If you’re new to credit, building credit for the first time can seem like a bit of a chicken or an egg scenario. To get approved for the best credit cards, you need to have a high credit score. But to have a high credit score, you need to have a credit card. So where’s a credit newbie supposed to get started? Half of Americans don’t know the answer to this question. So, you are not alone in your search for the cure to no credit.
The good news is that you’ve come to the right place. This page explains how to build credit without a credit card step by step. That way, you can understand how credit works and what you need to do to get the credit score you want. You can also use this advice to maintain a high credit score even if you decide never to use credit cards. So, let’s get started!
Step 1: Understand How Credit Scores Work
First, you need to understand what goes into a great credit score. That way, you can understand what steps you need to take to start building credit fast. FICO is the credit scoring model used by most lenders when evaluating credit applications; it’s used in about 90% of financing decisions. FICO’s scoring method is widely publicized, so you don’t need to rely on guesswork as you build credit.
Know the 5 factors that determine your score
Here’s a breakdown of what FICO takes into consideration when generating your credit score.
- 35% is determined by your payment history. How long have your accounts been open? Are you making your payments on time? Having payments that are more than 30 days late will negatively impact your credit score. Showing a pattern of late payments or having payments that are more than 90 days late are credit killers.
- 30% of your score is tied to the amount of debt that you owe. Generally, you want to use less than 30% of the credit available to you. That means that if you have a credit line of $1,000, you never want to have a balance of more than $300. Ideally, you should keep your credit utilization under 10%. This not only benefits your credit score; it also limits interest charges and helps you avoid debt.
- 15% of your score relates to credit age. That’s the length of time you’ve used credit. It’s based on the number of years each of your accounts have been opened. More old accounts that are still active and in good standing shows you have a history of using credit the right way.
- 10% is made up of the number of new accounts you recently opened. If you open too many accounts too quickly, you appear desperate for credit in FICO’s eyes. This will have a negative impact on your credit score in the short term. However, you score should rebound fairly quickly as long as you don’t continually open lines of credit in quick succession.
- 10% consists of the type of credit you have access to. If you’re able to show that you can manage multiple types of credit, you look like a responsible borrower. The ideal credit mix is a mortgage, installment loan (think car loan, personal loan, etc.), and a revolving line of credit like a credit card.
Step 2: Review your Credit Report
Now that you understand what goes into a credit score, you’ll want to see what is on your credit report. The information your report contains is what gets used to calculate your credit score. So, you want to know what your report says so you can make sure it makes you look as good as possible.
There are several ways to get your credit report. If you just want your reports with no score attached, you can download them for free. However, if you’re trying to build credit, then you may want to get your reports and see where your score currently stands. In this case, you need a credit monitoring service.
Just keep in mind that most free credit monitoring tools use the VantageScore 3.0 scoring model. That’s the scoring model created by the three big credit bureaus in the U.S. (Experian, Equifax, TransUnion). This is an important call out, as all credit scores are not created equally. Most major lending institutions use FICO rather than VantageScore when reviewing your application. It’s not uncommon for the two scores to vary by 50 points.
Still, both scores use the same scoring factors and have same scoring range (300-850). So, if you take action to get a good VantageScore, then you should have a good FICO credit score, too. If you want to get your exact FICO score, then you would need to go directly to FICO and pay for it.
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Make sure to fix any inaccurate information you find in your report!
This may come as a surprise, but maintaining credit score accuracy is not the responsibility of the credit bureaus, it’s up to you to make sure that the information on your report is correct. One in five consumers have had items on their credit reports corrected. Making sure you’re starting with an accurate credit score is going to give you the best shot at credit success.
If you’re new to credit and just starting out, you probably don’t have any information to correct. But if you’re figuring out how to build credit without a credit card following a period of financial distress, then you could have mistakes that you need to correct. To learn more about how to fix mistakes in your credit report, visit Debt.com’s Guide on How to Repair Your Credit.
Step 3: Find ways to build positive credit history
With 35% of your score being tied to payment history, you need to figure out how to start adding some history to your report. The most traditional way to build credit history is to use unsecured credit cards. However, qualifying for an unsecured card on your own can be tricky. Luckily for you, there are a few of options available for people that don’t qualify for unsecured credit.
Building credit history with no credit cards required
The easiest way to build credit without credit cards is by using installment loans. Installment accounts are typically things like auto loans, student loans, mortgages, and personal loans. If you’re building credit, you generally start with small personal loans to build your way up to the bigger types of financing.
You can use the funds from the loan to:
- renovate a home
- invest it in either your retirement or a college fund
- fund a major purchase
- take a credit card free vacation
There are also credit builder loans available through companies like Self Lender that automatically invest the money for you. Credit builder loans allow users with no credit history to open a small loan. But rather than get the loan funds, they are placed into a Certificate of Deposit (CD). So, it saves you the trouble of investing the money you receive from the loan.
Another good option for a personal loan may be a peer-to-peer loan through a company like LendingClub. You can often take out small dollar loans as low as $1,000. Make sure that your payment is affordable, and that your interest rate isn’t too high. Rates on personal loans can range between 5% – 36%. Shop around and try to get something under 10% if you can.
