Building credit in the US

Welcome to this step by step guide on how to build your credit history in the United States. Following these steps early after you have arrived in the US will enable to take full advantage of the American credit card market. This can be highly beneficial in various ways:

  • Receiving attractive sign up bonuses from 100-1000 USD (typically in the range 50-200 USD), when opening new accounts.

  • Receiving cash back or bonus points/miles which often leads to an effective discount of 3-5% of most purchases.

  • Having a comprehensive insurance package and other card benefits that are often particularly valuable to frequent travelers.

  • Building your credit history and improving your score to lower your interest rates on future loans (e.g. mortgages).

  • Providing significant liquidity if you have a credit limit of 10,000-20,000 USD and typically have at least 20 days to pay back.

  • Many companies (such as online banks/brokers) use your credit file to verify your identity online (and reject you if there is none).

Important note: Never use credit cards to borrow money with interest, i.e., always pay your monthly credit card bill in full!

Why you should apply for US credit cards

The market of US credit cards is quite unique in the world. On the one hand, signing up for American credit cards promises the highest bonuses (reaching 1000 USD and more, just for signing up and spending a few thousand dollars on regular purchases), but on the other hand banks charge crazily high interest rates (reaching 20-30% per year) and it is well known that credit cards contribute to wealth inequality, as they effectively transfer wealth from the financially illiterate ones to the financial literates. You can read more about this in a later section.

Either way, when living in the US, it is hard to get by without owning a credit card and it makes life much easier. In short, you should get a credit card for the following reasons:

  1. Car rentals. When renting a car in the US, almost all rental agencies require you to present a true credit card (not a debit card!) in order to rent a car. Even if some agencies allow you to put down a debit card or even cash, you will typically need to make a large deposit as they rental agencies need to protect their property (their car).

  2. Fraud protection. If your debit card number is compromised, any criminal misuse of your card will directly block or withdraw money from your bank account. Even if you can prove that you were victim of fraud and did not approve the respective transaction, you may be partially liable (starting at 50 USD or so) and typically you will need to wait until you get your money back. In contrast, if there is an illegitimate transaction on your credit card, you just dispute the transaction with your bank and you will not need to pay this portion of your monthly bill.

  3. Saving money. Using credit cards can save you a significant amount of money. Almost all proper American credit cards give at least 1% of cashback to their customers, so you receive a discount of 1% on all purchases. Using the right cards for the right purchases, you can push this typically to 2-5% on most purchases. Moreover, you can receive attractive signup bonuses, such as receiving 100-1000 USD after spending 500-5000 USD within the first three months after being approved for the card. This often comes out to a 10-20% discount on your first purchases. Of course, you should time your application for new cards, such that you can take advantage of such offers, when you are planning to spend money anyway (purchase of laptop, flight, hotel, airbnb).

  4. Liquidity. While the interest rates of credit cards are very high, you do not need to pay any interest (on purchase amounts - withdrawing cash at an ATM typically incurs immediate interest) when you pay your monthly credit card bill in full. If your credit card statement comes out on the 1st of every month, you typically have 20-25 days to pay the balance in full. This means if you make a purchase on the 1st of May, the charge will be listed on your statement on 1st of June and you have another 20-30 days to pay the bill leading effectively to a free loan for 1-2 months. While you should never use credit cards to borrow money, you do not have, it gives you some flexibility. For example, you can keep your cash in central savings account collecting interest and only once a month you withdraw a single sum to pay your credit card bills.

  5. Credit file. If you only have a regular bank account, some information will be reported to ChexSystem, but you will not have a proper credit file with one of the three rating agencies (Transunion, Equifax, Experian). Having a credit file has two key advantages. On the one hand, it will allow you to build your credit file which will give you better rates when borrowing money (e.g. a house mortgage) and on the hand, it will be regularly used to verify your identity. Without a credit file, you may not be able to sign up for certain online services and even online bank accounts (such as Ally Bank), because some services only allow this automatic verification.

Prerequisites

In order to follow this guide, you need to satisfy the following conditions:

  • Social Security Number. You need to have received your US Social Security Number (SSN). In many cases, you can even receive an SSN if you do not pay taxes in the US, but because you need to apply for a driver's licence in your state. Most temporary visa (such as J1, F1 etc.) will allow you to apply for an SSN. You should use the opportunity of spending time in the US to get your SSN. Make sure that you keep your Social Security Card save, because you will sometimes need to provide a copy or scan of it to your bank.

