The other day a friend of mine was expressing his spiel on the importance of avoiding debt, and how easy it is to fall into the American cycle of debt.
It is a pretty commonly accepted fact that most American citizens are in debt some how some way. Whether it be credit cards, a car note, mortgage, or the most prevalent in every millennial’s story: student loans. Another commonly accepted idea, is that making the payments for your debt on time will lead you to good credit. And while yes that is certainly 100% true, it is also not the only way to have good credit. Being in debt is a hassle, and the misconception we have been fed pretty much all our lives is that if you do your due diligence with your debt, you are on the fast track building your credit. That is the trade off right? But what about if you want to build your credit without being in enormous amounts of debt?
Let’s walk through the concept and various ways of building your credit without taking on the burdens that come along with debt.
Do Student Loans Build Credit ?
There are so many financial myths and false information at every turn on the internet it is easy to get lost. Lets debunk all the nonsense from jump. The first question I am going to address, is do student loans build credit ? The simple straight forward answer to that is: NO. Having student loans does not automatically guarantee that you will have good credit, or that you are some how “building” your credit. If you’re confused let me break it down for you so we can be on the same page.
On my credit report, my student loans are marked off as my first line of credit dating back to 2006, my first year in college. Each loan I took is marked off as a different line of credit that has been opened. So on my report it would appear that I have had credit since 2006. From 2006 to 2010 these loans sat on my credit report as open installment loans, and not as revolving credit (which is what credit card debt is categorized as). It wasn’t until I started making payments that I understood what having student loans did for my credit, and what it could potentially do.
When I graduated from college, I had a large amount of student loans, and a low income. When I looked into getting a mortgage (I was clearly bugging at the time) I wasn’t approved because even though I essentially “was building my credit” since 2006, I didn’t have many monthly on time payments under my belt, and I had a very high debt to income ratio.
Here’s what you need to know in order for your student loans to truly build your credit in a positive way.
- You need to make all of your payments on time (100% of the time). Even one late payment can severely hurt your credit score.
- Either pay off large amounts of the interest, or make more money. (Easier said than done I know). But the longer you have a high debt to income ratio, the harder it will be for your “good credit” to work its advantages in your favor.
- Avoid landing in default. Your loans go in default when you just stop paying. Instead try and work a deal out with your loan provider before your credit takes a huge hit. Look into possible forbearance or deferment as options as well.
5 Ways To Build Credit Without Taking On Debt
Many people get stuck with the idea that having good credit is based on paying everything on time, and never having late payments. Which means they That is just one piece of the pie. According to Forbes, in order for you to have good credit you have to keep in mind the following variables :
- 35%: Paying bills on time
- 30%: How much debt do you have? And what is your utilization?
- 15%: How long have you had credit?
- 10%: How many different types of credit do you have?
- 10%: Have you applied for a lot of new credit recently?
1. Get A Credit Card: I know it may come as a surprise… but, you don’t need to be in debt or carry large balances when you have a credit card. Having a credit card that you handle responsibility is a great way to hit many points on the credit building structure. By paying your credit card statement in full every month, you are hitting 65% of the credit variables. I pay most of my monthly bills with my credit card, and pay off the balance in full every month. That way I’m showing the credit bureau that I can handle credit responsibly.
2. Secured Credit Card: This is similar to a pre-paid credit card that you would get through a bank. The bank will be responsible for reporting your responsible use of the credit card, which makes it different than getting a regular pre-paid credit card from your local drug store. When you open up a secured credit card, you put down a “deposit” which then becomes your credit limit. So if you go into a Chase, Citibank or Capital one and put down 1,000 dollars you can charge up to 1,000 dollars. The key to building credit with a secured credit card is to actually use it and use it responsibly. Pay off the bill every month in its entirety to keep the amount of debt created/used low.
3. Credit Builder Loans: A credit builder loan is not your regular run of the mill loan. You actually do not get the loan money, until after you have paid off the loan. How this works, is you borrow a certain amount and make your regular monthly payments as you would on a regular loan. However the amount you have borrowed is put into a “savings account” of sorts by the bank, and is only released to you after you have paid off the entire amount. These are a little harder to come by than getting a secured credit card, but they are definitely helpful in building your credit. Most credit unions (if you are not a part of a credit union I suggest you find your way into one) offer the opportunity to take a credit builder loan.
4. Pay All Of Your Debts On Time: I know this should go without saying, but don’t go out and make new debt for yourself, especially if you have old debt you have to take care of. When I became strapped down by my student loans, I was determined not to have any other forms of major debt so I could focus on paying my student loans down as soon as possible. It is unwise of you to have debt that you are putting off, and going to get more debt to add to the problem. Not only will this ruin your debt to income ratio, but it will also impact your credit score negatively. Take care of your current debt first to see an increase in your credit score.
5. Become An Authorized User: If you can not get approved for a credit card, and don’t want to go the secured credit card route, you can become an authorized user on someone else’s account. You do not have any real say on the account (you can’t raise the credit limit or anything) and you are not responsible for the payments. (though you really should not be charging things and not paying for them). This will help build your line of credit, as long as the line you are an authorized user for is paid on time and in good standing. Most parents/guardians put their children on their accounts as authorized dealers with limits or restrictions. Chase is pretty well known for this type of account, and may be something you look into with someone who will trust you on their account.
So there ya have it! 5 methods you can use to secure the bag and build up that credit. And if you need some more motivation or information watch my detailed explanation of how I paid off 85,000 in student loans in four years! Click my smiley smiley picture below!
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Hey there! I’m Melissa, co-founder of Trials n Tresses, natural hair and beauty lover, binge tv watcher and lover of life. When I am not creating content for TNT, I’m busy teaching the future of society.