Good credit is all about having a good credit “history.” Lenders look at our past history as a predictor of how we will use credit in the future. Our past credit record is the basis for our “credit score,” which calibrates our degree of risk to the lender. The lower the credit score, the higher the risk.
So, for a young person to establish credit, he must begin to make his own record of wise credit usage. I want to reduce the process down to three words: Remember, Report, and Repay.
1. Remember. Young people need to remember that good credit, although important, is not the focal point of life. Having good credit means we have the ability to go into debt with good terms!
With planning and patience, most needs in life can be obtained without creating debt. But a peculiar phenomenon can take place once a young person has a credit card in his wallet. The new access he now has to buy can subtly encourage an attitude to buy. In other words, because we have access to buy a new pair of shoes, we now see the shoes as a need instead of a want.
So, as a young person begins to establish his credit, he must understand that having good credit can quickly get him into debt. He needs to be vigilant to distinguish between his wants from his needs.
2. Report. At age 18 the young person should apply for a “secured” credit card at his bank or credit union. This credit card will report monthly to all three credit bureaus, thus creating a record of responsible usage. Other payments like cell phone payments, rent payments, and utilities payments usually do not report to the bureaus so there is no history recorded.
This card will require a cash deposit of at least $300 that is used as “security” against the charges that are made. This presents less risk to the lender.
3. Repay. One small item will be charged on the card each month, and as soon as the monthly statement arrives, a check for payment in full will be sent in.
To create a good credit history, it is not necessary to charge big items, nor is it necessary to create long-lasting debt. Here is the rule: “Never put more charges on the card than you have cash to pay for in full. When the bill comes, pay it off.”
Therefore, it does not matter that the card may have a high interest rate. By paying off the full balance each month, no finance charges will be incurred.
Our credit history cannot be established over night. It requires a bit of patience and it requires a proven plan. Normally, it will require 9-12 months of following this procedure before sufficient history has been recorded to show we have a pattern of responsible credit usage. Eventually the secured credit card can be exchanged for a standard credit card, and the deposit returned.
The extra benefits for a young person using this plan to establish good credit is (1) he has become accustomed to not charging more than he can pay in full, (2) he has developed the habit of paying off the balance each month and avoiding finance charges, and (3) he is in much less danger of using a credit card to turn all of his wants into needs.