You may have taken calculus in high school but unfortunately most high schools don’t educate you on how to deal with real life financial issues – the main one for most young people being how to build a credit score for the first time.
Many young people do not realize that they cannot take out a loan (or in some cases even own a credit card) without undergoing a credit check. There, the conundrum begins. You cannot take out a loan or a credit card (i.e. build credit) without a credit rating, but you do not have a credit rating until you build credit. Sound confusing? Well here is a no-nonsense guide to what a credit score/rating is and how to build one for the first time (or repair one if you’ve made some financial mistakes).
What even is a credit rating
Banks and lenders will not just give you money in the form of a loan or credit card without first trusting you and your ability to manage money. Because of this, they check your credit history and see if you have ever lent money before. If you have not, they have no idea whether you are responsible with money or not. Therefore they can assume the worst and refuse to give money to you because they do not trust you.
The term ‘credit rating’ or ‘credit score’ can be confusing because different lenders use different systems. In its most basic form, you will have a ‘good’ credit score if you consistently loan and pay back money on time and ‘bad’ credit score if you do not pay money back on time or don’t pay it back at all. Not having a credit score (as a consequence of listening to those who advise ‘Never ever get a credit card!’) can be as bad as having a bad credit score.
So if I have no credit rating, who will lend to me?
The answer unfortunately is very few people. Those that do lend to you will probably try make hay out of your naivety by charging large amounts of interest. More reputable institutions may lend to you if you have collateral, but young people are unlikely to own a home or another large asset against which they can secure a loan.
So how can I build a credit rating then?
There are a few avenues open to you if you are looking to build a credit rating and they are:
Store cards – ever been in Topshop and been offered a store card? Well these are perfect ways to build some credit. These are basically store-specific credit cards that ‘lend’ you money to make a purchase which you can then pay off at the end of the month. Every time you’re in the store, instead of paying by cash or card, use the store card. Stores pass on your credit information, so if you always pay your repayments on time then you will build a good credit rating.
Take out a bad credit loan – If you need to build credit fast then take out a small loan and pay it back on time. Although the loans available to you without a credit rating will probably be what is known as a ‘bad credit’ loan with high interest, it’s the price you pay for needing to build credit in a hurry.
Credit cards – I know you’ve spent your entire life being told to avoid credit cards like the plague, but using them responsibly is actually one of the few ways you can build up credit. Read the fine print of all the credit card offers that are thrown at you, then use them responsibly. Spend small amounts and always pay back on time.
So there you go. By following these simple tips you’ll be able to build up good credit. The key with credit is simply to stay within your means so that you can always make the repayments on time. So long as you keep your repayments regular, you should have no problems with obtaining credit in the future.
This is a guest post by Victoria Abrams. Occasional blogger on personal finance and full time blogger on bad credit loans. Victoria currently represents Lendersmark.org a great resource to find information about personal lending and debt reduction.
I have found a lot of young people are having trouble signing up for store credit cards – they get denied even for these! What is your experience with store credit cards? Are there some stores that are easier to get a line of credit with than others?
When you are young I would expect you’d have a better chance of getting approved for student credit cards. Still, your chances are probably better if you have some income coming in at the same time. I would think student loans would also help with building credit, but obviously that wouldn’t start until you begin repaying the loan.