|Build your credit without credit cards
You don't need plastic to establish credit, but you do need a good credit history even if you don't intend to borrow. Here are 7 tips -- plus 4 traps to avoid.
By Liz Pulliam Weston
The fastest way to build or rebuild your credit scores is by using both of the two main types of credit:
Revolving accounts (credit cards, which allow you to build up and pay down debt).
Installment loans (mortgages, auto loans and other debt that's repaid in periodic installments).
But some people can't get credit cards in today's tight environment. Others don't want to use them, often because they don't trust themselves not to overspend or because they don't trust credit card companies.
Fortunately, these folks don't have to give up on having great credit scores, which is a good thing. These days, getting a good rate on a mortgage or most other loans -- or even getting approved at all -- depends on having decent scores.
Even if you don't plan to borrow, having good credit is important, because credit information is also used by cell phone companies, landlords and employers to evaluate applicants and by insurance companies to set rates.
There are several ways to build or improve a credit history without using credit cards. Among them:
1. Get a secured loan from a credit union
Often called a share-secured loan, this type of borrowing is backed by money you place in a credit union savings account or certificate of deposit. The interest rate you pay is typically a few percentage points above the rate you earn on your money.
These loans may be easier to get than bank loans, since credit unions are often willing to look at more than just your credit scores, said Susan Tiffany, the director of consumer publications for the Credit Union National Association. (Find a credit union near you.)
"(Credit unions) don't treat credit scores as the only source of information about you," Tiffany said. "They're looking for ways to say yes. Are you responsible with your checking account? Are you demonstrating that you're trying to be a regular saver? Those behaviors can help."
But you need to know something important about these and other installment loans: After they're paid off, creditors may stop building your scores.
The leading FICO credit-scoring formula is designed to predict people's risk of default, and it responds best when people actively and responsibly use credit. A history of responsible credit use will get you only so far.
"All things being equal, it's better to have at least one open account as opposed to having them all closed," said Barry Paperno, the manager of consumer operations for Fair Isaac, which designs the leading credit-scoring formula.
Eventually, your old loans may not help you at all, because they'll be dropped from your credit reports. How long that takes depends on the lender and its policies; some report closed accounts indefinitely or for 10 years, while others stop reporting them within months. Once a loan disappears from your credit reports it stops helping your scores.
And yes, there is irony here:
You don't have to pay a dime in interest if you use credit cards to build your scores. If you use them and pay them off on time and in full, you can improve your credit without paying finance charges.
If you refuse to use credit cards, however, you may have to stay in debt to build your scores.
You'll also want to make sure your loan is reported to all three major credit bureaus: Equifax, Experian and TransUnion. Some credit unions and smaller banks save money by reporting to only one. You want all three of your credit bureau reports to reflect the loan so that you get the benefit no matter which bureau is used by future lenders, insurance companies, landlords or employers.
2. Consider peer-to-peer loans
Peer-to-peer, or social, lending sites such as Lending Club and Prosper aim to connect borrowers with individual investors. The rates borrowers can get on three-year fixed-rate loans depend on their credit and their applications, with a loan at Prosper running anywhere from 7.8% to 26%, said spokeswoman Tiffany Fox. Investors "bid" on the borrowers' applications, with the investor willing to provide the lowest interest rate winning the contract.
Lending Club reports all payments to the three credit bureaus, while Prosper reports to just Experian and TransUnion. Prosper requires borrowers to have credit scores of at least 640, while Lending Club's minimum is 660.
3. Student? Get a federal student loan
Federal student loans don't require credit checks, but you do need to be at least a half-time college student and to have submitted a Free Application for Federal Student Aid (FAFSA), said Mark Kantrowitz of FinAid. You don't have to show financial need, and rates for unsubsidized federal Stafford loans are fixed at 6.8%.
Your loans may not show up on your credit reports until you're in repayment mode, but once they appear, your on-time payments will help boost your scores.
