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by The Ascent Staff
October 25, 2019
by The Ascent Staff
October 25, 2019
I have a good friend who recently started the process of buying a house after years of living in a rented apartment. In his mind, he's done everything right—he has a steady job that pays well, he has no debt, and he saved up 20% for a downpayment. But when he tried to get pre-approved for a mortgage, he ran into one little hiccup: He has no credit score, because he has no credit history.
You see, my friend knew how many people struggle with credit card debt, so he decided to avoid plastic and pay for everything with cash. He has also avoided auto loans, and his college tuition was paid by a scholarship. My friend has done an excellent job of avoiding debt—but having no credit history can be a major obstacle in the long term, and there are good reasons to apply for a credit card. Eventually, almost everyone will need a decent credit score to help them with a large purchase—a new car, a house, a personal loan for starting a new business, etc.—and building this credit early will help ensure you're ready when the time comes.
For most people, building credit by opening a credit card and using it responsibly is a great idea. But for people like my friend, who want to avoid credit cards at all costs, there are some great alternatives.
In many ways, a secured credit card functions the same way as a regular credit card. The main difference is that a secured card requires you to make a deposit, often equal to your credit limit, that's used as collateral. In other words, if your card limit is $500, you may have to deposit $500 to guarantee your ability to repay. These cards help prevent you from racking up massive debts, all while helping you build your credit score. Because these cards require collateral, most people can qualify for them with little to no prior credit history.
Credit-builder loans are exactly what they sound like: personal loans that help you build your credit. Unlike other types of personal loans, when you receive a credit-builder loan, you don't receive the funds right away. Instead, you start making payments on the loan amount, and the bank holds the money in a CD or other savings account, and you receive the funds when you have repaid the loan.
While you will pay interest on the loan amount, some lenders offer refunds or credits for the interest when you have repaid in full, so choose your lender carefully. Credit-builder loans are reported to all the major credit bureaus, making them a great way to help you establish credit history.
Chances are that anyone who's conscious of avoiding credit card debt is pretty responsible when it comes to paying their rent (or mortgage), phone bills, and utility bills on time each month. Fortunately, there are third-party companies like Rent Track, Rental Kharma, or Experian Boost that can verify these payments with your landlord or utility company and then report them to credit bureaus. These services are often not free and require participation from your landlord, but they can be an easy way to get credit for payments you're already making.
It's great that my friend got through school without student loans and received his car as a gift. However, many people aren't so lucky. Fortunately, with interest rates near historic lows, both student and auto loans are considered relatively "good" types of debt. You may need a cosigner if your credit file is thin, but they can both be relatively safe ways to build credit. As with any sort of debt, you should think through your ability to repay. Don't take on more student debt, or buy a more expensive car, than you can really afford.
Meanwhile, make sure you stay away from higher-interest loans like payday loans. With interest rates that can reach triple digits, they aren't a safer option than credit cards for building up your credit history.
Ultimately, there are many ways to build your credit score besides opening a credit card. Just make sure you're taking steps to build credit early, long before you're ready to apply for a mortgage or other bigger loan. Having good credit is a key step in controlling your financial future, so make sure you're on the path to the future you want.
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