Your credit score is your ticket to affordable financing on just about everything. Want to buy a new car at zero percent interest? You’ll need great credit. Likewise, if you’re eager to take advantage of low mortgage interest rates, you’ll need to meet all of your lender’s criteria, including a great credit score. The definition of a great credit score varies, but generally falls between 740 and 760. Remember that most lenders look at FICO scores, which range from 300 to 850. If you have a Vantage score, the range is 501 to 990, so you’ll need a higher number to be considered “excellent.”
If you are extremely financially conservative, you might prefer to avoid debt altogether. Many consumers believe that this low-risk behavior should result in a very high credit score, especially when compared with the millions of Americans who struggle with debt. Unfortunately, you cannot build a great credit score until the credit reporting agencies (Experian, TransUnion and Equifax) “see” some financial behavior to score. Paying in cash makes you invisible to them.
The credit card trap
The problem, then, is when an individual gets a credit card in order to build credit, only to fall into the trap of carrying revolving debt that grows when it isn’t paid off in a timely manner.
You do not have to carry credit card debt in order to have great credit. Your score is mostly made up of your payment history (35 percent) and your balances (30 percent). In other words, if you always pay your bills on time and your balances are low, you’ve already covered 65 percent of a great score. (“Low balances” generally means no more than 30 percent of your available credit; the people with the highest scores generally show a utilization ratio of less than 10 percent.)
The other 35 percent of your score is made up of the length of your credit history (15 percent), the number of new accounts and inquiries over the past 12 months (10 percent) and your diversity of credit (10 percent). So, having credit cards makes up only one tiny bit of your credit score. So what are the ways to build credit without using credit cards?
Ways to build credit
Put utility and cell phone bills in your name. Many major utility companies
and cell phone providers report payment behavior to the credit agencies. Some, however, only report negative information. Find out what data your provider reports.
Get an auto loan or a small personal loan from your bank. This is called an installment account, and the reporting agencies like to see that you can handle one responsibly. If your credit isn’t good enough to get this type of loan, visit a local credit union and ask about a secured loan – a loan that is made against your existing assets.
Learn to use a credit card responsibly. One great strategy is to choose one expense to charge each month (like gas for your car, for example) and pay off the balance every time you get the bill. If your credit isn’t good enough to obtain an unsecured major credit card, try for a gas card or department store card. Again, pay the balance off completely every month.
Although the credit reporting agencies currently do not accept any data on prepaid credit cards. one card, Eufora, has developed an ingenious way to report payment behavior and help its customers build credit. Eufora structures its $99 annual fee as an installment loan. The card holder then makes payments each month toward the loan balance. All other activity on the card is similar to that of any other prepaid card (you can only charge as much as you’ve loaded on the card). One Eufora customer reported that with no activity on her credit history other than obtaining a Eufora card, her credit score jumped from 640 to 787 in less than one year.
Other factors to consider
Lenders look at more than just your credit score when they evaluate your credit worthiness. Many, especially mortgage lenders, look for stable employment and housing. Short stints at multiple jobs, and too many address changes in a two-year time frame make you look more risky. Also, maintain checking and savings accounts in good standing and with some cash reserves.
Lawmakers have introduced bills that would require utility and phone providers to report on-time payments, and some companies in the financial sector are pushing for debit card and prepaid card use to be reported. Until then, practice good financial habits, like setting up automatic payments so as to never be late, and avoiding collections at all costs.