Before you can borrow money, you need to borrow some money. 

Doesn’t make sense?  Not a lot in finance does, at least not at first.  Either way, it’s true: you need credit to borrow money.  This can be done a number of ways, but first let me point out a number of ways NOT to establish credit.

Myth #1: Having a cellphone and paying on time will build credit.  Nope, this does not affect your credit rating most of the time.  Now, if you decide to stop paying your bill and refuse to settle up with your provider, they’ll probably hit your credit bureau with a tradeline that actually LOWERS your credit. 

Myth #2: Paying the cable bill establishes credit.  NOT!  Just like the cellphone, it can HURT your credit if you DON’T pay, but does nothing for you good or bad if you pay as agreed.

Myth #3:  Having a VISA or MASTERCARD Check Card/Debit Card builds credit. Nope, these are just linked to your checking account, and while they have the look and feel of a credit card, you’re not actually borrowing money. 

Myth #4: Making more money gives you better credit.  If you followed the advice in the last column and checked your credit reports, you may have noticed that there was nothing in there about your income.  Nadda. Zilch.  Income has NO bearing on your credit score.  Remember credit is merely figuring your WILLINGNESS to repay, not your ability.  There are millionaires who get rejected for credit cards all the time, though they probably don’t lose any sleep over it.

To establish credit, you actually have to borrow some money.  Borrowing services, such as with the cable or phone, don’t really establish credit and only show up on your bureau if you don’t pay and the account is sent to collections(Subject for another article). 

***A special note about utilities(electric, gas, etc.): There is such thing as “Utility Credit” used by these providers who provide you a service and bill you later.  Paying on time in this case does build credit, but not credit that will show up on your mainstream credit reports.  It will, however, save you having to make a deposit or provide a letter of guarantee when you establish new utility services.  Again, NOT paying your utility bills can land a huge negative mark on your regular credit reports.

Okay, so enough with the myths, how to go about establishing and building credit.  The plan is this:

1) Open up 2-3 credit cards and/or microloans(more on this in a bit)

2) Pay on time every time!!! Payment history is crucial.

3) Don’t use too much of your total available credit.

First one: Apply for some entry-level credit cards.  These should be unsecured cards, meaning you don’t have to put down any deposit, and have no annual fee.  If you’re a student, you probably can’t walk more than 20 feet without someone offering you a t-shirt in exchange for a credit card application, so go ahead and fill one out if it meets the above criteria.  If you’re out of school and getting those annoying offers in your mailbox, try filling one out that looking like a good deal.  If neither of those apply, look around online for some good starter cards. Again, be sure there are NO FEES associated with it aside from the high interest rate we’ve all come to know and love. 

If for some reason you just can’t get approved for a card, if your credit is already shot, if you have no credit but your parents can’t or won’t cosign for the card, there is another way.  To do this, you’ll need to open an account at a small, local bank.  Basic rule of thumb: if anyone outside your area has heard of the bank, it’s probably too big.  Open up a savings and possibly a checking account at this bank and let them get to know you, but before you do make sure you ask if they will issue small loans(some banks don’t make loans under a few thousand dollars). 

Once you’ve found the right bank and opened your accounts, talk to the loan officer about your desire to establish credit and ask if they’d be willing to do a small, short-term CD loan and report your payment history to the 3 major Credit Bureaus.  Basically, the bank loans you, say, $500, which you use to purchase a CD(Certificate of Deposit) You give that CD to the bank which holds it as collateral on your loan.  This means zero risk for the bank, and after the term of the loan(6 months or so should do it), you get the money from the CD back plus the interest it’s earned. It ends up being like a savings account except you’ve paid a little more interest than you earned. Not a bad way to establish some good credit and much cheaper than a secured credit card with all it’s hundreds of dollars in fees. 

Once you have a solid payment history hitting your account, your mailbox will be flooded with offers.  Pick a couple others from well known companies with low rates and no fees, and now you should have no trouble being approved.  To make sure the credit cards actually report, you need to buy something and pay it off over 3 months or more, making each payment on time.  If you pay off the balance in full each month, they might not even report the account to the Credit Bureaus.  Eventually you will want to keep low or zero balances on your cards by paying off any charges on time each month, but for now your focus is building a solid credit history. 

Be careful not to use too much of your available credit as this is a huge factor in your credit score.  15-20% of your available credit is a good rule of thumb at this point, meaning that on a card with a $1000 limit, you don’t want to carry a balance over $200.  This is called your Debt-Credit ratio, and comprises about 30% of your final credit score.  When you have multiple cards, the percentage rule applies to the total amount of available credit added together.

Six months or so after starting this plan and you’ll have stellar credit and about an acre of rain forest flooding your mailbox each week.  Having a few cards is good as it shows responsibility managing multiple payments.  If you have a car loan and/or a home loan, those are also wonderful trade lines to have on your credit report, though not something you’d want to do simply to establish credit.  So, to recap:

1) Open up a few credit cards and make small everyday purchases and then pay those amounts off over a 3-6 months.

2)If you can’t get a card at first, do a CD loan with a local bank.

3)Keep your Debt-credit ratio low

4) MAKE ALL PAYMENTS ON TIME

Credit can be an unforgiving thing if you’re not careful. A missed payment can stay on your report for 2 years and send your interest rate up near 30%, possibly on all your other cards even if you’ve been on time with them!  More serious defaults stay on your reports for 7 years, and the most serious such as bankruptcies and judgements will stay on there for 10.  Future articles will deal more in depth with these topics, but for now, get out there and start building a solid name for yourself!