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The best way to build a credit score

About 52 million American adults don't have sufficient credit histories to generate a credit score.

By MSN Money Partner Apr 9, 2012 8:30AM

This post comes from Tim Sullivan at partner blog Get Rich Slowly.


Get Rich Slowly on MSN MoneyI recently had dinner with my friend and fellow 20-something, Gwynn. When the check came, I put down plastic; she put down cash. The following conversation followed:


Gwynn: Would it be easier to just take the cash and put it all on your card?


Image: Man paying with credit card (© UpperCut Images/UpperCut Images/Getty Images)Me: No, I'll just have him split it. I tend to do this awesome thing where I take the cash, thinking I'll get the miles, and then spend the cash on whatever. When the bill comes a month later, I'm wondering why I spent $50 on dinner for myself.


Gwynn: I just don't trust those things.


Me: Credit cards?

Gwynn: Yeah, never had one, never will.


Gwynn and I kept talking and not only has she never had a credit card, but:

  • The only school loan she took out was directly from her father.
  • She's never had a car payment.
  • She's never had a mortgage.

Do you know your score?
Gwynn has worked at the same nonprofit since graduating college and saves with every paycheck. When a big purchase comes up, whether it be a plane ticket or a vacation, she saves and pays out-of-pocket. For her lifestyle, it works great.


That said, after our conversation, I got curious about her credit score, and Gwynn said she had no idea what it was or really what a credit score is. According to the 2011 Consumer Financial Literacy Survey by the National Foundation for Credit Counseling, two in three adults haven't checked their credit score in the past 12 months, and one in three have no clue what their score is.


I've had a credit card for years now and find it helpful in pursuing my long-term goals, like buying a home. Although length of credit history is only 15% of a FICO credit score, I still consider my credit card as my No. 1 way of building solid credit, and perhaps more importantly, establishing good credit habits for the future.

Quick overview of credit scores

Let's review the anatomy of a FICO credit score. There are a few categories that determine your final number. All you Gwynns out there, lend a quick ear:

  • Payment history (35%).
  • Credit utilization, or how much of your credit you're using (30%).
  • Length of credit history (15%).
  • Recently issued credit (10%).
  • Types of credit used (10%).

A FICO score serves as a quick reference guide for lenders to determine the risk level for them to lend money. It's a number between 300 and 850, the higher the better. In short, a high score indicates less risk, therefore earning the borrower a lower interest rate and less overall cost.


By maintaining good credit from now until the purchase date of my home (whenever that may be), I will lower my monthly mortgage payment and end up saving myself thousands of dollars in the long run. (Post continues below.)

What are Gwynn's options?
Building a solid credit score with my card is working for me. I know my habits, like how I shouldn't take cash from friends at a restaurant to get the miles on my card.


But if Gwynn wants to start paying attention to her FICO score, what are her alternatives to credit cards? I called Gwynn and asked her if she had looked up her score with myFICO since we talked. She had, and found that she had no credit record at all, making her one of 22 million Americans who don't, says Craig Watts, public relations director at FICO. He says an additional 30 million have very thin files.


Gwynn says her cardless system is working for her now, but she still wants to build her credit. What are her options?

  • According to the FICO website, she can take out a small personal loan from her bank. She already has established a good relationship with her bank and should be able to get a small personal loan. When she pays it off quickly, her credit record will start to grow. However, this seems like debt for debt's sake. This isn't what I would choose in order to build my score from the ground up.
  • According to FICO, another solution is to get a secured credit card. A secured credit card involves putting down a given amount of money as collateral ($200 on the low end), and your line of credit is equal to the initial money down. Here's a great article that includes suggestions for specific cards with low annual fees.

A third option? Get a credit card and use it only for automated expenses. Yes, this option involves opening a credit card, but she could limit its use to a few automated payments. In about an hour, Gwynn could set up her card to automatically pay for her utilities, cable, and Netflix (or whatever else), and then automate a payment from her checking account to pay off her credit card in full. She'll get emails before transactions go through telling her everything is working like clockwork.


She can put her card in an ice cream carton filled with water and stick it in the freezer if she wants. She can give it to her father and say, "Never ever give this to me ever." She won't have access to the numbers, but will still be building credit.


An alternative to the credit card alternatives?
There is a philosophy growing in popularity that having no FICO score is just fine, that everything should be paid without using credit, including a house. There are also alternatives to standard loan approval, such as a bank doing manual underwriting. There are a few forums that discuss pros and cons, such as this one.

I can understand the philosophy that all purchases, including very large ones like houses and cars, should be made with cash. As with all things personal finance, you have to do what works for you, just as Gwynn does what works for her. I, on the other hand, like how credit cards are improving my creditworthiness.


What ways do you recommend for taking a credit score from zero to hero? Do you think of your credit score as a friend, a necessary evil, or something you can live without?


More on Get Rich Slowly and MSN Money:

Apr 9, 2012 4:26PM

Your Credit rating IS your slave rating. More and more people are catching on to this. The ONLY way to win the credit game, is NOT TO PLAY!


No Usury.

No fees.

No late payments and penalties.

No perpetual debt.

No foreclosure or reposessions.


If you have the cash, you can afford it. If you don't. You can't. Remember, that's how our grandparents lived..

