How to Build Credit When You’re Just Starting Out
The American dream is a little bit different for everyone, but most people include homeownership as part of it. For those without established credit history, securing a Home Mortgage Loan can seem like a daunting task. They tell you the only way to build credit is to get a loan and make regular payments on time, but how do you secure a loan with no credit? The whole thing seems cyclical, with no place to enter, and is enough to drive a person mad.
We are here to tell you that it does not have to be this way. There exist non-traditional paths to building credit, and buying your first home is attainable.
There exist non-traditional paths to building credit, and buying your first home is attainable.
The Conventional Method of Building Credit
Traditional credit is often based on loans, debt financing, income level, and timeliness of payments to accounts that report to credit bureaus. These bureaus then use a formula to create a credit score, which ultimately rates how risky it is for lenders to give you a loan or a line of credit.
You could start building credit with a credit card, but individuals without a credit history will have a hard time securing one without someone to co-sign, in which someone essentially lends their own credit they’ve built up to you. If you don’t pay off the debt you build up on your card on time, your co-signer will be on the hook for the money you owe and their own credit score will be negatively affected. If you don’t have anyone able or willing to co-sign for you, or to add you as an authorized user on a credit card of their own, building credit with a credit card may not be an option for you.
Don’t worry; you aren’t alone. The traditional way of building credit doesn’t work for approximately 45 million Americans.
[Five Tips for First Time Homebuyers]
Falling Outside the System
Individuals who fall outside the traditional path to building credit are broken down into two categories:
- Credit Invisibles: An estimated 26 million individuals or about one in every ten adults does not have any credit history or applicable data with one of the three nationwide credit reporting companies.
- Credit Unscorables: Another 19 million are known to credit bureaus, but their credit history wasn’t enough to ascertain current credit standing due to the data being stale or just insufficient.
If you fall into one of these categories, your focus should be on building your credit profile through non-traditional means.
Establishing Non-Traditional Credit
The FHA requires lenders to not deny you a loan if you fall into the credit invisible or unscorable categories. What they must instead do is build an alternative credit profile of you based on demonstrated regularity of payments in many potential ways. The following methods can help build your non-traditional credit profile and strengthen your application for securing a home mortgage loan:
Automobile Insurance Payments
Whenever possible, choose to pay your car insurance on a monthly basis. If you pay your car insurance annually, it likely is not counting towards your credit score. Paying every six months or quarterly will sometimes count, but paying in monthly installments is very likely to contribute to your non-traditional profile. It demonstrates that you both have regular income coming in, and you are able to manage your finances on an ongoing basis.
Monthly car payments are also going to count, provided that they’re reported. For this reason, buying a used car from a dealer instead of an individual seller, is of greater benefit to you. However, make sure to ask the dealer if they report monthly payment information to credit bureaus. If they’re not, try to negotiate that into the deal for your car. It’s a customer benefit they can offer that costs them very little but can help you immensely.
Rental Housing Payments
Payments you make to a management company or landlord might work to your advantage, but only if the landlord actually reports them. Inquire with them to see if they do. If they don’t, ask them if they will start. Keep in mind that reporting such information might cost them a token expense that doesn’t really benefit them directly, so they may say no. However, this is something to keep in mind when looking at moving to a new rental property, if that is in the stars before you go on to purchase your first home.
You’d probably rather be paying homeowner’s insurance, and that day will come. For now, you need to protect yourself and your personal possessions in the home you’re renting. It’s probably already mandatory as part of your current lease, so you might as well look at these payments as something that can help you end your renting days. Many larger insurance companies will report these payments to credit bureaus, so keep this in mind when shopping for renter’s insurance.
Any utilities you pay for can also help you, but only if you’re paying it separately from your rent. Anything included with your lease or bundled in with another payment won’t help you, but monthly utility payments paid in full and made on time can also help establish a reliable credit profile. Bills for cable or satellite TV, internet, electric and gas, garbage collection, or water all count so make sure to make your payments on time every month.
Cell Phone Plans
If your wireless plan is in your name and your carrier reports payments to the credit bureaus this can also help build you a strong credit profile. If you are still on a parent or family member’s plan, it may be time to consider going off on your own plan if you can handle the monthly payments.
Leaving your little ones in the care of others might be something you hate, and the expense involved might be one of the worst parts of your budget. Then again, those payments might just open the door to the new or new-to-you home they wind up growing up in. However, make sure to collect and save invoices and receipts as it is likely that many child care providers are not reporting this information.
If this is a routine monthly bill for you, then it can be one of your three or more non-traditional tradeline pillars. However, that’s only if it’s out-of-pocket. Payroll deductions for an employer-sponsored benefit won’t count.
Medical debt usually shouldn’t count against you in building a credit profile of the non-traditional kind. Any payment plans you stick with consistently can build good credit, so if your provider offers a payment plan for major medical expenses take advantage of them.
If you pay monthly premiums for your medical insurance out of pocket, then you can build a profile with them. As with life insurance, however, payroll deductions don’t count.
Store Credit Card Payments
While a major credit card may not be obtainable for you at the moment, store-specific credit cards may. While store cards don’t build credit as effectively as major credit cards do, the qualifications for obtaining them are typically much lower.
School tuition may help build your non-traditional credit profile if you make monthly payments on tuition. Paying annually or even semesterly often won’t cut it, though, so if monthly payment plans are an option at your institution opt for those.
A Word of Warning
If you do choose to pursue non-traditional credit as a means of building your history of credit, then you should know that there are still guidelines you need to follow that work a lot like conventional credit-building does. While specific rules might vary from one lender to the next, the following are common industry requirements for unconventional credit when applying for a mortgage:
- If two people are applying for a mortgage together, and one doesn’t have a credit score, that individual might need to prove two non-traditional tradelines.
- If one person applies for a mortgage without a credit history, they might need three non-traditional tradelines.
- Non-traditional tradelines are usually expected to go back at least 12 months.
- Some lenders require 24 months of non-traditional tradeline history.
- Missed payments or accounts more than 30 days behind can void progress in non-traditional reporting so make sure to make all monthly payments in full and on time. If you are going to miss a payment, contact the service provider ahead of time to discuss your options. Even if the provider is willing to give you extensions or defer collection, always ask how that option will be reported. You may have to talk to multiple vendors to make sure you are making the best decision for you right now and in the future.
[CRA Loan Officers: On Your Home Team]
When it comes to building credit so you can buy a home, we know there is a lot to consider. If you have questions about what’s required to be approved for a home mortgage, our experienced and local loan officers at Great Midwest Bank are ready to help.
We can answer your home financing questions and walk you through the application process, step by step, so you know exactly what to expect and what will be expected of you. Even if you aren’t ready to buy right now, we can help you create a plan to get there.
Get started by talking to a local loan officer or stopping by one of our convenient locations.