Establishing Good Credit
May 06, 2013
Having spent numerous years educating and counseling service members, I have come to realize that a very large number of them have very little if any financial education. Especially now, in my present position, counseling service members who have no knowledge of establishing credit, is a daily occurrence. Regardless of the reason, these young adults never acquired this knowledge at home or while in school. For many of them, the military is their first regular paying job. They are expected to learn their new skill, be an outstanding service member, and, for the most part, live on their own. Living on your own comes with great changes and responsibility. Everything from feeding yourself, to showing up to work on time is now done without a lot of outside assistance. The days of mom and dad feeding you and making sure you are up and moving in the morning are over. There is no longer a parent or bus to take you to school every day. This is the foundation for the first large financial decision that most young service members must make; purchasing a vehicle.
For those of us who have established credit(good credit), purchasing a vehicle may seem like an easy task, however, for someone who has nothing more than a checking and savings account it is more difficult. With a good established credit score, you can walk into a bank or credit union and, in minutes, walk out with a pre-approved loan to purchase a vehicle. You can even take care of this over the phone. With no credit history, this is a different story. Forget about doing it over the phone. You can also forget about it only taking a few minutes. You are also not going to be offered as low of an interest rate. Without a history of credit, you will be expected to show proof of employment and some history of paying bills over consecutive months. The bank or credit union will use this information to fill out a scorecard which will help decide your interest rate. It is because of this scenario and others like it, we see the importance of establishing good credit as soon as you turn 18.
Establishing at least one savings and checking account should be the first step. Having done this, acquiring a secured credit card, could be your next step. Unlike prepaid cards, secured credit cards give you a credit line, and your payment activity will be reported to the major consumer reporting agencies. Getting a secured card is easy! Funds you deposit, usually $250 or more, are used as collateral by the bank or credit union for the credit card. You use the card like any credit card. This allows you to build or rebuild your credit history by making on time monthly payments to all of your creditors and by maintaining your balances under the credit limits. Over time, as you build your credit file, you can switch to a traditional credit card. Be certain to select a secured card that reports to all three of the main credit bureaus (Equifax, Experian and TransUnion), because not all cards do. When my son turned 18, he acquired a secured credit card and utilizes it, vice a debit card. Credit cards are safer against fraud and provide greater consumer protection on purchases. They also earn points that can be utilized to acquire gift cards or other items. However, the trick is to use the credit card like a debit card and pay it off as you make purchases, not letting the balance build. Paying in this manner requires you to be a little more proactive with your account, but you will not pay interest and you will always be on time.
After you have mastered the use of the credit card for a few months, continually paying off the balance, it is time to work on another line of credit. Again, using my 18 year old son as my example, after he showed he could use his credit card responsibly, he pursued a second line of credit. For this line of credit he went to a local credit union and obtained a secured loan. A secured loan is a loan that has collateral attached to it. This type of loan generally has a lower interest rate because the bank is taking a lower risk and it can collect the collateral if you default on payments. The process was fairly simple. He made a deposit of $400, which acts as the collateral, while the loan officer checked on his credit report. He then filled out the application for the secured loan in the amount of $300. Within a few minutes, the loan was approved, he had the $300 deposited into his savings account, then set up an automatic payment from his savings to pay off the loan over the next six months. By depositing the money into his savings account, part of the interest he will pay for the loan will be offset by the interest the money earns in his account. He was in the credit union about an hour and now has a second line of credit. The cost of the loan was 2.25% interest. Pennies for a good line of credit.
You now have two lines of credit and have been paying on your secure loan for four or five months, what is next? Your next line of credit may be another credit card or another secured loan. If your choice is a credit card, shop around. A second credit card may not need to be a secured card. This card, which we will only use for food purchases, can be an unsecured card with no annual fee, but still receives awards points. Due to the fact that you are only using the card for food, a limit of no more than $500 is the most practical. However, for credit reasons, you will want to keep your charges below $250. Having a credit card “maxed out” will hurt your credit score as well. Just remember to shop around. Don’t be afraid to get on the phone and talk yourself into a better deal.
It has been six months to a year since you first started to establish your credit. What have we done so far? We have established one, preferably two, savings accounts and one checking account. We have one secured credit card, one secured loan and one unsecured credit card. Now it is time to see what interest rate your bank or credit union will offer you for the purchase of a vehicle, which will give you a good idea of how your score is progressing. Keep in mind that all banks and credit unions have slightly different criteria you must meet in order to get their best rates. However, the bank or credit union should always be your first stop when purchasing a vehicle. You always want to have the bank or credit union pre-approval prior to walking into a dealership. Additionally, you want to avoid lenders that appear to target the military and/or primarily provide their services online.
At the time of this writing, it had been 9 months since my son turned 18 and his credit score was 761 from Equifax.
by David Blyar
Relief Services Assistant (RSA) for the Navy-Marine Corps Relief Society
Retired Master Gunnery Sergeant (USMC)
Command Financial Specialist