4. Become an authorized user on someone else's card
When you're added as an authorized user to someone's credit card, his or her history with that card is typically imported to your credit reports. If the person is responsible with the card -- charging lightly and paying on time -- that could enhance your scores. Conversely, if the other person messes up, that could hurt you, although you just need to be removed as authorized user for the bad stuff to disappear from your files.
The other person doesn't need to give you access to the card to add you as an authorized user, but you should make sure the credit card will export the information to your credit reports. Some issuers report authorized-user information only for spouses or family members.
Also, don't go overboard. The newest version of the leading FICO formula limits the number of authorized-user accounts that are counted, a step that was taken to discourage credit repair firms that were adding people to strangers' accounts.
5. Get (or be) a co-signer
Getting a co-signer can help you land a loan you might not otherwise get, and the loan can help build your credit scores. Or you can ask to be added as a co-signer to a responsible person's loan, and his or her payment history will be included in your files.
Co-signing is risky for each party because it makes you equally responsible for the debt. If a payment is missed, it can trash both parties' credit scores, and the effects can last for up to seven years. Unlike authorized-user status, which can easily be changed, you can't be removed from a co-signed debt -- it must be paid off or refinanced before you're released from the obligation.
If you're being added as a co-signer, you should be able to pay off the loan yourself and get online access to the account to make sure payments are made on time.
6. Put up your own money with a secured credit card
If you really don't like credit cards, you'll want to skip this option. If you want a card but can't get a regular account, however, this may be the way to go.
Secured cards require that you make a deposit with the issuing bank, typically of $200 to $1,000. You usually get a credit limit equal to your deposit.
There are fewer secured cards available these days, and many have higher credit standards than in the past. Index Credit Cards offers the most complete look at what's available, but you can look for secured cards among the offerings aimed at people with limited or poor credit histories at CardRatings.com, LowCards.com and CreditCards.com.
Look for cards that report to all three major credit bureaus. Check the fees; avoid cards that charge more than $100 in setup and other initial fees.
7. Charge it -- but not on a credit card
If your credit history is already good and you want to keep it that way without using credit cards, consider a charge card.
These cards, provided by American Express and Diner's Club, don't normally allow you to carry a balance. You're supposed to pay off your bill in full every month, and you typically have no preset spending limit.
There's a hidden benefit to using charge cards: You don't have to worry about credit utilization.
For credit-scoring newbies: Credit utilization measures how much of your available credit you're using. This ratio makes up 30% of your FICO score, so it's pretty important. The more of a credit card limit you use, the bigger the potential dent on your score, which is why you typically want to keep charges to 30% or less of your limit, even when you pay in full.
But charge cards don't have traditional credit limits. So the latest versions of the FICO formula treat them differently from credit cards. Charge card balances aren't included at all in credit utilization formulas, so you can run up big bills without fear -- as long as you can pay them off when the bill arrives.
"The newer models of the FICO separate out (charge cards) from credit cards," Paperno said. Balances on charge cards "aren't included in the revolving utilization calculations."
And 4 to avoid
You may be tempted by other ways to build your credit, but many have hidden traps or won't work. Methods you don't want to use include:
Prepaid cards. Some prepaid cards promise to help you build your credit, but the fees charged are often high, and your activity may be reported to an "alternative" credit agency, rather than to the three bureaus that most lenders use. For example, the fee for Eufora's prepaid card Credit Builder is $139.75 to $219.95, and the card reports to just two of the three bureaus, according to Michelle Jun, a staff attorney for Consumers Union, who recently researched prepaid cards. AccountNow doesn't even do that; this prepaid card reports to the Payment Reporting Builds Credit, an alternative credit-reporting agency that consumers can sign up with to self-report their bill payments.
Bad-credit credit cards. These unsecured cards tend to come with tiny credit limits and high upfront fees. A secured card is typically a better option if you're going to use plastic.
Rent to own. You'll pay two to three times over for stuff you buy from one of these outfits, and your payments typically aren't reported to the three major credit bureaus.
Other loans that aren't reported to the credit bureaus. Loans from your retirement plan or life insurance policies won't help boost your scores because your payments aren't reported to the bureaus.