  • US address with proof. You require an US address with proof. The easiest way to prove your address is by having a US bank account, in which you can typically change your address manually to your current one. Otherwise, you can also use a utility bill, a tax return or similar official letters that contain your address. In many situations, you do not need the proof anymore, if you already have an active credit file, because your address will be verified through this.

Once you have an active credit file, your identity will usually be verified by comparing your application data to your file. At this stage, you will usually not provide any further proofs. In fact, your credit file will be even used for identity verification with other services.

Step 1: Creation of credit file

Most banks will only consider applications for credit cards, if they can verify your identity and your credit worthiness from your credit file, which is provided by one of the three credit bureaus Transunion, Equifax and Experian. However, such a credit file is only created, once you have a credit card, take out a loan or have an account with regular payments (phone plan, internet subscription etc.). What appears like a Catch-22 is indeed a small challenge, but it is possible to create a credit file in one of the following ways:

  • Already having a credit file. If you have some ongoing subscription (phone plan, internet etc.), where you had to provide your SSN, you may already have a credit file about you. In many situations, such a credit file is not sufficient to generate a credit score, so you may also need to also use one of the other options.

  • Apply for a credit card in your local bank. You can go to your local bank and ask if you can apply for a credit card. This often requires you to prove that you receive regular income (for example by allowing the banker to check your monthly income of your bank account) and sometimes the bank requires you to have lived 6-12 months in the country. Certain credit card providers, such as Discover, will even consider online applications from people without credit file, but you will typically need to prove your identity, address and income by sending scans of the respective documents. Many universities have local credit unions or are associated with banks (for example, PNC), such that it is easier for students and staff to apply for a credit card. If none of this works, you will typically be offered to apply for a secured card, i.e., you need to put down a deposit (e.g. 500 USD) which is locked in a savings account and in return the bank provides you with a credit card whose limit equals this amount. Whatever credit card (secured or not) you are able to open, make sure that there is no monthly fee attached.

  • Being added as authorized user. If you have a friend or family member, who already has a US credit card, you could politely ask this person, if they are willing to add you as an authorized user on their account. When they add you as authorized user, the bank will provide them with a credit card in your name, which is linked to their account. You can tell them that they do not need to hand out the card to you, but if they just keep the card in your name linked to their account, it will often trigger the creation of a credit file in your name - in particular, if they provide your SSN when adding you as authorized user. Clearly, this option requires a minimal level of trust, but technically there is little to no risk involved, as long as they do not hand out the card to you (which would allow you to make arbitrary purchases, for which they will be liable for with their account).

It typically takes 1-2 months, before your credit file is created. Sometimes, it also does not suffice to only have a single credit card, in which case it may be good to open two accounts (usually with different banks). Most credit card providers will report your payment history (i.e., did you pay your credit card bill on time?) to all three credit bureaus, but some smaller banks may only report to one or two. To verify that there exists a credit file about you, you should use the following services:

  • Creditkarma.com. This is a free credit monitoring service that will access your credit files stored with Transunion and Equifax.

  • Freecreditreport.com. This is a free credit card monitoring services that will access your credit file stored with Experian.

  • There exist more free credit monitoring services, such as credit.com and creditsesame.com, but the above two services are sufficient to monitor and access the credit reports of all three agencies.

If you can register for the above services and your credit cards (or your subscription account payment history) appear on your file, everything is good. If above services cannot find your file, check all your data (birthdate, SSN, address etc.). If you have only one credit card open, you may need to open a second one to trigger the creation of your credit file. If nothing works, you can request an official copy of your credit report using the website annualcreditreport.com. While there is in theory an option to request the file online, you will typically need to request it by filling in a paper form (or fax) and include proof of your identity (copy/scan of passport, social security card, proof of address). After a few weeks, you will receive a printed copy of your credit report by mail. Most importantly, by providing your proof of your personal information the credit bureau will update and verify your information for your report. In most situations, you should be able to sign up for above free credit monitoring services, once you received a paper copy of your file.

