Credit Q&A: “Do you need a credit card to build credit?”
Being credit score conscious seems to be all the rage these days, along with being green and reducing your carbon footprint.
It seems everyone is now obsessed with their credit score, which isn’t necessarily a bad thing.
The only downside is the misinformation that surfaces when things as complicated as credit scoring make it to the forefront.
Credit Cards Can Help Build Credit
You see, most consumers start their “credit journey” with a credit card, largely because it’s the easiest line of credit to get approved for. It also happens to be the most advertised credit-related product out there.
You may be shaking your head, thinking about how you couldn’t get approved for a credit card, but compared to an auto loan or a mortgage, it’s much more accessible to the average consumer.
If you’ve ever had a checking or a savings account, there’s a great chance the issuing bank offered you a credit card to go along with it.
They basically “trust you,” knowing that you’ve got some money in the bank to make purchases using credit.
In a way, it’s almost a quasi-secured credit card because they know you have money to back it up.
But this type of credit card would still be considered unsecured, meaning you don’t necessarily have to have money in an associated account to be issued one.
And this type of credit card will be reported to the three major credit bureaus, and in turn will help or hurt your credit history. Yes, it can go both ways.
Just because a credit card builds credit history doesn’t mean it’ll be completely positive.
If you miss payments, your credit score will suffer. If you pay on time and keep balances low, your credit score will rise.
[See: Credit score range.]
Tip: Prepaid credit cards do not build credit, which is one reason why they approve everyone!
More Available Credit Will Help Your Credit Score
Theoretically, a credit card should also provide you with more available credit, which will boost your credit score over time.
For example, if you open a credit card with a $5,000 credit limit, that’s another $5,000 you’ve got at your disposal in the credit department.
This means your credit utilization should drop, which should lower your default risk and boost your credit score. Of course, there comes a point when you could have too much available credit, which could make you appear as more of a credit risk.
But again, if you max out your new credit card limit, you’ll hurt your credit score and wind up in a worse spot than where you started.
What Else Builds Credit History?
While I focused on credit cards being the most common credit builder, you don’t need a credit card to have excellent credit.
But it would probably be trickier to get credit without one. It’s possible that you could forego credit cards and instead get an auto loan/lease, a personal loan, a mortgage, and so forth.
You’d probably have to start building credit by piggybacking off someone else, like a family member, by being an authorized user or having them co-sign.
And once you had enough installment accounts opened, you’d build your own credit history. But this would be a less direct and potentially more difficult way of building credit.
Another less common option is a “credit builder loan,” which many credit unions offer. You basically request a small loan amount that is placed in a interest-bearing account. Each month you make a scheduled payment until the loan is paid off in full, typically in six months to a year.
During that time the credit union reports your payment activity to the credit bureaus, which helps establish your credit history. And you earn interest along the way. Ideally, after paying back the loan successfully they’ll consider offering you a real line of credit. And your credit score should get a boost, allowing you to apply for conventional loans and/or credit cards elsewhere.
But at the end of the day, revolving accounts like credit cards act as stepping stones to larger installment loans (auto loans and mortgages).
So if you “skip” that stone, you’re going to be jumping a long way…from zero credit to a major loan.
It’s possible, just less conventional and more difficult. Of course, if you have a great job, steady income, and a ton of money in the bank, you may be able to get access to all types of loans without even bothering with a credit card.
Lastly, keep in mind that a good variety of credit is important for your credit score as well. In fact, “type of credit used” is one the major factors that determines Fico scores, so a healthy mix of credit cards and installment loans may be best.
- You don’t need a credit card, but it’s the most common first line of credit
- Credit cards are stepping stones to larger lines of credit like auto loans and mortgages
- But there are alternatives such as secured credit cards and credit builder loans
- You can also become an authorized user on a spouse or family member’s account to build credit
Read more: Are credit cards bad for your credit score?