Establish Credit if you Don't Have Any

Bad Credit is a lot worse than No Credit, but you should still seek to establish some credit if you don't have any.  You might be able to get away with having no credit history if you're getting an FHA loan (vs. a conventional loan), but still, it never hurts to have credit.

Credit cards and bank loans are just about the only things that will show up positively on your credit report.  Other items like utility bills and rent payments usually don't appear on your credit report to show that you've paid them on time; they only show up when you don't pay on time.  They can't help you, they can only hurt you.  Yeah, it's not fair, but what are you gonna do?

What you're gonna do is at least get some things on your credit report that CAN help you.  You want at least two items on your credit report: two credit cards, or a credit card and a bank loan (like a car loan).  Of course, don't rush out and buy a car just because you don't have a car loan; it's easier to just get two credit cards.  The primer below will help you do this.

Getting a Discover Card

Discover is one of the easiest cards to get.  Just call 1-800-DISCOVER, they'll ask you some basic questions like how much money you make, and you have to make only $15,000 a year to qualify, as I write this in fall 2006.  And if you're a college student then there is NO minimum income requirement.  (I got my card when I was a student, but they didn't ask for any documentation to prove I was.)  After answering the questions, you'll get an answer on whether you were approved for the card in just a few days.

Getting a Visa or MasterCard

While the Discover card is available from only one source (the company that owns Discover), Visa and Mastercard are issued by individual banks—so there are hundreds of places to get a Visa or Mastercard—and if one turns you down there are plenty more.

Start with the bank that carries your checking or savings account.  Just go in and ask for a credit card, and they'll see if you qualify.  If you have a Visa check card or debit card on your checking account, that does NOT count as a credit card and doesn't show up on your credit report; you'll need to obtain a credit card separate from that.

If your bank says you don't qualify for a credit card, then ask for a secured credit card.  This means you put money into an account (often a savings account) and you can charge no more than the amount in the account.  It sounds like a Visa check card on a checking account, but the difference is that this is a "real" credit card and shows up on credit reports to help you build credit.  (Some secured cards don't help you build credit, so make sure you ask your banker if their secured card will.)

If your bank doesn't offer secured credit cards, find another bank.  There's almost certainly a bank in your area which offers them.  You can also search for them on the web.

How to use the card

Your goal in getting a card is to prove to a home lender that you pay your bills on time, so that's what you should do: Use the card and pay your bill on time.  If you never charge anything to the card, it won't help you much.  And if you use it but don't pay your bill on time, then that's worse than not having a card at all.

How much should you charge?  The less you charge, the higher your credit score, except that charging nothing at all actually hurts your score.  (Go figure.)  So the best bet is to make one small purchase per month.

However, if you got a card that pays cash rewards (like 1% of all purchases), then you might be tempted to put all your purchases on the card to get the rewards.  Here's how to deal with that:  If you're not planning on getting a house loan, car loan, or putting in an application for a new apartment soon, then your credit score doesn't really matter right now, and you can charge as much as you like on your card to get the rewards.  However, if you are planning on doing any of those things soon, then a good credit score is more important than the 1% rewards, so make just one small purchase per month on your card.  Once you've got your loan or apartment, then you can charge more on your card.

If you pay your balance off in full each month, I'm pretty sure that the CRAs (credit reporting agencies) take account into what your balance was before you paid it off, so you don't get dinged for having a $0 balance.  But if you want to be on the safe side, pay your balance in full except for $1 (e.g., on a $358 balance, pay $357).  The interest you'll pay on that $1 will be trivial.

Credit card interest

As long as you control your spending and pay off your balance in full each month (or in full minus $1), there's nothing to fear from credit cards.  If you pay off your balance in full, you don't have to pay any interest on your purchases—not one cent. This is how you should use a card.

Card companies hope that you WON'T pay off your entire balance and that you'll just make the "Minimum Payment" listed on your credit card bill instead.  It looks so enticing—if your credit card bill is $1000 you can make a minimum payment for perhaps just $20.  And the next month you can pay just $20.  Paying $20 certainly seems a lot more attractive than paying $1000.

Here's why you should never make the minimum payment:   It will take you forever to pay off your card, and you'll pay interest out the wazoo. I f you make the minimum payment on a $3000 balance with 20% interest, it will take 31 years to pay off, and you'll pay a total of $12,000!  (And yes, credit card interest is around 20%.)

The moral of the story is: Pay off your balance in full every month.  If you've gotten yourself into debt and you can't pay off the whole balance, then pay at least double or triple the minimum payment.  (In the above example, doubling the minimum payment cuts your payoff time down to 6 years and $4600 total.)  If you have multiple cards, pay more aggressively on the cards with higher interest rates.

Don't take cash advances

You don't pay any interest on purchases if you pay off your balance when you get your bill, but if you get a cash advance on your card, you start paying interest from the millisecond you get the money—PLUS you pay a cash advance fee.  Never take a cash advance on a credit card unless it's an emergency.

Under 18?

If you're under 18 then you won't be able to get a credit card, but you might be able to get a bank loan if your parents co-sign for you.

How to figure how much of your payment goes to interest

An advanced topic: When you make your payment, how much goes to interest?  Just take your balance and multiply it by the interest rate divided by 12.  (There are 12 months in the year, and you want to figure only the monthly interest, not the yearly interest.) If your balance is $3000 and the interest rate is 20%, then your monthly interest is $3000 x (20%/12) = $50.

How is the minimum payment figured?  It's usually 1/48th of your balance, or $20, whichever is higher.  So your minimum payment would be $3000/48 = $63.  So if you make the minimum payment of $63, then $50 will go to interest and only $13 will go towards paying down your balance. After making this $63 payment your outstanding balance will be $2987.  Ouch.

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