortgage takes time, so the earlier you get started, the better off you will be. If you are right out of school with a part-time job, you are ready for a credit card.

Not all credit cards are the same, and some companies have become relaxed with their approval criteria. Just because one card rejects you for lack of a credit history doesn’t mean they all will. And it can be a bit confusing what some credit card companies factor into their definition of “credit history.” For example, you can be approved on the basis of something as arbitrary as a gym membership or student loan.

Start Small

You are not going to have a whole lot of spending money to spare at this stage in your life, so start small and responsibly. Apply for one or two low-limit, low-interest cards and treat them like a debit card. In other words, at the end of the billing cycle pay off the full balance on your cards immediately.

Choose your cards wisely, and be frugal with your applications. If you apply for too many in a short span of time, you will be penalized with a knock against your credit score. To minimize the risk, consider starting with one of the options below.

Bank Cards

Credit cards through your bank are a wonderful first option because your bank should approve you based upon your financial history. Bank credit cards typically offer a secure line of credit, meaning your available balance is equal to the cash deposit you offer when first receiving the card. It’s a low-risk option that isn’t going to carry much weight on a credit history report (and most secured credit cards also require security deposits and annual fees), but you have to start somewhere. When you are still getting used to how credit works, bank cards are a great way to start.

Store Cards

Store credit cards are also a good choice. Most have low credit limits, lenient approval criteria and usually come with buyers’ incentives that can vary depending on both the store and the time of the season.

Don’t be fooled. While these perks may seem beneficial in the short term, the incentives are designed to get consumers to sign up on a whim. If you open a credit account in a store you barely frequent, it will do your credit history more harm than good if you don’t use the card regularly.

Pay more attention to stores you frequent. Do you always buy groceries at the same store, card or no card? If this is the case, go ahead and take advantage of their sign-up benefits, which could include everything from 25 percent off an entire store purchase, to gift cards, to 90-day, no interest periods. If you plan on being a regular shopper anyway, this is an easy decision, and, in the process, you will be well on your way to building a solid credit history.

Again, don’t be eager. Store cards are offered everywhere, and if you open more accounts than you can handle, you could dig yourself into a financial pit that takes years to climb out of. Building a credit history can be a slow process, but debt can pile up quickly if you are not careful.

Beware of Bad Credit Advice

Doing research on how to boost your credit score fast can result in so-called financial “experts” giving misguided advice, such as taking out a small loan from your bank to buy a car. Avoid these quick-fix tips. Applying for a loan for the sake of applying for a loan is irresponsible, as you will be stuck paying unnecessary interest for the entire length of the loan. A good credit history is created with time and care, and it doesn’t have to cost a dime.

It Will All Pay Off

Working to establish a good credit history early can potentially save you thousands of dollars down the road. Not only will you be quickly accepted for a mortgage when the time comes, but most credit card companies will offer individuals who have stellar credit significantly lower interest rates. Start early, and when you are getting ready to close on your first home, don’t forget to teach your children the financial lessons that got you there.