Establishing healthy credit in the U.S. is crucial, as your credit score is an important part of many lending decisions in your life.
From renting to owning a house, buying a car, to even simply opening up a credit card, a credit score is a vital part of finances in the United States.
Building credit and maintaining healthy credit habits is the key to a successful financial future. With that said, here is our simple guide to establishing credit in the U.S.; designed for anyone just entering into the world of credit in the U.S.
How the U.S. credit system works
Even if you have had a positive credit history in other countries, in the United States your credit score is effectively zero. Most scores and credit histories do not cross borders, and every country has its own rules to follow.
The good news is that the purpose of a credit report and credit history is always the same. The credit system in the U.S. is designed to help creditors analyze your ability to responsibly manage and pay back anything they lend you.
If you are new to the world of credit, it helps to understand how credit works. To put it very simply, lenders make decisions about you based on your credit score. Your credit score is a sign of how worthy you are to lenders. A high score indicates you are responsible with credit, and will likely pay back your loan.
A low score indicates you have had trouble being responsible in the past, and may be more of a risk with any money you are lent. It may also be a sign that you simply don’t have enough credit history in your name.
Lenders find your credit scores on your credit reports, which are a compilation of many important financial behaviors such as:
Types of credit
Length of credit history
These factors combine to create your credit score, typically between the range of 350 -800.
In general, a score of about 700-720 or more is a good, strong credit score. It qualifies you for the best rates and the most ideal terms. Any lower than this, and you may get less than favorable terms and higher interest rates.
How are credit scores created?
Creating a credit score takes a few steps. First, you make a payment towards a line of credit or other reported account. Then the lender sends this information to the credit bureaus. The credit bureaus then compile this information on your credit report. Once there is enough data on your file to generate a score, the bureaus will create your credit score.
Before you can think about building your credit, you will need to set yourself up for success first. There are a few steps to setting up a financial identity for yourself, including:
Obtaining an ID number such as an SSN or ITIN
Opening a bank account
Generating provable income
Additionally, in most cases you will need to be over the age of 18 to open up any line of credit.
Applying for an SSN or ITIN
When applying for any type of credit, it is very likely the lender will ask for your social security number (SSN) or individual taxpayer identification number (ITIN). It is the easiest way to check your personal history, as each person has a unique number only for them.
If you were born in the U.S., you will automatically have a social security number. If you are new to the U.S. and are not authorized to work, you may not be eligible for a SSN. You may be able to get an ITIN however, which may allow you to apply for a credit card without using an SSN.
Opening a bank account
In order to apply for a line of credit, you will need a way to pay for it. This usually means opening a checking or savings account in your name, as lenders may want to check your bank to see you have enough cash flow to pay for their loan.
Opening a bank account has its own requirements, and you will typically be asked for:
Date of birth
ITIN or SSN
In some cases if you do not have an ITIN yet, the financial institution may allow you to use a passport number or other government-issued ID card. Keep in mind, though, that this does not necessarily mean that you will be eligible for credit.
Generate provable income
When you are new to the world of credit, lenders will tend to immediately see you as a risk. This is because you have no credit history, so lenders have no way to asses how responsible you are with money – and therefore how likely you are to pay back what they lend.
Because of this, it is very common for lenders to ask you to prove your income. They will likely ask your annual income. They may want to see bank statements, pay stubs, or other verifiable sources of income which prove you can pay back the money they lend.
Lenders will also use this information to determine how much credit you can take on, as well as your interest rate.
It is important to be honest about your income here. It does not help anyone to lie about what you make, and in fact it is against the law to lie on a credit application.
Building credit in the United States
So now that your account is set up and you have some positive cashflow coming in, it is time to start looking for ways to build your credit.
Keep in mind that as a new account, lenders will see you as a credit risk. This means there may not be as many options open to you as there would be for a person who has a long history of excellent credit. With that said, there are a number of ways you can start building credit to reach your financial goals.
Secured credit cards
Secured credit cards are a great way to start building credit, as they teach you the basics of credit cards while also helping you create a positive credit history.
A secured credit card is like a reverse credit card. Instead of getting a card with a set credit limit which you then use to buy things, you first provide the money up front, and then essentially borrow against that collateral with your card.
Most cards start out at about 200 or 300 dollars. So you would give this money to the creditor, and they would give you a credit card with a limit for this amount. You then use the card in the same way as any other credit card.
The best way to use these cards may be to make small purchases and then pay them off immediately. Doing so helps show you are responsible with credit, and will start building a positive credit history in your name.
Make sure that the credit card issuer will be reporting payments to the credit bureaus, or these cards may not help your credit at all.
Credit builder loans
Credit builder loans are designed to do just that – help you build credit. They are not great for people who need money in a hurry, but they are ideal for people who are just starting out and want to build a positive credit score.
Unlike a traditional loan which gives you a lump of money at the start which you then pay back, credit builder loans work in reverse. You make a series of monthly payments until you reach the agreed amount and “pay off” the loan. Then you get the money.
Credit unions or other financial institutions generally offer credit builder loans in small amounts, from around $500 to $3500. Completing one of these loans may open up new options and higher loan limits.
Interest rates on credit builder loans tend to be low as well. However, before applying for one of these loans, be sure that the financial institution reports their payments to the credit bureaus, as this is the only way the loan will help you build credit.
Have your rent reported
In some cases, if you rent a home, it may be possible to get those rent payments reported to the credit bureaus and therefore added to your credit score. Positive rent history helps build an overall positive credit history, and can have a positive impact on your credit score along with other habits.
Keep in mind that a landlord is not required to report these rent payments. This may be something you want to discuss with a landlord before moving in to a new apartment. There are also some online services which will accept rent and report it to the bureaus. They typically charge a small fee, and again, the landlord would have to agree to use these services.
Become an authorized user
In some cases, it is also possible to become an authorized user on a person’s credit card.
This means that the reports the company sends each month would affect both your credit score and the primary account holder’s score. It is important this is a close friend, family member, or someone else who trusts you, because while this means that helpful marks will impact both off your scores, it also means that negative marks will affect both of your scores.
However, make sure that the credit company or financial institution which issues the card reports data for all users, as they do not have to report data for authorized users if they do not want to.
With your first steps towards your financial future complete, you are ready for the next step.
And the next step is – patience. It takes at least 6 months of reporting to build any kind of credit history. Additionally, even after 6 months, it can take even longer to establish a healthy credit score or get your credit score where you want it to be.
Once you start to build up your credit scores, check back for new offers and credit options. More credit and lending options tend to begin opening up as you build up your score, and these options could open up better terms, bigger limits, and better loan offers.
Responsibly handling your first steps as you establish credit in the U.S. sets you up for success as you move forward. Now that your credit is established, you are ready to head into the broader world of credit and finance.