Credit Building

Credit Building refers to the process of raising an individual or firm's credit score and establishing a positive credit history. Banks and other lending institutions often prefer borrowers with higher credibility for offering loans, credit cards, and other debt products at favorable terms and interest rates.

Moreover, many landlords examine credit scores before renting out their property to ensure the non-defaulter background of the tenant. Some employers check the credit reports of the candidates as part of recruitment for certain roles that involve financial responsibilities. Hence, good credit habits, like paying bills timely and managing debt responsibly, foster overall financial stability and future opportunities.

• Credit building is a process of maintaining a positive credit history and having an ideal credit score to take up loans, credit cards, and other forms of debt at favorable terms and interest rates.
• Building credit is a consistent practice necessitating accountable financial behavior, like timely repayments, using credit wisely, and managing debts effectively.
• Lenders often favor a borrower with a long credit history and credit score above 700 to offer attractive loan terms and interest rates.
• Individuals with no credit history can begin building one through a secured credit card or credit-building loan.

Credit building involves creating a positive credit history, which is vital for an individual or organization's financial stability. A borrower's credit history is a record of all their previous loans, credit cards, and payment activities. The credit bureaus publish credit reports, the credit history of an individual or organization, on their websites based on the information they collect from the lenders. The lenders are required to report the borrowing information and payment behavior of each borrower to these bureaus.

Based on a borrower's credit report, a credit score is calculated by these bureaus. It is usually between 300 and 850 and represents the borrower's creditworthiness, i.e., their ability and efficiency to repay the borrowed money. A favorable credit score is the one above 700. To build credit, a borrower needs to use the funds responsibly. Even the shareholders and investors monitor the company's creditworthiness before investing to mitigate the risk.

People with limited or poor credit history can initiate with a secured credit card or a credit-builder loan. Thus, by making timely payments, they can demonstrate the ability to handle credit responsibly. Remember that lenders trust a more comprehensive credit history, as it exhibits a borrower's repayment capacity and credit managing efficiency over an extended period.

Mentioned below are some effective practices through which an individual or firm can gradually build a strong credit history:

1. Pay Bills on Time: A borrower's payment history is a significant factor in their credit score. Hence, paying credit card bills and loan installments regularly and timely helps to maintain a positive credit history.
2. Use Credit Responsibly: Borrowers should sensibly use and manage debts, not maxing out the credit limits to be recognized as low-risk borrowers for the lenders.
3. Diversify Credit: Having a mix of well-managed different credit types, including personal loans, credit cards and mortgages, can positively impact the credit score.
4. Monitor Credit Report: A borrower should regularly check their credit report for errors and address any discrepancies. Almost all major credit bureaus, including Equifax, Experian, and TransUnion, offer a free credit report annually.
5. Become an Authorized User: If a family member has a credit card with a good payment history, the individual can ask to be added as an authorized user of the same to establish a positive credit history.
6. Have a Secured Credit Card: Such credit cards demand a security deposit that becomes the borrower's credit limit. Using a secured card sensibly can facilitate building or rebuilding creditworthiness.
7. Don't Apply for Multiple Credit Accounts in a Short Period: Each time a borrower applies for credit, it leads to a minor negative impact on their credit score; hence, it is better to keep a sound gap between credit applications.
8. Create a Budget: Budgeting is critical to managing finances well by limiting the needs to what one can afford to avoid late payments and poor credit scores.
9. Negotiate with Creditors: If the borrower is in a bad financial state and struggling to make payments, the best way is to discuss the situation with the creditor to work out a modified payment plan, if possible.
10. Be Patient and Consistent: Building good credit takes time; therefore, consistent and responsible financial behavior can aid individuals and firms in improving their credit scores over time.
11. Limit Credit Utilization: Borrowers should use only some of their available credit since lenders prefer a credit utilization ratio of below 30%.

Let us now gauge some examples of building a positive credit history in a real-life scenario:

Example #1

Suppose Mary is a recent graduate who is keen on establishing good credit. She decides to open a credit card with a modest limit. She decides to have a secured credit card as a beginner. Carefully managing expenses, Mary consistently pays off the balance each month, laying the foundation for a positive credit history.

Next year, she decides to take a loan to improve her creditworthiness, as she has now secured a stable job and is in a position to pay off loan installments on time. She applies for a personal loan with her father as a co-signer with a strong credit history. Now, she has limited the use of her credit card to 25% of the available limit, as she earns well, which increased her credit limit by 10%. Also, she pays off the loan installments and credit card bills on time and secures a credit score of 720 in 3 years.

Example #2

Kenji Niwa, the CEO of Firstcard, faced challenges accessing financial products without a credit history upon moving to the U.S. in 2017. Founded in 2020, Firstcard is dedicated to assisting college students in building credit through a range of financial products.

• Recently securing $4.7 million in a seed round, Firstcard's total funding now stands at $7.7 million.
• The Credit Builder Card, launched this month, is focused on international and local college students, featuring no annual fees and no credit history requirements.
• Users can earn savings with an annual percentage yield (APY) between 1.25% and 4.25%.
• Firstcard offers a bank account for students with cashback benefits at selected local merchants.
• Plans include community-building, financial aid and student loans, and an AI-powered financial advisor tool.
• The company distinguishes itself from neobanks by providing higher benefits like cashback and APY.
• Monetization strategies encompass interchange fees, a $3 monthly subscription fee for Firstcard Plus users, and interest revenue from unsecured credit cards (yet to be launched).

Building credit without a credit history can be challenging, but it is not impossible. The following steps can help a beginner to secure a good credit score:

• Secured Credit Card: One can obtain a secured credit card that needs a collateral or cash deposit. It is advisable to use it wisely, making timely payments, to establish a positive credit history.
• Student Credit Card: For students below 25 years of age, getting a student credit card can be a good option since it charges lower interest rates and fees while providing various rewards like cashback and loyalty points.
• Credit Builder Loan: Many small financial institutions like credit unions offer credit builder loans. These are small loans where the borrower deposits funds in an account from where they can draw it as a loan. After the repayment of the loan, the borrower receives the deposited fund with a positive credit history reflected in their credit report.
• Authorized User: An authorized user is a person who shares another person’s credit card account, preferably someone they know very well, with a sound credit history and a good credit score.
• Alternative Data: Some credit scoring models consider alternative data, such as rent payments, utility bills, and even banking history. Some lenders or credit bureaus consider this information for assessing the creditworthiness of a first-time borrower.
• Find a Co-Signer: If an individual's parents, siblings, or close friends have an excellent credit score, they can convince them to become the co-signer while registering for a credit card or loan.

However, a first-time borrower should follow the strategies mentioned above, like paying loan installments on time and other best credit practices to maintain their creditworthiness since responsible financial behavior is critical to establishing a positive credit history.

This article has been a guide to what is Credit Building. We explain how to start building credit with no history, strategies, and examples. You may also find some useful articles here -

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