Whether you use tools like Self Lender, LendingClub or just a basic personal loan, the process works the same once you take the loan out. Make payments each month to pay off the loan and you’ll build positive credit history. This is a safe way to build credit history, save a little bit of money, and learn how to effectively manage monthly bills.
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Credit card alternatives
It’s worth noting here that just because you can’t qualify for a traditional unsecured credit card on your own, it doesn’t mean the credit door is completely closed to you. There are other ways you can get access to credit cards if you so choose.
- Secured credit cards are cards that you can get approved for with bad credit or no credit. You must put down a small cash deposit to open the credit line. The credit limit is usually equal to the amount you put down. Then, that money is used to cover the creditor in case you don’t pay.
- Cosigning is another way you can get access to credit cards when you can’t qualify on your own. For instance, if you have a family member who has good credit and they’re willing to open an account with you, you should be able to qualify for a traditional unsecured credit card. Just keep up with the payments! Otherwise, you can ruin your family member’s credit instead of building yours
But again, deciding to use credit cards is a choice, not a necessity for achieving good credit. There are many people who for one reason or another decide to steer clear of credit cards. And those people can still achieve good credit using the installment technique we’re describing.
Step 4: Monitor your progress, manage your debt, and build gradually
Once you start building credit history, see what other levers you can pull to build more credit. If you took out a personal loan for a home renovation project, after about 3-6 months, you might consider getting a CD through Self Lender. Once you’re comfortable managing that debt, then you can add a peer-to-peer loan or even consider something bigger like an auto loan.
Make sure to take on new loans gradually or you can damage your credit score. Spreading new debt out also gives your budget time to adjust so you’re not struggling to make payments or trying to juggle bills. Monitoring your score over time and understanding how your actions impact changes in your score is going to be the most beneficial way to continue to build a good credit score.
Deciding if you want to include credit cards
After about 6-12 months of consistently building positive credit history with installment loans, you’ll be to a point where you can qualify traditional unsecured credit cards on your own. Then, it’s up to you to decide if you want to start using credit cards or not. Credit cards can make it easy to achieve an excellent credit score faster. However, they are not required to do so.
If you decide to start using credit cards, make sure to follow these tips:
- Try to pay off your balances in-full every month so you can use credit interest-free
- If you don’t pay in-full always try to keep your balances low – it’s a myth that you need carry balances over to achieve good credit
- Don’t just accept any credit card offer you receive; only open a new card if you have a clearly defined need for it
More tips on how to build credit without credit cards
Tip No. 1: Stick to a Budget
If you’re building credit from scratch, it means that up until this point, you’ve likely been living in a cash-based lifestyle. Having open lines of credit and debt to repay adds a new layer of responsibility to your budgeting. Falling behind on bills will have a negative impact on your credit score. And once your score goes south, it means more work to crawl back out of that hole.
The best way to avoid debt problems is to create a budget and stick to it. Don’t be among the 26% of people that we polled who think you can just maintain a budget in your head. Take the time to write your budget out so you can ensure that you don’t spend more than you earn. It may sound simple, but it’s the best way to avoid financial challenges that usually lead to credit damage.
You’ll also want to continuously evaluate your budget to make sure the spending patterns you’ve established are working for you. Is a $100 budget each month for entertainment reasonable, or are you constantly going to go over that? Set reasonable expectations, or you’ll find yourself creating debt that you can’t pay off.
Tip No 2: Understand What Doesn’t Work
Unfortunately, all bills aren’t created equal in FICO’s eyes. Paying your monthly utility, phone, internet, cable, and rent payments on time won’t impact your FICO score. That doesn’t mean you don’t need to pay these expenses on time, though. Those companies can still send you to collections, which will negatively impact your credit score.
There are some companies that will report some monthly expenses like rent to the credit bureaus, but those payments typically won’t impact your FICO. However, any accounts – even a utility bill – that goes to a third-party debt collector becomes a public record. Those records get listed in your credit report and thus negatively affect your score.
Investing instruments like stocks, savings plans, and 401k contributions will also not help you build your credit score. Establishing savings is an important part of any financial plan, and having savings can help you qualify for some loans, especially large loans like mortgages where a down payment is required. Even though a credit score is going to be the biggest factor in determining your eligibility for a financial product, banks may consider other factors, like the amount of savings you have, or an existing relationship you have with the bank.
Finally, not all credit card use will impact your credit score. Let’s say you’re an authorized user on someone else’s credit card. You can use the card and make charges, but you’re not responsible for the payments. As a result, you don’t build credit history even if the account you’re authorized to use gets paid on time every month. It affects the primary cardholder’s credit history, but not yours. Only cosigners get joint credit reporting from a single account.
Build Credit the Right Way!
If you follow these steps, you should be on your way to building a strong credit score without a credit card. Having a good credit score will unlock the best interest rates for mortgages, auto loans, and credit cards as you continue your financial journey. A bad credit score can cost you tens of thousands of dollars over your lifetime. Spending time getting to understand the ins and outs of credit when you are building credit for the first time will set you up for a lifetime of success.
Through smart planning you can use FICO’s scoring model to your advantage. At the end of the day a credit score is a math equation, and you already have the solution to the problem.