The post, 4 Ways Credit Can Help You Build Wealth, outlined how credit if used properly, can give you access to capital to accelerate wealth building.  This post is a continuation for those that want to build and establish their credit to leverage this strategy.

As mentioned in the previous post, you could save the money and pay for everything in cash, but this approach can take a very long time because you are relying only on your earning capacity.  However, if you are convinced that leveraging other people’s money is a strategy that you want to include in your toolbox, this article will help you understand ways to build your credit score so that you become appealing to lenders.

This article is for individuals:

• Establishing Credit
• Repairing Credit after bad habits
• Rebuilding Credit after bankruptcy

Why Is Your Credit Score the Way It Is? 

Before we discuss the different techniques on how to build or improve your credit, it’s important to find out WHY your credit is the way it is. Specifically, identify what behavior has created this score.

Understanding the ‘why’ is critical to your success because you want to make the necessary mindset changes to have lasting change.  I will always promote BECOMING the person with strong credit OVER the specific techniques because if you implement the techniques without becoming the person you need to be, you will only fall back into the same habits.

If you are rebuilding credit, ask yourself a few questions:

• Did you max out your credit because you were overextending your lifestyle?
• Did you decide that you were not going to pay back what you borrowed?
• Were you robbing Peter to pay Paul?
• Were you consistently late on payments because you forgot the due dates?

You must acknowledge the behavior and path that got you here before you can move forward.

Why?

Because if not, you will repeat the same behavior.  Again, It doesn’t matter how many tips you learn if you do not work on BECOMING the person that has strong credit.

The person that has strong credit is RESPONSIBLE, ACCOUNTABLE, ORGANIZED, and TRUSTWORTHY.  They honor their word and take their commitments seriously.  Focus on exhibiting these traits first, then implement the strategies.

Now that this is out of the way, here are 4 ways you can build credit to accelerate your wealth building journey.

Request a Secure Credit Card

A secure credit card is a product that is backed by money that you give the bank.  For example, you deposit $500 and the will provide you a credit card with a $500 limit.  In essence, you are borrowing from yourself.

Why would you do this?

Individuals request a secure credit card because they need to prove that they are responsible with using capital.

1. Why would anyone offer you money and you have not demonstrated that you can and will pay it back?
2. Would you loan someone money that cannot pay it back?

Using a secure credit card gives you an opportunity to prove that you can handle credit effectively.

How Does It Work?

A secure credit card mimics an unsecured credit card, but its purpose is to allow the bank to monitor your behavior.  The bank will send monthly statements, offer minimum payment options, and report your payment history to the credit bureaus.

Essentially, you are borrowing your own money but establishing credit at the same time.

How to Make This Work for You?

Use the credit card responsibly by paying on time and keeping the balance less than 30 percent of the balance, you will gradually build your credit profile.

Here is a key point:

You should not use the full amount.

Even though the banks offer you $500, you should not use the entire amount. Ideally, the bank only wants you to spend 30 percent of it.  For example, if you have a $500 credit card, only maintain a balance of $150 or less.

It may take 6 months to a year to establish a positive record, so continue to stay the course.

The Risk

You assume 100% of the risk because it is all your money.  The bank is just reporting your behavior to the credit agencies – Equifax, Transunion, and Experian.  If you do not pay it back, you lose your $500 AND destroy your credit score.

Apply for a Secure Loan

A secure loan is a product that is backed by collateral such as a car or a house.  Ironically, it is much easier to get approved for a car than a house with low or no credit.  However, you must be careful with this type of loan because individuals with low or no credit history, will be offered higher interest rates.

How Does It Work?

The financing company or bank will offer you a loan that is attached to a physical product such as a car. You send monthly payments over a certain number of months to gradually pay down the balance.  The payment amount will typically stay the same throughout the loan.

If you default, the bank will repossess the collateral and report your default to the collection agency

How to Make This Work for You?

Pay on time and make more than minimum payments to pay the loan off early. This is especially true if the interest rate is more than 5 percent.

Why? Because typically, you could earn a return greater than 5 percent in the stock market.  Therefore, you are better off earning more than 5 percent rather than paying 5 percent interest.

The consistency of paying early and more than the minimum demonstrates that you have the capacity to pay off the loan in full as agreed.

The Risk

Make sure that you understand the terms of the loan and how much interest you are truly paying. For example, financing companies like to disguise the amount of interest paid by extending the loan out for several years to make your monthly payments lower.

Additionally, ensure that the bank or financing company you are working with reports your payment history to all three credit bureaus.  You would hate to have a perfect payment record only to find out that the company never reported anything.

As mentioned before, with poor credit or no credit history, you will likely be offered higher interest rates.  Borrow as little as possible and pay it off early.

The bank reduces their risk because in the event you do not repay the loan, they will repossess the car or foreclose on the home.

 

Become an Authorized User

One strategy parents can use build their child’s credit is by adding them as an authorized user on their credit cards.  While parents can use this strategy for their kids, adults can also assist other adults as well.

How Does It Work?

The authorized user will gain the credit history as the primary cardholder.  If the primary cardholder has an extensive record of paying their bills on time and keeping a low balance, this can build and/or improve your credit score quickly.

The authorized user will also receive a card and gain access to the credit limit.  The authorized user does not need to use the card to receive the benefit of the credit history.

It is important that the primary cardholder and the authorized user discuss how the credit will be used BEFORE they sign up.  This will eliminate confusion on what the authorized user can and cannot do.

How to Make This Work for You?

As an authorized user, you can leverage the payment and credit history of the primary cardholder. This could accelerate your time to establish your credit.  If the primary cardholder has excellent credit history, this can work in your favor.

Note that the authorized user will only receive the credit history of that card, not the person’s entire credit profile.

Additional note: If you had a bankruptcy then this may not be as effective because the bankruptcy will be reported on your credit report for at least 7 years.  However, it can demonstrate a step in the right direction to managing credit.

The Risk

Just as you can inherit the good credit behavior, you can also inherit the bad.  Ensure that the person continues to manage their credit well and be aware if they fall on hard times.  This will impact your score as well.  Additionally, if the primary cardholder chooses to close the account (which is highly discouraged), both of you will lose the credit history previously established.

Request Someone to Co-Sign

In the personal finance industry, co-signing is highly discouraged for the person with established credit.  However, it is one of the fastest (and more riskier) ways that someone can build and improve their credit scores.

How Does It Work?

Typically, when an individual is not able to qualify for a loan due to poor credit or lack of credit, they will need someone who has strong credit to guarantee the payments in the event of default.  The primary individual is still responsible for the payments.  However, if the primary fails to pay the co-signer is responsible for making the payments or their credit will be affected.

How to Make This Work for You?

This one can be tricky because you are requesting someone to assume your debt if you cannot or do not make the payments.  This requires substantially trust and confidence.

Be committed to making payments on time and more than the minimum.

The Risk

Because this method is highly discouraged, it may be hard to find someone who will comply with this request. However, if you do, it is your responsibility to honor your word because your decisions not only impacts your credit but the co-signers’ as well.  This could damage a relationship and erode trust.  Proceed with caution and only when you are confident you can maintain the payment.

Next Steps

Now that you understand ways to build credit, take action on one or more of these strategies and work to build your credit history.

Not sure exactly what is on your credit profile? Receive your credit report for FREE from all three credit agencies at www.annualcreditreport.com.

Take action and share with a friend.

That’s getting your FINANCES ON POINT.