Credit Demystified – Chapter 3, Section 4: Improving Your Score

Problem:

You have no history of credit activity.

If you don’t have a credit card and have never had an installment loan (student loans not yet in repayment don’t count), then you’re probably “credit invisible.”

As crazy as it might sound, being credit invisible is just about the same as having “poor” or “bad” credit. Algorithms can’t cope with a lack of data. No history, no data. No data, no score.

Update: “Fixing” this problem isn’t quite as easy now as when I first wrote this guide. The U.S. is dealing with a pandemic that has led to unprecedented levels of unemployment. At times like these, just as during the Great Recession that began in ’08, banks tend to get very stingy with credit. Credit card applications that would have sailed through two years ago are now being denied. And existing cardholders are opening their email to find their existing credit limits have been reduced.

Don’t let this period of tightening credit discourage you from your efforts to establish credit. Credit might be harder to get right now but it’s also more important than ever. Credit begets credit. Believe it or not, it’s generally easier to get credit when you’re young. A credit invisible 18-22 year old is not unexpected. A 30 year old with absolutely no credit history raises eyebrows.

That’s not to say that credit cards are no longer the easiest and fastest way to establish and build credit — just that you might have to be a little more creative and flexible in how you get started.

Fix:

Get a credit card — and use it.

Option 1: If you’re young and in college, consider applying for a student credit card. All of the major credit card issuers offer a card targeted specifically at college students and, therefore, expect the applicants to be credit invisible and have little to no income.

Of course, they also expect you to fall for all of their tricks. They expect you to get yourself into debt. They expect you to not understand the billing cycle or know how the grace period works.

If you’re considering a student credit card, please do yourself a favor — write down the (much higher than average) interest rate on your card to help remind yourself of the high cost of daily compounding interest.

Option 2: Have someone add you as an authorized signer on an existing credit card.

Being an authorized signer on a card is different than being an owner (or a joint owner) on a credit card. An authorized signer has full legal authority to use the card but no legal responsibility for paying the debt incurred.

Being an authorized signer on a card does build credit — but it’s not full credit. Let’s call it “gateway credit.” As an authorized signer, the history of the card owner’s payment activity and credit utilization will be reported on your credit report. Also reported, however, is your “responsibility” for the loan. Activity and history as a full or co-owner will carry more weight than activity and history on an account where your responsibility is simply “authorized.”

A cardholder can add anyone as an authorized signer to a card they own: a child, a parent, a spouse, a partner, an in-law, and even a friend. It is not a decision to be lightly — by either party. The cardholder is legally agreeing to take responsibility for all charges made by the signer. As a cardholder, if you have a credit limit of $10,000 and you add an authorized signer, you’re accepting legal responsibility for the potential $10k pile of debt they rack up. On the flip side, the cardholder’s credit activity on that card will be reflected on the authorized signer’s credit report. If the cardholder misses a payment, that missed payment shows up on the signer’s history too.

Option 3: The next step up from being an authorized signer is being a co-owner of a credit card. Opening a co-owned credit card requires that each party submit an application and be approved. Or, in the case of adding a co-owner to an existing account, the person being added will have to go through the application process and be approved before being added as a co-owner.

This is a good option for adding a spouse or life partner to an existing account or for a couple wanting to combine their finances as they build a life together.

It might also be a stepping stone in the process of transferring ownership from an authorized signer into a full owner of a card. Let’s imagine, for example, you opened an account with a major credit card and made your 16 year old an authorized signer. That child is now 22 and gainfully employed. That card is their oldest card so you want to preserve the credit history for them (see below for why this is important). You decide to have your child apply to be a co-owner of the account. Now they have full legal control over the card and their credit reports will reflect that they are a co-owner.

Be aware that if your plan is to fully transfer ownership by adding a co-owner and then have the initial owner extricate themselves by taking their name off the account — not all credit card companies will allow this. If the card has no carried balance and has always remained in good standing, then a bank that considers these requests might well approve it. But some banks may have a hard policy of simply not considering such requests. In that case, the original owner could remain as a co-owner and simply never use the card. But as long as your name is on a jointly owned credit card or loan, you can and will be held legally responsible for the other person’s debt on that account. Again, not a commitment anyone should take lightly.

Problem:

You have a credit card but no credit history.

Let’s say you already have a credit card and you use it occasionally but you’re afraid of messing up or going into debt so every time you charge something to your card you go online soon afterward and pay the balance to $0. Or you heard from a friend that a good habit is to log in and pay your balance to $0 every Friday. Sound familiar?

I can’t tell you how common this is! My own daughter, well-versed as she was with billing cycles and grace periods, admitted that for the first few years as a cardholder she routinely paid her balance to zero during her billing cycle because having a balance made her extremely nervous.

Problem:

You have a history of missed or late payments.

In my practice, I encounter three common reasons for missing or late payments:

–   busy schedules, chaotic lives, and/or extreme emotional stress related to finances leads to missing due dates;

–   a general plan to pay more than the minimum but confusion and the stress of trying to figure out how much you can pay without leaving yourself short for the month leads to missing dues dates;

–   having a due date that clashes with other financial obligations such as rent or car payments and/or is poorly timed with your paychecks makes it very difficult to get a payment in before the due date.

Depending on the reason for missing payments or paying late, I offer a few suggestions below.

Fix:

Autopay is your friend.

Set up your account to automatically make a payment just before the due date. This ensures that, even if you get busy, you won’t miss a payment. Even if you’re simply making minimum payments at this point, set it to autopay. Nothing worse than incurring a $35 late fee because you forgot to make a $25 minimum payment.

Fix:

Don’t engage in self-sabotage.

Trying to pay down your debt is admirable but self-sabotaging your efforts by missing payments is not. Set up autopay for your minimum payment. Later in the month or in your paycheck cycle, when you know your budget can absorb an extra debt-reduction payment without having to add new debt right back onto your credit card, log into your account and make up another payment.

[Most credit card companies will limit the number of payments you can make in a given 30-day/billing period but I haven’t seen any that won’t accept at least three payments in a 30-day period. That allows for the minimum payment plus two additional payments in each one-month period.]