Building Credit From Scratch: Tools, Trade-offs and Habits

Is a credit card the only way to build credit? It is not. A credit history is made of information reported to the credit reporting companies, and a handful of tools are designed for people who have little or none. Each has trade-offs, and the habits behind the account tend to matter more than the product.

Key takeaways

• Credit scores are built from the information in credit reports, so an account helps only if its activity is reported to the credit reporting companies.
• Secured cards and credit-builder loans are designed for people with little or no credit history, and the CFPB advises asking each lender whether it reports.
• Debit cards, cash and prepaid cards do not show that you can repay debt and generally do not help build a credit history.
• The CFPB calls payment history the number one factor in most credit scores and says experts advise using no more than 30 percent of your credit limit.
• A hypothetical 500 dollar limit would mean keeping balances at or below about 150 dollars at the time they are reported.

What a credit history is

The Consumer Financial Protection Bureau describes a credit report as a statement about your credit activity and current credit situation. A credit score predicts how likely you are to pay back a loan on time. Many scores exist, and they can differ by scoring model, data source and date. The common thread is that scores come from reported information, so an account helps only if its activity is reported.

Tools designed for a thin credit file

The CFPB describes several options in its materials on building credit from scratch:

• A secured credit card. You make a deposit, the bank holds it and extends a credit line matching it. The CFPB says you can generally build credit this way, but advises asking the issuer about reporting to the credit reporting companies. Some include a path to move to a regular card after a pattern of consistent payments.
• A credit-builder loan. An institution, often a credit union, places the loan amount in a locked savings account. You repay in small payments over months, and the payments are reported. At the end, you receive the accumulated money.
• A retail store card. These tend to be easier to obtain and usually come with lower credit lines, which makes them an option for a thin record.

Some people also ask a family member to add them to an existing card account. Whether and how that is reported varies, so the issuer is the one to ask.

What generally does not help

The CFPB notes that some everyday money tools do not build a credit history. Debit cards and cash do not show that you can repay debt, and prepaid cards do not establish credit. On-time payments on payday loans are not reported, and some buy-here-pay-here auto dealers report only negative information, such as late payments.

Habits that matter

According to the CFPB, most credit scores treat repayment history as the number one factor. A few related points:

• Pay on time. Autopay or reminders can help avoid missed due dates.
• Keep use low. Experts advise using no more than 30 percent of your total credit limit. On a hypothetical $500 limit, that is about $150.
• No need to carry a balance. Paying cards in full each month can also reduce interest costs.
• Go slowly. Opening many accounts in a short time can lower scores, and closing a card can raise the share of your limit you are using.
• Check your reports. You can request reports from each nationwide credit reporting company at no charge at annualcreditreport.com, and the CFPB encourages disputing errors.

Some cards also carry fees or rewards. For someone whose goal is a credit history, one question is whether any reward outweighs the fees, and whether a balance would ever be carried, since interest on a carried balance can be larger than the value of a reward.

Questions to ask before opening an account

1. Does the lender report my payments to the credit reporting companies?
2. What are the fees and the interest rate?
3. Is there a path from this account to a regular one?
4. Can my budget pay it in full and on time every month?
5. How will I check my reports and scores over time?

None of these steps guarantees a particular score or approval. They are building blocks, and results depend on the individual record and the scoring model.

Common questions

Do I need a credit card to build credit?

No. The Consumer Financial Protection Bureau describes other tools too, such as credit-builder loans, where payments are reported while the money is held for you. What matters is that on-time payment activity reaches the credit reporting companies.

Does carrying a balance help my credit score?

The CFPB says you do not need to carry a balance to build good credit. Paying cards in full each month can also reduce interest costs.

Will closing an old card hurt my score?

It can, in one way. The CFPB notes that closing cards can raise the share of your total limit that you are using, which could lower your score.

NIFE provides general financial education. LendsightAI and Debt Done Date are separate for-profit partners; optional services may have a fee.