A few weeks ago I was doing a public speaking event and one of the questions I received was “what is the best way for someone with no credit to build a credit score?” Before I answered the question the person got even more specific and told me that a bank had told him the best thing he could do was to deposit $1,000 (with this institution) then to take out a $1,000 installment loan against that deposit.
I am sure the bank had lots of “great” reasons as to why this was helpful advice, but telling someone this is the best and fastest way to build a credit score is where I take issue. Let’s address the issue of time first.
In order to generate a FICO score two things have to happen;
1. You have to have an account that has been open for at least 6 months (collection accounts do not count)
2. You have to have an account that has been updated to the credit bureaus at least once in the last 6 months. One account can work to qualify for both of these rules.
In looking at the criteria listed above you will not see that it mentions the “type” of account as a factor, since it doesn’t then we know the “type” of account is not a factor in how long it will take to generate a score! So in answering the time question of the equation the answer is 6 months if you currently have no credit now. Regardless of the “type” of account!
Let’s look at the other issue now; the goal is not to just have a score, but to have the best score we can.
If you understand how the FICO score works you know that revolving accounts (credit cards) hold a much higher value than installment loans. Knowing that is why I disagree completely with the advice from this bank. In this scenario it will be a lot better to get a credit card and use it properly, than it would be to get an installment loan. For someone with no credit at all the biggest challenge will be what type of card to apply for to have the best chance to get approved. For this situation we want to get a secured credit card. In case you are not familiar with this term, very simply it is a credit card where the limit is secured by a deposit. Most banks have a minimum amount of $250, so you give the bank $250 that they hold as a deposit, you then get a credit card with a limit of $250. This is what makes the account secured. Since it is secured it is a lot less risky for the bank which makes it a great option for people with no credit or damaged credit.
Comparing these two ideas, both will take 6 months to generate a score, the revolving approach will yield you a higher score when you generate a score than the installment option (if you use it correctly) and the last factor, with the banks installment idea it will tie up $1,000 of your money vs. only $250 with my approach!
Be careful with the advice you listen to when it comes to your credit. Clearly the bank had an ulterior motive with this type of advice. It sounds to me like it is a plan to generate higher deposits instead of the best and fastest way to generate a FICO score for this person!
