How to Build Credit Without Going Into Debt

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Kumiko Ehrmantraut

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Kumiko Ehrmantraut

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How do you build credit or improve your credit score without debt? It's a question that I got a lot after I became debt free at the end of 2018. After paying off over $77,000 of debt, I made the decision that I no longer wanted debt to be a part of my life. Living a debt free life doesn't mean that I don't know the importance of having a good credit score, especially as a business owner. I think it's important for many reasons, but can you sustain or build a good credit score without debt?

Here's the simple answer. You can't. The standards of a FICO score determine your credit score. That FICO score uses certain elements about debt, such as what type of debt you have, how you pay your debt, how much debt you have, and how long you have had it. This, in turn, means you need some type of relationship with debt to have a credit score.

Now, the real question is, “Can you improve your credit score without accumulating debt?” Yes.

Debt becomes a financial problem when you carry balances for an extended period or are paying interest. So, let's take a look at improving your credit score without accumulating debt.

1. How to Build Credit with a Credit Card — The Debt-Free Way

Let’s start with the credit-building approach. You’re likely to have the most questions about this first — credit cards. Now, I can already feel some of you thinking, “Wait just a minute, Miko. Don’t credit cards and debt go hand in hand?” If you’re asking this question, stick with me. I’ll explain.

A credit card doesn’t automatically create debt. You get to choose how to use it. A credit card only results in debt if you charge purchases on your account and don’t pay them off by your statement due date. Pay your balance off every month, and you’ll not only avoid credit card debt, but you won’t have to pay expensive interest fees either.

You don’t even have to use your card all the time for it to help you build your credit. Using your card occasionally (i.e., once a quarter) is typically enough to keep it open. As long as you pay on time and keep the balance-to-limit ratio low, you should be in good shape from a credit score standpoint.

• Read: How to Improve Your Bad Credit Score

I do acknowledge that credit card debt is a very real temptation. (Been there!) Here are a few tips you can use to avoid falling into the credit card debt trap.

• Keep the card locked up in a safe place outside of your wallet.
• If you use a credit card for a purchase, immediately take the money out of your cash envelope and set it aside for your upcoming bill.
• Pay your credit card bill early online, before the statement is issued.
• Always keep a $0 balance and pay your bill in full each month.

Best Credit Cards to Build Credit

Finding the right credit card depends on your situation. Do you have no credit or damaged credit? A secured credit card might be a wise option to consider. Is your credit already in decent shape? If so, you might qualify for a more attractive offer, like a credit card with 0% introductory APR. (I once used a 0% balance transfer card to pay off $7,500 in credit card debt.)

2. Loans to Build Credit

A credit builder loan is another possible way to establish credit without taking on expensive debt. Like secured credit cards, you might be able to qualify for a credit builder loan even if you have no credit history or a damaged credit rating.

Despite the word “loan” in the title, credit builder loans may help you build a small savings fund. Here’s how they work.

• Credit builder loans are often issued for small amounts — commonly $1,000 or less.
• Once approved, the lender holds the funds in a savings account or CD instead of releasing the money to you immediately, like a traditional loan.
• You may owe an origination fee, but it’s typically $25 or less. (Verify with the lender.)
• Make monthly payments (usually for 6-24 months) for the loan principal plus interest.
• Many lenders will report your account to the three credit bureaus. (Confirm before you apply.) Pay on time each month, and you should establish positive credit history — worth 35% of your FICO Score.

Once you make the final payment, the lender releases the funds you “borrowed,” plus any interest your money earned. 

• Read: Dealing With Credit Card Debt When You’re in Over Your Head

If you pay on time, at the end of the process, you should have 6-24 months of on-time payment history on your credit reports. You’ll also have a stash of cash you can use to pad your emergency fund, pay down debt, or use it in another productive way.

You can find credit builder loans with some credit unions as well as online lenders, like Self.

Self

With Self, you can easily apply for a credit builder loan and manage your account online. You choose the payment term and loan amount that’s right for your budget.

Self reports your account to all three credit bureaus (Equifax, TransUnion, and Experian). So, each on-time payment you make could help you establish a positive credit history. Credit builder loans from Self are available in all 50 states.

3. Can You Build Credit as an Authorized User?  

Do you have a friend or family member with good credit who already has a credit card? If so, you can ask your loved one to add you as an authorized user on the account. As an authorized user, your loved one’s good payment history might help your credit scores too.

Many credit card issuers report credit history to the credit bureaus for both the primary cardholder and the authorized users on an account. When you’re added onto someone’s card, the account and all of its payment history might show up on your personal credit reports.

Assuming the credit card is managed well (on-time payments and a low balance-to-limit ratio), it could help your credit scores once it appears on your credit reports. Payment history is worth 35% of your FICO Score, and your balance-to-limit ratio (aka credit utilization) influences another 30% of that number. If the credit card your loved one adds you to is older, even better. The average age of the accounts on your credit reports influences 15% of your FICO Score.

• Read: Should You Cancel Your Credit Card After Paying It Off?

Of course, everyone doesn’t have this option. You might not have a friend or family member with positive credit card accounts who can help you out. Even if you do, you might not be comfortable asking for this kind of favor. If you prefer to build credit on your own, the first two options above may be a better fit.

4. Pay Debts You Already Have

If you already have debt, you don't need to take on more debt to increase your credit score. When you are already dealing with installment loans, like student loans, making your payments on time and not missing any payments month by month is best practice. Payment history, or showing that you are paying your bills on time, makes up 35% of your credit score.

Track Your Progress

Whether you’re trying to figure out how to build credit fast or how to build credit when you have none, it’s smart to track your progress. You can (and should) check your three credit reports often. You can claim a free report from all three credit bureaus once every 12 months at AnnualCreditReport.com.

Have you already claimed your free reports? Do you want to see your credit scores for free too? Credit Karma is another resource you can use to update your credit reports and scores from Equifax and TransUnion as often as once a week.