Step 2: Keep track of your cards

Keeping track of several credit cards and bank accounts can mean some work. Nowadays, you can check all your accounts with a finger tip on the web, but still you would need to log into every single account and keep an overview when to pay which card if you have sufficient cash in your bank account to pay all monthly bills. Would it not be extremely convenient if there were service that compiled the information of all your accounts into a single coherent layout? Lucky for us, there is such a service:

  • Mint.com: You need to provide your login information (username and password) for all your bank and credit card accounts, and this website pulls all information, including individual transactions and current balances, from all your accounts. You can search for transactions, check which bills are currently due, confirm that you have made the relevant payments and keep a clear overview over your finances. In return, Mint will advertise to you about financial products and they may run some type of big data statistics over your data. You may be very skeptical, but it provides an extremely valuable and convenient service. Check it out and decide for yourself, if you want to use it or if you are concerned about your privacy or believe that your financial information is at risk. The website is run by a legitimate company, namely Intuit, which also specializes in Tax Preparation and general financial advice.

Step 3: Climbing the ladder

Once you have opened your first credit cards, it will take time until your credit score will be high enough to get approved for the best premium credit cards that the US market has to offer. The most important way to sustainably improve your credit score is by waiting, using your cards and always paying your credit card bills on time. For this, follow these steps:

  • Card usage. There is a good reason to use your credit card for all expenses that can be paid by credit cards without additional fee. This includes most shops (physical and online), restaurants/bars and in particular large travel purchases, such as hotels and flights. You should not use credit cards for purchases when it incurs an additional fee (if it is higher than your cashback), which is typically the case for rent payments and purchase of assets (real estate, gold, stocks, crypto currencies).

  • Always pay your credit card on time. Credit cards are organized in billing cycles. A billing cycle goes from the n-th day of a month to the n-th day of the next month. The n-th day is called the statement closing date, because you will owe the total sum (statement balance) of purchases that you have made during a billing cycle (assuming you did not carry any debt previously). After the statement closing date, you have a grace period of 20-25 days until you need to pay at least the "minimal payment". If you use more than one credit card, it makes sense to organize your statement closing dates or the payment due dates. However, if you do not pay the full amount, you will be charged daily interest on your purchase, which you should avoid at all costs. Even more important, you should never forget to pay at least the "minimal payment", because any missed payment will be recorded and reduce your credit score.

  • Keep your statement closing dates together. If you keep more than one credit card, you may have several statement closing dates and due dates. However, you can call your bank (or sometimes even use the online system) to change your due date. This allows you to ensure that all your cards require payments around the same time. For example, it could make sense that all statement closing dates are towards the end of a given month, when you receive a new salary, so you have enough time to pay all your cards in the first few weeks of the new month. Note that there are often some restrictions which dates in the month you can choose and due to different grace periods (20-25 days), so you will not be able to match the dates of different cards perfectly.

  • Bonus: Never carry a balance. Carrying a balance means that you do not pay the full amount of your last credit card statement, in which case you will need to pay interest. This will annihilate any bonuses or other benefits you receive through your card. Always pay at least the full amount on your statement. This does not mean that you need to already pay for purchases completed after your statement posts. For example, if you spent 1000 USD from June 1 until July 1, such that your statement balance on the statement closing date July 1 is 1000 USD, it suffices if you pay 1000 USD by the due date (typically 20-25 days after the statement closing date), even if you spent more money afterwards.

In the meantime, it does not hurt if you expand your credit card portfolio a little bit. Strictly speaking, it probably suffices if you have a total of 3-5 cards after 3-4 years to qualify for most premium cards (provided your income is sufficiently high). However, it will not hurt your score if you open twice this number or even more.

Step 4: Enjoy your card portfolio

While the applications for the previous cards mostly had the purpose of just having some credit cards, you can finally lean back and just choose some of your favorite cards. Many people only keep 1-2 favorite cards in their wallet, which can be used for most of your purchases, but thanks to Google Pay / Apple Pay, you can effectively carry as many credit cards as you like on your smartphone. The following cards make an excellent portfolio, but if you like to keep it simple, you can just stick to the first or the first two cards:

