Many potential borrowers-particularly young people graduate from high school or college, land that good job, and decide it would be a good idea to buy a house. I commend that line of thinking. Buying a home is the single best way to build net worth in the United States today. However, many people right out of school haven't established enough credit to buy a home. Likewise there is a whole group of people who were brought up to believe if you can't pay for it, don't buy it-and those folks too, have no credit scores- and if they wish to use a mortgage to purchase a home will need one.
Credit is king in the mortgage world. The way to establish credit is to borrow money and have those accounts reported to the credit reporting repositories that track payments, how much credit someone uses vs how much is available to them, credit inquires, and delinquencies in payments.
So the question remains-if you have no credit, how do you establish credit? The ideal method of establishing credit is to open a credit card or two with your children as they graduate from high school to assist them in learning to manage credit. This does require some monitoring on the part of the parent to be sure that the student doesn't blow through their credit limit or miss payments. Another method of helping children establish credit is making the student a co-borrower on an established credit account of the parent. That way the student benefits from the established history of the parent as the account(s) begin reporting on the child's credit report. I would suggest using a card that is not at it's credit limit, with a low payment as the payments will go into the student's debt ratio, even though they aren't the sole owner of the card. Making your child an authorized user doesn't do a lot for credit scoring as being an authorized user doesn't make you responsible for the account. The purpose is to establish how borrowers manage their credit, not whether or not someone allows them to use the credit account. And the down side of being an authorized user is that you have no responsibility to the account but the payment will still be considered in the debt ratio.
But, let's say no credit was established using the above method. The former student is now on their own and needs to build a credit score. If the person has a job that pays enough for a small car payment that is a good place to begin. However-please note the use of the word "small" car payment. One huge mistake I often see is a young person who buys a truck or vehicle with a $500+ payment. In this type of a situation the borrower may be able to make the car payment just fine on their income but can they add in a house payment? Then there may be a problem. With house payments in our area available at $500 per month, it is my opinion that the vehicle better have two bedrooms and a bath if the payment is going to be that high. So if a young person is making $2000 per month which would not be unusual for an entry level job, a $500 car payment plus a $500 house payment would put them minimally, if they had no other consumer credit payments, at a 50% debt ratio which is to high in most cases for mortgage lending.
Let's assume that the potential borrower has a small car payment that they have been paying on for awhile-the next step to take would be to apply for credit at a merchant that the borrower uses frequently, such as a gas card or big box grocery store. I have had borrowers of mine have good luck using that approach. Once that card is attained, then obtaining another is easier.
The third method of acquiring credit when one has none, is to open a secured credit card or a secured loan. I would advise a combination of the two. A secured card or loan is obtained by giving a bank that offers them an amount of money to hold in reserve as security to open the card. Typically the amount would be $500 or $750.
Once a borrower has three credit lines open-a car loan, a secured loan and a credit card for instance, it is important to make the payments on time for a period of twelve months. This creates a history of payments. When that is combined with twelve months of on time rental payments-voila! There will be a credit score and most likely a good one. Student loans also report on credit, so if a student loan has been in repayment for twelve months that is also a good source of credit. A large amount of student loan debt is another issue and can effect a borrower's buying power, but that is a subject for a different time.
It is important to note that utility bills, insurance payments, rent payments, medical or dental payments do not go on the credit report unless they turn up as collections or judgments. A medical credit card can be established so those balances and payments report on credit.
Please understand that I am not advocating that a person run out and run up balances on credit cards-use them sparingly but regularly. The balance can be paid off every month, but use them again the next month so the card remains active. Within a year the credit should be established and the borrower will be ready credit wise to purchase a home.
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