14 - Building (or Rebuilding) Credit from Scratch

Whether you have a blank credit file or are recovering from past financial mistakes, this episode provides a clear roadmap to a better score. We lay out actionable strategies for building a positive credit history, starting from day one. We’ll explore how to leverage a secured credit card to prove your creditworthiness, the benefits of a credit-builder loan, and how becoming an authorized user can provide a powerful head start. It’s never too late to write a new financial story.

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Transcript

Episode 14 | Building (or Rebuilding) Credit from Scratch

00:00:00 Daniel Hill: All right, Shanna, let's picture a young person, maybe nineteen or twenty, trying to get their very first apartment. They have a good part time job. They've diligently saved up for the security deposit, but they keep getting denied by landlords.

00:00:15 Shanna Browning: Well that's frustrating. So what? Why? What's the reason?

00:00:19 Daniel Hill: Well, the answer is always the same - lack of credit history. It's incredibly frustrating for them because they feel like the classic catch twenty two. You can't get approved for things without a credit history. But how are you supposed to build a credit history if no one will give you a chance?

00:00:36 Shanna Browning: It's like chasing your tail. It really is. And it's such a problem that so many young people face. And honestly, it's not just young people. The same thing can happen to someone who's recently moved to the country, or even someone who's just made a point to pay for everything with cash their whole life.

00:00:53 Daniel Hill: And on the flip side, you have people with long credit history, but it's one they'd rather forget. They made some past mistakes, and now they feel like they're stuck in a financial hole they can't climb out of.

00:01:06 Shanna Browning: Yeah, yeah. Neither one are great, but we're going to talk about both of those groups today. And so whether you're starting from a blank slate or just from a place of repair, building a positive credit history is possible. And it's truly one of the most powerful things you can do for your financial future.

00:01:32 Daniel Hill: Welcome back to this episode of Making Sense of Your Cents. I'm Daniel Hill.

00:01:37 Shanna Browning: Hi friends, and I'm Shanna Browning. So last week we took a really deep dive into how to read your credit report. And today we're talking about how to write a great story on that report page by page.

00:01:49 Daniel Hill: Yeah. We're going to lay out a clear, step by step game plan for anyone who needs to establish credit for the first time, or rebuild their credit after some past mistakes.

00:01:59 Shanna Browning: All right Daniel, we're going to start with that frustrating situation you just described. So why is having no credit history a problem? I mean, to some people it might sound like a good thing, right? But it means it specifically means you may have no debt.

00:02:13 Daniel Hill: It's a logical way to think. But in the modern financial world, it's unfortunately not how lenders see it. When a lender looks at your credit report, they're not just looking for negative information. They're also looking for positive information. They're looking for evidence that you are responsible and reliable borrower.

00:02:34 Shanna Browning: And so what I'm hearing is, is a blank report basically gives them no information.

00:02:39 Daniel Hill: Exactly. A blank credit report is a big giant question mark. The lender has no idea if you're a good risk or a bad risk. And because their business is to manage risk, they will most always err on the side of caution and say, no. It's not a judgment of your character. It's a judgment of their data. And in this case, there's no data.

00:03:04 Shanna Browning: Well, and I'm guessing that's probably going to affect more than just getting a loan, right?

00:03:08 Daniel Hill: Yes. It affects so much. As we mentioned, landlords often check credit to decide if you'll be a reliable tenant. Insurance companies can use credit information to help set your premiums for car and home insurance, and even some employers may review a version of your credit history as part of the background check for certain positions, especially those involving financial responsibility.

00:03:30 Shanna Browning: That's right. So building a positive credit history really isn't just about borrowing money. It's about building a reputation of pretty much financial worthiness and trustworthiness that can open doors for you in many, many, many areas of your life.

00:03:47 Daniel Hill: Yeah. So let's talk about that nineteen year old version of, well, me, someone with a blank slate. What are the first, safest steps to start building that positive history.

00:04:00 Shanna Browning: Well, I think the first, probably in easiest step is for a young person in this case, is to become an authorized user of a parents or guardians credit card.

00:04:13 Daniel Hill: That's a good point. Tell us how that works.

00:04:15 Shanna Browning: Pretty simple. So the policy cardholders - say your mom - will call her credit card company, and she adds you to her account as an authorized user. That way, you get your credit card with your name on it. But the responsibility for paying the bill still rests with your mom. So as long as she continues to manage the account responsibly and pay the bill on time, that payment history will start to appear on your credit report, giving you a really, really powerful head start.

00:04:47 Daniel Hill: That is a great option. But Shanna, what if that's not possible? Or what if you're not a young person and you're starting out on your own?

00:04:53 Shanna Browning: And that's a scenario too. So the next one, The next best tool is a secured credit card. So that's a product specifically designed for people who are new to credit or are rebuilding their credit.

00:05:07 Daniel Hill: How is a secured card different from a regular card?

00:05:11 Shanna Browning: So the difference here is a security deposit. To get a secured card, you make a small cash deposit with the bank. Typically, I don't know, a few hundred dollars and then that deposit becomes your credit limit. So if you deposit three hundred dollars, you're going to get a credit card with a three hundred dollars limit.

00:05:30 Daniel Hill: So the bank really has no risk in that the deposit is their collateral.

00:05:34 Shanna Browning: That's right. That's exactly correct. And so that collateral is basically meaning that we're taking it as a hold. Right. If you don't know what collateral is, it's basically a hold on that three hundred dollars.

