One of the effects of the Credit CARD Act of 2009 may be that it's going to get tougher for younger people to get credit. Depending on your point of view, this could either be wonderful or terrible news. I tend to see it as great news, because it'll be more difficult for younger adults to get deep into debt at an early age. Of course, I come at this with a biased viewpoint, having gotten into credit card debt in my early 20s and never really managing to get out until my late 30s, and then only because of a bankruptcy.
In any case, the question for a lot of younger people becomes, "How can I establish credit, if I can't easily get a credit card?"
Easy! You don't need a credit card.
This is a topic I touched on last month on WalletPop in a story on rebuilding credit ; establishing credit is the same deal. Yes, a credit card will show lenders you can handle a loan to buy a car, get a house or manage another credit card. But if you wanted to, you could establish good credit without ever carrying plastic in your wallet.
Here are the main ways you can fairly easily establish good credit:
Live your life, and pay your bills on time. If you're a college student or you're living with your parents -- whatever your situation -- and you have a checking account and have managed to pay your bills on time, you're creating a solid credit history. Down the road, if you want a car or a credit card, a lender may note the absence of credit cards, but if they can see you've had a job for awhile and have kept your name out of the hands of collection agencies, they're likely to see you as a solid citizen deserving of a loan.
A lot of whether you're perceived as a good credit risk depends, of course, on what your income level is and where you are in your life. If you're 45 and are just trying to establish credit for the first time, that may look a little odd to a lender, even if you actually have a perfectly reasonable explanation for your late start; if you're 22, though, a lender isn't going to expect as much from you.
Co-sign with someone who has a good credit. I don't love this idea, because I've seen this situation go awry for someone I know. But if it works out, it can be a good way to start establishing credit. And in many cases, you may not have a choice: The Credit CARD Act of 2009 requires anyone under 21 who wants a credit card and does not have a regular stream of income (think: job) to get a parent or guardian to co-sign for the card.
Here's my basic rule of thumb if you're a parent debating whether to to co-sign a loan: If you can afford to pay for whatever your son or daughter needs the money for, then go ahead and sign for it. For instance, if it's a card with a maximum balance of $500 and you'll be okay if they max it out in two weeks, then you should agree to be their co-signer. Why not? There's a huge difference, after all, between co-signing for a credit card with a $500 credit limit and co-signing for
a car. The aforementioned person I know (no, it wasn't me; I'm an open book ; I'd say it if it was) had his well-intentioned parents co-sign for a car loan and later a house, and things went pretty badly for all of them.
Having a parent co-sign for a loan is a perfectly acceptable way to get a lender to pay attention to you and create a good credit history. But if you're the co-signee, as in your parents are co-signing for you, be forewarned that if you blow a payment, you're hurting the co-signer's credit, even if you call the credit card company to explain that it was completely your fault and not theirs.
If you must, get a secured credit card. A secured card works like this: You give the credit card company a certain amount of money -- usually somewhere between $300 to $500, which is the limit you're allowed to spend on the card -- and then your plastic works like any conventional credit card. So let's say you give a card company $300 and buy something for $100. The minimum payment is (I'm just making up these numbers) $30, and that's what you pay. You'll then pay, say, 18% interest on the $70 that you still owe. But the $70 is really your money -- after all, they have $300 of your greenbacks already. And then there's the annual fee they charge, so after you give them $300, they immediately take $20 as a fee. If the secured card has a processing fee or an application fee, that's even more money they take from your own cash.
That annoys the heck out of me. But if giving the card company your money and being charged fees and interest doesn't bother you as long as it helps establish your credit, then a secured credit card is a perfectly reasonable approach. Just make sure you get a card with one low fee and as low of an interest rate as you can find.
And be sure to read the fine print before you sign up -- you want to make sure you know exactly what you're getting into before you sign your life away. That's one nice thing about the Credit CARD Act of 2009. CARD, in this case, stands for Card Accountability, Responsibility and Disclosure. The fine terms of all credit cards are supposed to be spelled out in plain English and at a type size where you don't need a magnifying glass to read them.
One last thing: Don't get prepaid cards confused with secured credit cards. Like secured credit cards, with a prepaid card, you put your own money down on the card, but interest doesn't accrue and there are no payments. Of course, that's the appeal for people who don't have a debit card and checking account; they feel safer carrying the card around than keeping cash in their wallet. But there are often hefty fees attached, and a common misconception is that prepaid cards will help build a credit score. They won't.
If you're reading all this and thinking that it's pretty hard to establish credit -- you're right. It's harder than ever. But that may be good news. For far too long, it was far too easy. Trust me on that.
Geoff Williams is a frequent contributor at WalletPop. He is also the co-author of the new book Living Well with Bad Credit (HCI Books).