The credit history Catch-22
Published 9:54 pm Thursday, April 2, 2015
By Nathan Rice
Most people are familiar with the term “Catch-22.” It describes a situation in which there are no favorable solutions, because of the way the factors relate.
Starting your credit history is one of the most frustrating Catch-22 problems in the financial industry. This happens most frequently to young people looking to obtain their first loan, but it can happen to anyone who has not used any forms of credit in their recent history.
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Lenders often turn down those with no credit history, because they have yet to show their ability to repay loans. But how can one obtain a credit history if they are unable to get a loan due to their lack of previous credit?
Many individuals find themselves facing this perfect example of a Catch-22 when they apply for their first loan.
Thankfully there are several ways individuals can build their credit. Many young people obtain their first loan by having a parent co-sign for their first loan. Co-signing can be a great start for many young people, but it can have its drawbacks for parents.
This new loan will show on the parent’s credit report, and even if the parent is not making the payment, it will often still be counted as debt if he or she ever applies for a loan. I cannot tell you how many times I have heard, “That payment is not my responsibility. It is for my son/daughter.” But if it is showing on your credit, lenders will most likely count it as your responsibility.
Sometimes people looking for credit grab the first credit-card offer that comes in the mail. Interest rates are typically high on these cards, and sometimes they come with annual fees. They can help establish credit, but they often come with a hefty price.
My favorite credit-building option is a share secured loan. These loans allow you, in essence, to borrow your own money. It may sound a little strange at first, but it’s the best, lowest cost option for building credit.
Financial institutions that do share secured loans use funds in your account as collateral on your loan.
Let’s take for example a young Joe Q. Public, who wants to establish credit. Joe can deposit some of his paycheck into his savings account. The money placed in savings will then be held as collateral for his share secured loan.
The amount of money being held, however, is the same amount given back to Joe as a loan. Therefore Joe is not short any cash from his paycheck and can continue to buy a $5 mocha latte every morning. So if Joe had $300 held in his account as collateral, he will be given $300 as a loan.
The rest is simple: Joe makes monthly payments on his loan and the financial institution reports this loan to the credit bureaus. This allows credit history to be established. Since share secured loans are virtually guaranteed, the interest rates are often very low, which means the cost is minimal.
If Joe borrows $300 at a rate of 3.10 percent for six months he will only dish out about $2.70 in interest over the life of the loan. That’s only half of one mocha latte.
No matter how you decide to establish credit, the main point is to start early. If you wait to establish credit until you need a loan, you will often find yourself in the financial Catch-22.
Building credit early through inexpensive ways like share secured loans is a great way to prepare for your financial future.
Nathan Rice is the Relationship Manager of the Downtown Suffolk branch of ABNB Federal Credit Union. He is a Hampton Roads native and can be reached at email@example.com.