00:05:49 Daniel Hill: So this allows the bank to give you a chance to prove your credit worthiness. You use the secured card just like a regular card. You can use it to buy gas, groceries, whatever, and you make a payment on it each month. The bank then reports that payment history to the credit bureaus.

00:06:07 Shanna Browning: That's correct. And this is the most important part. You got to treat it like a real credit card. Always pay the bill on time. Every single time. Don't go over the three hundred dollars. After about six to twelve months of responsible use, you've established a positive credit history, and the bank will often upgrade you now to a traditional unsecured credit card and refund your security deposit.

00:06:36 Daniel Hill: So another great option to consider is a credit builder loan. This is another product designed specifically for this purpose.

00:06:44 Shanna Browning: Yeah, but that kind of sounds like you're taking on debt. And if you don't have credit history. So tell me how a credit builder loan works.

00:06:51 Daniel Hill: It's a bit different than a traditional loan. With a credit builder loan, you're not actually given the money up front. Let's say you take out a five hundred dollars credit builder loan. The bank would then place that five hundred dollars into a locked savings account for you. Then you make small, regular monthly payments on that loan for a set period, say, six to twelve months. The bank reports those on time payments to the credit bureaus. At the end of the term, once you've made all the payments, the bank unlocks the savings account and gives you the five hundred dollars.

00:07:23 Shanna Browning: Hold up a minute. So you're basically paying yourself, and in the process, you're creating a record of on time loan payments for your credit report? I like it. It's brilliant.

00:07:34 Daniel Hill: Now Shanna, let's shift gears. Let's talk about the other group of people. People who have made some mistakes in the past. They've had late payments, collections, or maybe even a bankruptcy, and their credit score is low. It can feel like a hopeless situation. What's the first step back?

00:07:51 Shanna Browning: Well, first step is you got to take accountability and you got to face that music, and we got to get a clear picture of what that damage is. Again, no judging. We can only help you if we know your story. So let's just go back to our last episode real quick. You can pull your credit report for free from Annualcreditreport.com and you can see exactly what's on there. You can't fix a problem, and we can't help you until we know exactly what that problem is.

00:08:21 Daniel Hill: And once you have the report, what should you focus on first?

00:08:25 Shanna Browning: Well, your number one priority is going to be bringing is to bring any past due accounts current and then to focus on making every single payment on time going forward. Payment history is the single biggest factor in your credit score. It makes up thirty five percent of your score. The impact of past mistakes will go away. It'll go away over time, but only if you replace that old negative history with new consistent track record of on time payments.

00:09:00 Daniel Hill: So what you're saying is consistency is key.

00:09:03 Shanna Browning: That's right.

00:09:03 Daniel Hill: Even if you can only make the minimum payments, making them on time is what starts to rebuild that trust with lenders.

00:09:10 Shanna Browning: That's right. Don't just not make a payment, make some sort of payment, whether it's five dollars or ten dollars, make the payment. And then the second most important factor you got to tackle is your credit utilization ratio. So that's the percentage of your available credit that you are currently using. And it makes up thirty percent of your score.

00:09:31 Daniel Hill: Shanna, can you give us an example of that?

00:09:34 Shanna Browning: Of course I can. So let's say you have a credit card and you have one thousand dollars limit and you have a nine hundred dollars balance on it. So you owe nine hundred dollars to one thousand dollars limit. Well, your credit utilization is ninety percent. And to us as lenders that looks kind of risky. It suggests you are pretty much maxed out and financially stressed. So good rule of thumb is to keep your overall credit utilization below thirty percent. In this example, paying that balance down from nine hundred dollars to below three hundred dollars is going to cause a significant and quick increase to your credit score.

00:10:15 Daniel Hill: So paying down existing balances is a powerful way to rebuild. And for someone in this situation, would a secured card also be a good tool to help add some positive history?

00:10:26 Shanna Browning: Absolutely. It's a great tool. Just like for a first timer, getting a secured card and using it responsibly, meaning making a small purchase each month and paying that bill in full and on time can start to inject much needed positive payment data into your credit report, helping again to offset the older negative information.

00:10:49 Daniel Hill: This is extremely helpful information. The key takeaway for me is that your credit history is not set in stone. Whether you're starting from scratch or starting over, you have the power to write a new story. And that brings us to this week's actionable tip.

00:11:10 Shanna Browning: All right, here's what we're going to do. Your action item for this week is to choose one. Just one of the strategies we discussed today. And you take that first step.

00:11:20 Daniel Hill: If you're a young person with no credit, your action is to have a conversation with your parents about becoming an authorized user on one of their cards. Just ask the question.

00:11:30 Shanna Browning: And if you're starting out on your own, or you're just in that rebuilding phase of life, your action is to research a secured credit card. You don't have to apply for one this week. Just go online, do your research and read about their secured offerings, understanding the deposit requirements and the terms.

00:11:50 Daniel Hill: This specific action is less important than the act of starting, building or rebuilding. Credit is a marathon, not a sprint. Taking that one single proactive step this week is how you start moving in the right direction.

00:12:06 Shanna Browning: That's right. The right direction. And that's our show for today. We hope you found it helpful. Next week we're going to be talking about all refinancing your car or a home loan.

00:12:17 Daniel Hill: That is a great topic that could save you potentially a lot of money. Thanks for tuning in and remember to send us your questions at podcast@fcbtn.com. And subscribe to Making Sense of your Cents wherever you listen to your podcast. I'm Daniel Hill.

00:12:33 Shanna Browning: And I'm Shanna Browning, and as always, we want you to go out and make some sense of your cents.