Apr 22, 2012 6:18AM
I used to not have any credit at all. This was ok to up until 2001 I tried to buy a truck. I had an ok job but no one would give me a loan without a co-signer which I could not get. I was afraid of credit cards so I thought I would start with a small personal loan. Then I started buying vehicles at an extremely high intrest rate. I only wish I knew then what I know now. I could have saved myself thousands of dollars. Over the next 6 years or so I hit a few snags and made some poor choices but for the most part paid my bills on time or early. In 2007 I decided that I wanted to buy a new Harley. I figured my credit score should be pretty good, wrong. At a whopping 550 score my only choice was a 21.99 intrest rate. Even with the Harley and never missing a payment when I decided to buy a home in 2010 I only had a 620 score. I did not want a credit card but I knew I had to change 2011 I got a Capital One card with no rewards and a high APR but no anual fees. I now have 3 cards, each one with a different limmit and purpose. My Capital One is for small things like gas, eating out and other small purchases. My Tractor Supply card and my Amazon Visa are for larger purchases. My credit rating is rising pretty fast now. As long as watch my spending I'll continue to do so. Bottom line is I wish I had gotten a card a long time ago.
Apr 22, 2012 8:47AM
Try not to laugh when I say this but Credit is the Debil!  I got my first card in college (5K limit on a schlub with a Subway job) and Ive been trapped ever since.  I am struggling now on a 5 yr plan to pay everything off and then I will be a cash only man. I am 45, making this a 25+ yr struggle.  If you dont have credit cards do not start.  You may think you can control it, you can game the system for free stuff but something will happen.  Credit cards make it too easy to make impulse purchases, they are way too easy to be stolen/scammed (which costs you little money but tons of time) and they are not truly necessary.  Just say no if you arent already enslaved.  Good Luck
Apr 22, 2012 10:59AM

The author is incorrect to some extent regarding getting a credit card and not using it.  Inactive accounts end up getting closed by the lender (as what happened to my spouse and his paid off Sears card that he had for years).  When they closed the account, his credit score took a hit even though he didn't have a balance or was ever late.  I hate my credit card but I know if I close the account (as much as I want to) my credit score will take a hit.  I also know that if I don't use the damned thing, they'll close the account and my credit score will take a hit.  Also, if I maintain a balance, it will hurt my credit score as well.  The only reason I got the thing to begin with was to build my credit score in order to hopefully qualify for a mortgage (as advised by guess who-lenders) Unfair?  You bet, but it is what it is.  I think FICO scores are a bunch of crapola and don't truly reflect on people's ability to pay.  If people choose to live without revolving debt, it should NEVER, EVER be held against them. 


Debt is just another form of slavery and if someone chooses to live without it, more power to them!!!  Debt is also a trap should your employment status change dramatically, which seems to be happening more and more in this new "wonderful" global economy (sarcasm intended).


 Gwynn in the article is just fine and could probably save up enough money to purchase a house OUTRIGHT so what would she ever need a credit score for anyway. 


Don't fall for the lie that you "have" to have credit.  You really, truly don't.  Furthermore, you'll be better off financially and have more freedom anyway.      

Apr 22, 2012 12:00PM

I, like most of you, am rather skitish when it comes to the use of credit cards. That credit slope is so slippery that if you can't make a payment, miss a payment, or live outside of your means via credit card, you are on a straight path to financial turmoil.


WIth that said, I have a credit card and use it ever so often. When I tried to apply for a car loan two years ago, I had issues with finding a lender. I had good credit (my score was in the upper 700s), but I just didn't have enough credit history. At that time my credit card was only used on a rainy day, but now I have found way to incorporate my credit card into my everyday spending that helps me build my credit score.


How many of us visit the gas pump at least once week? Gas is something we have to buy, something we have to include in our budgets. It costs $50 for me to fill up. $50 a week for four weeks... you can do the math. So every month I make sure that I have $200 set aside for gas. Instead of spending that money out of pocket, I use my credit card for my gas and at the end of the month, the $200 I didn't spend out of pocket at the pump is still in my bank account; I pay that $200 towards my credit card. Sorry for the long and winded comment, I just wanted to share my rationalization for the use of my credit card.

Apr 22, 2012 9:50AM

I agree that credit card companies operate under the fallacy that you have to have them. They are greedy bastards for the most part that suck the very life out of your finances. You have to prove that you dont need credit and be financially stable before you can even get credit.....thats because the credit companies want to make sure they get that huge amount of interest that they are going to lay on you. I am retired now and I have built up and crashed my credit three times. If I had to do it all over again I would try to live without it.


Apr 22, 2012 11:54AM
The borrower is slave to the lender. Credit cards will steal your dreams or opportunities. If you can pay them off every month good for you. BUT, it only takes one accident, job lose or natural disaster to cause you to fall behind. LIVE WITH IN YOUR MEANS! Want the convenience of a credit card? Save up $1500 - $5000 and put it in a separate account with a Debit / Mastercard on it and use it like a credit card. You can even charge yourself high fees and interest if it will make you feel better. This way if or when disaster hits you are not in debit. Credit scores are "I love debit scores" to quote Ramsey.
Apr 22, 2012 11:14AM
I'm 60 years old and been around the horn a time or two...stay away from credit cards (far, far away)
Apr 22, 2012 12:51PM
To get an idea on who is telling you how to manage your finances check were the information is coming from. See credits at end of this article.
Apr 12, 2012 4:07PM

"The 'other way' is to pay it off every month."


Smooth, that ISN'T 'the other way'.


Paying it off in 30 days, like an American Express card, IS NOT credit.

Apr 10, 2012 11:38PM

No, that's not the only way.  The other way is to pay it off in full every month.  I've never had any problems with those things either.

Apr 22, 2012 12:53PM

It should be a crime to charge higher interest to those with lesser credit ratings or credit scores.


Higher interest rate does not reduce the risk.


The risk of lending money (or credit) remains the same whether the interest rate is 1% or 1000%. This is just a ploy to squeeze money out of those; who are young, who would prefer to use money, who made poor choices, or who are victims of circumstances, beyond their control.

I say use cash and let them steal someone else’s money.

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