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Lenders look at credit scores to determine whether they want to extend credit to a consumer and at what rate. But you may not have a credit score if you don't have the credit history needed to generate it. It's a classic Catch 22: You can't get credit without demonstrating a track record with credit, but you can't build that track record without having access to credit.
Credit scores are calculated based on the information in your credit reports, which are maintained by the three credit reporting agencies: Equifax, TransUnion, and Experian, the publisher of this article. The Consumer Financial Protection Bureau estimates that 26 million Americans, or one in every 10 adults, do not have any credit history with one of the three nationwide credit bureaus. Another 62 million Americans have what is known as a "thin credit file." That means they have few (if any) credit accounts listed on their credit reports, typically four or less.
Reasons You May Not Have a Credit Score
There are a number of possible reasons you may not have enough credit history to generate a credit score, which can include:
- You have never used traditional credit accounts and typically pay for things with cash.
- You have not used credit in more than 24 months.
- You are a new immigrant who hasn't established a credit history in the U.S. yet.
- You are young and simply do not have any experience with credit yet.
The Consumer Financial Protection Bureau notes in a recent study that Hispanics and African Americans, as well as people who live in low-income neighborhoods, are disproportionately impacted by thin credit files.
Why Do I Want a Credit Score?
Credit, or the ability to buy things today using borrowed funds, can help you in a number of ways. Americans rely on credit to finance many big-ticket items, including homes, cars and even education. Access to credit, then, is dependent on the ability for lenders to evaluate your credit history. Your credit scores play a big role in that evaluation process. You want good credit scores so you are able to access credit when you need it at the best rates.
If you do have a good history with credit and high credit scores, you will be able to shop around with multiple lenders when seeking credit. High credit scores will likely qualify you for the lowest interest rates and best fee terms lenders offer. That can save you a lot of money. For example, reducing an interest rate by even just one percentage point on your mortgage can save you tens of thousands of dollars over the course of the loan.
What Is a Good Credit Score?
While there are dozens, if not hundreds, of different credit scoring models, one of the most frequently used by lenders and other businesses is known as the FICO® Score*, which has a scale ranging between 300 and 850. (Most scoring models use a similar scale, though some go as low as 250 and as high as 900.)
The score ranges are categorized as followed:
- 800 and above: Exceptional
- 740 to 799: Very Good
- 670 to 739: Good
- 580 to 669: Fair
- 579 and below: Poor
In order to achieve a good, very good or excellent rating, you must demonstrate a strong history of managing credit wisely over a long period of time. The biggest factor in building good credit is demonstrating a long history of making payments on time. Other factors that play a role include how much outstanding debt you have, how long you've used credit, what types of credit you have and how often you apply for new credit.
Establishing a Credit Score
The good news is that there are plenty of ways to build credit if you've never had experience with it before:
1. Apply for a Secured Credit Card
Secured credit cards are perfect for users trying to build a payment history from the ground up. They work like other credit cards when you make purchases, but you must make a cash deposit to backup your usage. That deposit, which is typically the same amount as your credit limit, is what "secures" the card.
Otherwise, you use the card in the same way: Make purchases, pay them off by the due date and pay interest on any charges you don't pay off in full. If you don't make your payments, however, your secured deposit is deducted.
Typically, you can use a secured card for a period of time in order to build up a credit history, after which you can convert the card to an unsecured option or apply for a regular credit card.
2. Get a Cosigner on a Credit Card
You can also apply for a credit card with a cosigner who does have a solid payment history. This is a good option for students who are just starting out and can get a card with their parents. However, the cosigner should know that if you do miss payments or carry a huge balance, their credit scores will also be affected.
3. Apply for a Retail Store Card
The first credit cards for some people are often retail store cards, which can be easier to qualify for and typically offer lower credit limits. They can also qualify you for discounts on purchases at that retailer. If you don't have much history with credit, retail cards can be a possible option for establishing a credit history, but they can also include some pitfalls, like high-interest rates and fees.
4. Get a Credit-Builder Loan
Credit-builder loans are designed solely to help you improve your credit score, so they function differently than other loans. Instead of giving you the loan amount up front, the lender sets it aside in a savings or certificate of deposit account (CD).
Then, once you've completed the repayment term, the lender gives you the funds, plus the interest accrued from the savings or CD account. Since the lender holds onto the cash from the beginning, many credit-builder loans offer decent interest rates.
Make sure the lender reports your payment history to Experian or one of the other credit reporting companies so that the loan actually helps you build your credit history.
5. Become an Authorized User on Someone Else's Credit Card
Another option is to piggyback off an already open account as an authorized user instead of getting a cosigner. A parent, spouse or other family members can add you to their credit card account with a separate card. You will build a credit history based on the usage of that card, but the primary cardholder will be the one legally on the hook for paying off any charges. If you're going with this method, be sure to establish rules in advance of how you will use the card with the primary cardholder.
6. Build a Credit History with Your Rental Payments
There are some rent-reporting services that send the information for your monthly rent payments to the credit bureaus in order to establish a credit history. They may not always be counted by every credit scoring model, but it's a good way build history based on rent you already pay before you have a mortgage. Experian's RentBureau is one such service. Check with your management company or landlord to see if they work with Experian or other similar services.
Checking Your Credit Reports and Scores
When you embark on your credit journey, you should also be sure that the information being reported to the credit agencies is correct. Make a habit of checking your credit reports from each of the three credit bureaus: Equifax, TransUnion, and Experian (the publisher of this article).
Look for any inaccuracies or discrepancies, and make sure your new credit is being reported correctly. If there are any problems, you should initiate a dispute with the credit bureau.
Get your free credit report from Experian, where you can also get your FICO® Score. You are also entitled to one free credit report every 12 months from Experian, Equifax, and TransUnion at AnnualCreditReport.com.
Want to instantly increase your credit score? Experian Boost™ helps by giving you credit for the utility and mobile phone bills you're already paying. Until now, those payments did not positively impact your score.
This service is completely free and can boost your credit score fast by using your own positive payment history. It can also help those with poor or limited credit situations. Other services such as credit repair may cost you up to thousands and only help remove inaccuracies from your credit report.
Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.
This article was originally published on November 30, 2018, and has been updated.
*Credit score calculated based on FICO® Score 8 model. Your lender or insurer may use a different FICO® Score than FICO® Score 8, or another type of credit score altogether. Learn more.