You need to have an established a line of credit for any number of needs: getting a cell phone in some cases, or getting a house if you choose to do so in the future.
But, with many millennials apprehensive about signing up for a credit card in the first place, or using one at all, building that credit can be tough. Most lenders will want to see that you have an established credit history before issuing an account, says Derek Brainard, a financial literacy coordinator at Syracuse University.
The catch is obviously that if you can't get a line of credit in the first place, there's no way to establish that history.
But that doesn't mean you're totally out of luck. "If you already have student loans or other types of consumer loans, you may already have an established credit history," Brainard says. "The quickest way to check is to pull your credit report from AnnualCreditReport.com."
Next, if you feel ready to push forward on signing up for a credit card specifically, he advises that you ask yourself a few questions first. Doing so will make it easier for lenders to trust you, but also give you an idea about how well you'll fare — and how reliant you might become — on debt.
1. Does my income support reliably paying my credit balance off, in full, each month?
2. Can I commit to making monthly payments on time?
3. Will I be able to avoid using a high percentage of my available limit at any given time?
4. Do I have a savings fund in place so that I can avoid turning to credit in case of emergencies?
5. Am I disciplined enough with my monthly spending that using a card will not cause me to overspend?
"If the answer to all five of these questions is yes, you may be in a stable enough place to start," Brainard says.
If things are a little shaky, you can still looking into other options.
What resources are available to people without credit card histories?
People who lack a substantial credit history, or need a bit of a buffer, have a few options to independently building credit.
"Secured credit cards, store cards, and cosigning are all completely viable ways to establish and improve a credit score," says Julie Pukas, the head of U.S. bankcard and merchant services at TD Bank. "The most important thing is to do extensive research on all your options and consult with a bank representative for advice."
Secured Credit Card
With a secured card, your own money serves as collateral for the card, by putting down a deposit with the bank, which typically becomes your credit limit, Pukas explains.
For example, Brainard says it works like this: You deposit $1,000 and the lender grants you a $1,000 line of credit using your deposited money as collateral in case you miss payments. After you show that you can responsibly use a secured card for a while, you can request to open an unsecured line of credit and then close the secured account to get your deposit back.
"Credit takes time to establish and build, so you may end up using this approach for six months to a year before your credit is established enough to qualify for a regular credit account," he adds.
Store Credit Card
Unsecured credit card might be unavailable in the short-term, but people with low credit scores can often still get approved for store cards.
"Banks are typically more likely to approve store card applicants who apply directly through the store. The catch with store cards is that the interest rates are often higher than a normal card, which will become expensive if you can't pay off the balance each month," Pukas says.
Plus, store credit cards can come with a host of other potentially debilitating fees. Proceed with caution, and with your eyes open if you go that route.
If you are unable to get a credit card because don't have the strongest history, or any history at all, you might find that a partner or relative is willing to cosign one with you, or open up a card for you. That is not a decision to enter into lightly.
"If your parent has good credit, cosigning on your first card with them is a quicker way to access loans or cards that you wouldn’t be able to get right away on your own," Brainard says. "There are a few layers of risk to be aware of as well, like the fact that financial misbehavior by either party will be reflected in both of your scores. The social risk is that card misuse can cause strain to your relationships over the long-term," he adds. "All risks should be weighed carefully before cosigning on any debt or credit accounts."
To have an effective cosigning relationship, the following areas need to be covered:
1. Talk about the terms of usage.
The person who cosigns a card will be on the hook for anything that happens, even if they aren't the person running up debt. Have a discussion about the way the card should be used in advance, with clear parameters. "Cosigning can certainly help build credit for a new user, but if utilized improperly, it can just as easily bring down the cosigner's credit score," Brainard says. "Always proceed with caution when cosigning because you may be risking your credit score, in addition to your relationship with that person."
2. Get involved.
"Both parties must ensure that the bill is being paid on time and preferably in full every month," Brainard says. "Lenders will see any debt on the account as the account holder's debt. It's important to diligently monitor the account and monthly bills to ensure that any debts — even if they aren't incurred by the cosigner — are being paid off."
3. Share the info.
An easy way to ensure that both parties can monitor a cosigned account is by making all documents related to the account accessible. "If you want to establish credit by becoming an authorized user on someone else’s account, just make sure to ask the credit issuer for that account if they report authorized user activity to the credit bureaus," Brainard says.
How do you know when you've established good-enough credit?
There isn't a set number that determines when you're ready for better or more credit. What does matter is your history, and proving your responsibility with all of the card payments you have made.
For example, Pukas says, after you've met the terms of accountability with a secured card, your deposit will be refunded and you can upgrade to a regular credit card. In the case of her bank, "TD has a proactive graduation policy that is designed to reward responsible credit behavior and upgrade our secured card customers into the TD Cash credit card in a timely manner, which then allows card holders to earn rewards for their spending."
Instead of making your bank responsible for tracking your progress, she and Brainard both say it's important to monitor your credit score and credit history with all credit cards, including store cards and cosigned cards. Some credit cards offer a VantageScore or FICO score on monthly statements, Pukas says, but going the official route with a full credit report is a great way of seeing where you are.
"The best way to keep tabs on your credit and debt activity is to pull your free credit report from AnnualCreditReport.com every few months. The three credit reporting agencies are Equifax, TransUnion, and Experian, and they each provide you one free report a year through this site," Brainard says, so you should be able to check your statements each quarter. "It's important to monitor your report throughout the year to see how you're progressing, and to check for suspicious account activity."
(FYI, monitoring your report is even more important now, in the wake of the Equifax hack.)
"After you develop a proven track record of paying on time and managing your accounts responsibly," Brainard says, "call your credit issuer and ask what they can do for you in terms of lowering your APR (annual percentage rate), reducing or waiving annual fees, or increasing benefits."
What cards are NOT good options for building credit?
Trick question, says Brainard. "The worst kind of credit card is the kind you are not ready to responsibly use, regardless of the terms. All of the airline miles in the world won't bail you out of excessive credit card debt."
In general, credit cards aren't the problem; how they are used (or regulated) is. Pukas offers the following guidelines to help keep your credit score strong:
1. Keep your utilization rate low.
"Your goal should be to never let your spending exceed 30% of your credit limit," she says. "The lower your utilization rate" — how much of your credit line you use up — "the better your score will be."
2. Pay in full, and on time, each month.
"Prove you're responsible by only charging what you can afford," she adds. Despite misinformation, there is no advantage to only paying the minimum amount due on your card. "That will only result in you paying interest and does not help your credit score. So only charge what you can afford to pay off at the end of each billing cycle."
3. Use the card for needs, not wants.
"When you're still building credit, be judicious in spending and do not make purchases that you cannot pay off each month. Think of it as a loan to yourself and pay it back as soon as possible to avoid interest charges."