Why You Need a Credit Card to Build Credit
by Lyle Daly | Updated July 22, 2021 - First published on March 1, 2021
When you're working on your credit, a credit card will get you the best results.
Do I absolutely need a credit card? It's a popular question among consumers who want to build credit for the first time. People wonder if they can get good credit by simply paying their current bills on time.
This has become even more confusing with the release of systems that use additional information, such as utility payments and banking information, to calculate your credit score. Experian Boost and UltraFICO™ are two notable examples.
Despite these new developments in credit scoring, the traditional method to build credit is still the most effective. Open a credit card. Use it for at least one purchase per month. Always pay the bill on time. Here's a breakdown of why this is the best approach.
The importance of a good payment history
Although several factors determine your credit score, the most significant is payment history. This is your record of on-time payments. Note that there are multiple credit scoring systems out there. Each one has its own scoring method, and you may have different credit scores with each system. That being said, every scoring model weights your payment history heavily when calculating your score.
Now, some credit scoring systems let you use rent and other bills to build a payment history. But not all of them. Indeed, the FICO® Score system, which is the one lenders most commonly use, looks at your payment history on just a few types of accounts.
Under the FICO® Score system, only the following types of accounts count towards your credit payment history:
- Credit cards
- Installment loans
- Mortgage loans
- Finance company accounts
There is a key point to clarify here. Those are the only types of accounts that can positively affect your payment history. Any type of account can negatively affect your payment history if you miss payments. If a utility company reports you haven't paid your bill in six months, that's going to damage your credit.
If you want a good payment history under every type of credit score, including the most important (your FICO® Score), then you need either a credit card or loan. Of the two, credit cards have a couple of advantages.
Why a credit card is better for building credit than a loan
When you pay a credit card or loan bill on time, the payment is reported to the credit bureaus. That's good for your credit score. The more on-time payments you have, the more your credit score will improve. Since both options can help your credit score, why is a credit card better?
The first reason is that you can avoid interest charges. There's no credit card interest charged on purchases if you pay your full balance by the due date. Loans charge interest, unless you find one with an introductory 0% intro APR offer. Even with those loans, you're still charged interest if you don't pay off the balance within the introductory timeframe.
There's also no limit on how long you use a credit card to build your payment history. Loans, on the other hand, have fixed terms, such as 12 months or five years. After you pay off a loan, you won't continue to build your payment history unless you get another one.
As your credit score rises, you'll eventually have access to the best credit cards. These offer quite a few additional benefits that loans don't, including rewards and purchase protections.
How to open a credit card and start building credit
If you want to start building your credit, a smart first step is to get a credit card. There are a few ways to go about this when you don't yet have much of a credit history.
Secured credit cards are one of the most common starter credit card options. You apply for the card, and if you're approved, you pay a security deposit to open it. Since there's a deposit required, card issuers are more flexible with whom they approve. You can get one if you're building credit for the first time or if you're rebuilding your credit score after previous issues.
College students often start out with student credit cards. If you're in school, you may be able to qualify for one of these cards without paying a deposit.
You could also get a card with the assistance of anyone you know who has good credit, such as a parent. If they're willing, they could make you an authorized user on their credit card. The activity on the card would then count towards your credit score. Or, they could cosign on a credit card application, assuming the credit card company allows cosigners.
Credit scoring models are changing. And some do now factor in alternative payment histories. But at the moment, the only surefire ways to build a payment history are with a credit card or loan. While a loan will work if you already have one, a credit card is the better long-term choice. You can use it indefinitely, and if you pay in full, you won't get stuck with any interest charges.
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