|Gary Foreman is a former Certified Financial Planner (CFP) who currently writes
about family finances and edits
The Dollar Stretcher website
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Dear Gary, My 20 year old son will
soon need to buy a car but he has no credit. What's the best way for
him to establish credit? I don't know of any stores that will let
him pay off a purchase without first checking his credit. Are there
still credit cards that will let him put some money on hold in order
to back any purchases he might make? How do I find them? --Margie
Margie's son is about to take one of
the big steps to adulthood - establishing credit. And it's important
that he get off to a good start. The record that he builds now will
follow him throughout his life. And it will effect how much he pays
when he borrows money.
A good first step is to open a
checking or savings account. It's an easy way to demonstrate that
he's able to handle money responsibly. Just making regular
transactions without overdrawing the account will begin to build a
The next step is to get a credit
card. To qualify he'll need to be 18 years old and have either a
steady source of income or a savings account. It's easiest to
qualify for a department store or gasoline card.
If you're a full-time student you
won't need to prove your income to qualify for a card with a low
credit limit. Most card issuers are anxious to sign up college
students. Even for major credit cards.
Ironically, it's harder to get a
first credit card after graduation. The card issuers figure that
parents will bail out students but not grads.
Margie's son shouldn't apply for a
bunch of cards. That will hurt his credit rating. It's much better
to get one card and pay it faithfully for a year. Then apply for a
second card. That will demonstrate that he's managing his credit
First time cardholders will not get
the lowest rates. But if he pays the entire balance each month it
won't make any difference. And paying bills on time is very
If Margie's son has trouble getting a
card, he'll need to use the strategy that she mentioned and apply
for a "secured card" first. Money is deposited with a bank
which acts as security for your card. If you don't pay the bill,
your money will be taken from the bank account.
There's enough competition now so
that you can find a number of secured cards that don't require an
application fee. Rates run from about 10% to 20% and annual fees
range between $18 and $45. Margie's son can ask his bank or check
out Bankrate Monitor to find a card issuer.
If you use a secured card properly
it's possible that you'll get a better reception on a non-secured
card after 12 to 18 months.
Margie's son needs to manage his use
of the cards. The best (and cheapest) plan is to pay the entire bill
each month and not carry a balance. Unfortunately, that's not what
most first time cardholders do.
Experts say that monthly installment
debt should not total more than 20% of your monthly take home pay.
Even that level could be too high. For instance, that much money
committed to installment debt could make it very hard to afford a
Now we move on to the specific goal
that Margie had - a car loan. It's likely that there won't be enough
time for her son to build up a good credit history before he wants
the car. He should apply for a loan at the bank or credit union
where he keeps his checking or savings account. Hopefully his
reputation there is good.
It's also possible that he'll be able
to arrange credit through the dealer where he buys his car.
Sometimes they'll make loans trying to attract younger buyers for
their brand of car. If he does go through the dealer he'll probably
pay a higher rate of interest.
Finally, if no one will give him a
car loan, he can get a co-signer. Margie could agree to be
responsible if he defaults on the loan. But that's a step that
should only be taken after careful thought. Remember, the banks are
saying that he's not a good credit risk. When you co-sign a loan, in
effect you're saying that you know more than the bank. And you're
willing to put your own money behind your beliefs. If anything
happens she'd be responsible to make the payments.
Now that we've seen how Margie's son
can establish credit, let's ask a different question. Is a car loan
really the best way to go? Is it wise to borrow to buy a car?
Just to illustrate, let's assume that
Margie's son borrows $10,000 to buy the car. He takes out a 4 year
loan at the current rate of 8.8%. He'll be paying $347.90 per month
or a total of $11,947 in payments. In effect, he's paid 20% more for
the car than if he had paid cash.
And, he's created a pattern that
could last a lifetime. If he's making car payments it will be hard
to save up for his second car. So he'll be borrowing again. And
again with the third. It's as if he's agreed to pay 20% more for
every car he buys as long as he lives.
Sure, he probably can't afford to pay
cash for the car he wants now. But by sacrificing with a cheaper,
affordable car now, he could save himself tens of thousands of
dollars over the years.