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USA Real Estate Blog

The Two Things I Did to Build Credit From Scratch – Pete Aragones – Medium

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Oftentimes, people are either unaware of how important credit is in an increasingly cashless society, or they don’t know where to start in the credit building process. It may be a generational distinction, but older generations tend to look down on paying with credit as it meant you didn’t have the cash to pay for it upfront. I was never taught in school the value nor the process of having and using credit, so I was more or less in that boat as well. Out of ignorance, I even graduated from college with no credit card and no credit history.

One year ago I didn’t have a credit score. Today I have near excellent credit.

Here’s how I did it:

1 — I Opened a Secured Credit Line

There are four main types of credit cards: Rewards, Low Interest, Balance Transfers, and Secured. For the purposes of building credit from scratch, I’m only going to focus on Secured credit lines.

Secured Credit Lines vs Unsecured Credit Lines

Secured credit lines differ from unsecured credit lines in that secured lines, the borrower (read: you) provide the lender (read: credit card provider) an asset (read: your money) — in this case usually $100-$1000 — as collateral (read: hostage) to secure the loan/ line of credit. This serves to mitigate risk and provide security to the lender in case of a default by giving said lender a lien to your collateral, thus allowing them to seize your collateral. It’s almost like Venmo’ing your friend money for dinner after agreeing to split the bill. First, your friend pays the bill upfront (Credit Line minus your portion of the bill.) The agreed upon collateral is your friendship. If you fail to pay your friend back you become a bad friend, default on your collateral, and he is allowed to terminate the friendship. Your friend, thus hedges his hope that the weight of the friendship will remind you pay back the bill. In an unsecured credit line, the only difference is that the credit card provider will grant you a credit line without requiring collateral. To use the example above, it’s almost like your friend paying the bill for your newly acquainted significant other and sending the venmo request the next day. The credit provider, like your friend, trusts your significant other to venmo back the balance due.

After that, however, both types of credit lines are the same (with some secured cards able to transition to unsecured lines after a specified amount of time.) They both report usage to the three major reporting bureaus. They can be used for various purchases on and offline. But bottom line, they both grow (and can also hurt) credit.

But why a secured card?

If you are building credit from scratch, oftentimes, you won’t be able to receive loans and if you manage to get an unsecured card, it will most likely be sub-prime. Sub-prime cards will trade a credit limit in return for high annual fees (which charge outside of the credit limit), non-refundable fees (unlike secured, which will refund collateral if you transition to unsecured), and high APRs (annual percentage rates.)

Annual percentage rates are the interest rates you will pay for borrowing money, and while it may say annual, the rate will be applied to each monthly statement for the outstanding amount. Say you have a credit line of $100 and your APR is 25%. If you carried over a balance of $10, the price on your statement would read $12.50. That interest is how credit card providers make a bulk of their profit, so you better believe that they hope that you always carry over a balance. But as both secured and unsecured sub-prime cards are usually bundled with high APR rates, the only difference is that since you provide collateral for the card, so psychologically you’re not borrowing money. Furthermore, since your collateral is probably going to be under $1000 and it is refundable until you close your account, it will be a reminder to keep your payments on time. For me at least, it kept me cognizant on maintaining healthy spending habits and focus on building my credit. So, a secured card has inherent features that allow a person to safely build their credit.

Automated spending

After being approved for a secured card, the first thing I did was to automate my monthly payments (spotify, netflix, nyt, etc) and this served multiple purposes. First, it ensured that I would have a constant stream of payment history and utilization, which is important to the bureaus. Second, since the balance was defaulted to pay in full each month, it allowed me to forget that I had the card. It also ensured that I would never miss a payment (which is a NO NO in general.) This was beneficial to me, because with a low credit limit (I only gave $100 as collateral) any balance carried over would be reported as a high utilization rate. Think about it like this:

Spotify: $10

Netflix: $10

NYT: $20

Credit Limit: ($100–$40=$60); = 40% utilization

Utilization

A quick browse around the internet suggests that a 30% utilization rate on an account is the max you want to get to. For me, though, I preferred to pay in full. My thought process was, why do I want to ever pay interest? This is still a guiding principle for me even now with established credit.

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When framed like this, the process of starting your credit history isn’t that hard, is it?

2- I Paid Down My Gym Membership

This one in itself is something that I didn’t consciously do to build my credit. I always had a gym membership, but what I didn’t know was that it was a membership plan paid on an installment system. And since this payment plan was automated as well, I didn’t realize that it got reported to the bureaus. Due to my diligence in wanting to build bodily gains, unbeknownst to me my credit was experiencing gains on its own.

Now I know a lot of gyms and payment plans don’t get reported to the bureaus so practice some healthy credit practices and check your history at free credit reports like creditkarma. Also if you don’t get lucky and have a gym that reports your payment history, look for and apply for some credit builder loans, which would simulate what I did. *disclaimer* I have no history of using these loans, so don’t take my word for truth.

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And that’s all I did, but remember this isn’t an overnight thing, it’s the long game. Good luck, friends.

May the reporting bureaus ever be on your side!

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