  • Chase Sapphire Reserve (annual fee: effectively 250 USD). If you travel a lot, this card is for you. It costs 250 USD per year and it has the following features:
    (1) The card comes with an annual fee of 550 USD, which appears like a very steep price. However, you often receive a signup bonus of 50,000 and more Ultimate rewards points (which are worth 750 USD and more, as discussed below) and you will be reimbursed for 300 USD of travel purchases per year. This means that you will effectively only pay 250 USD per year.
    (2) You receive a PriorityPass Preferred membership, which allows you to enter airport lounges in many major airports worldwide (see here). This will make your travel much more convenient and can often save you money, because you do not need to purchase breakfast, lunch or dinner on these travel days.
    (3) It collects 3 Ultimate rewards points per USD on restaurant and travel purchases (flights, hotels, bus, train, but not for gas) and 1 Ultimate rewards points per USD on everything else. You can either convert these points into airline miles / hotel rewards (e.g. with United, Singapore Airlines etc.) or book travel through the Chase travel portal (unfortunately run by Expedia) where each point is worth 1.5 cents. In the worst case, you can convert each point into 1 cent deposited into your bank account. In most cases, you can keep your points and wait for an opportunity to book a flight/hotel using points, such that the specific product would otherwise cost more than 1.5 cents per point. Otherwise, use it through the travel portal, where you can exactly 1.5 cents per point. In summary, it is usually possible to spend your points for at least 1.5 cents per points, which effectively makes this card a 4.5% cashback cards on restaurant and travel purchases.
    (4) The card comes with a large number of additional insurance perks, such as trip delay or interruption insurance, baggage insurance and primary rental car insurance (see here). If you travel a lot and do not mind filling in some forms, you can expect to receive 50-100 USD in reimbursements for additional travel expenses due to problems (delayed flights, weather problems etc.).
    (5) The card reimburses every five years 100 USD for a purchase of Global Entry, which speeds up customs / border control when entering the United States and includes Precheck, which means the security checks within the US are much faster (there is often a seperate line, you are typically not required to take off your shoes or take out your laptop). Note that only US citizens, permanent residents and certain citizens of other countries (such as Germany, UK and Switzerland) are eligible as explained here.
    In summary, you pay effectively 250 USD per year (annual fee) to receive very generous perks and Priority Pass Airport Lounge access and earn at least 4.5% cashback (in the form of Chase Ultimate Rewards points) on restaurants and travel purchases.

  • Capital One Venture* / Quicksilver* (annual fees: 95 USD / none). This card gives two Venture miles per USD on all purchases and does not have a foreign transaction fee. Each Venture mile can be converted to 1 cent if you reimburse for previous travel purchases. It is therefore best to collect these miles and then make a single travel purchase every couple of months or once a year (usually, it is better to use the Chase Sapphire Reserve to make travel purchases) that is large enough to use up all your points. You could also transfer your miles to travel partners, but this is often not as attractive (you can check yourself). The annual fee of 95 USD is typically waived for the first year (when it also offers an attractive signup bonus) and when using the card a lot one can often ask to have the annual fee also waived in later years. For this, just call within to 30 days after the annual fee posts to your statement and ask for a retention offer, i.e., say that you will either downgrade the card to not pay the annual fee or if they can waive it, so you can keep the card. If the annual fee is not waived, you should downgrade to the Capital One Quicksilver card, which does not have an annual fee and also no foreign transaction fee, but only gives 1.5% cashback on everything (which is still good). In summary, this card is optimal for people who spend a lot of time abroad making purchases not covered by the Chase Sapphire Reserve (anything else than restaurants and travel purchases), because it gives effectively 2% cashback on everything. However, if you cannot get the annual fee waived every year, it may be a better choice to downgrade it to the Capital One Quicksilver card.

  • Amazon Prime Rewards* (free). If you use Amazon a lot and have an active Amazon Prime subscription in your name, this cards gives you an easy 5% Cashback on all Amazon purchases (only in the US). There is no annual fee. In summary, this is an excellent card to have when you are an Amazon Prime customer in the US.

  • American Express Preferred / Everyday* (annual fees: 95 USD / none). This credit card comes in two versions. The American Express Everyday card does not have an annual fee and gives 3% cashback in supermarkets (but not in stores like Walmart or Target) for up to 6000 USD in purchases per year (1% thereafter). The American Express Preferred card has an annual fee of 95 USD and gives 6% cashback in supermarkets for up to 6000 USD in purchases per year (1% thereafter). There are often promotions with signup or upgrade bonuses, which is larger than the annual fee. In summary, this card is useful to get in the Preferred version (with signup bonus) to use for one year (with 6% cashback on groceries) and then downgrade it to the free version (with 3% cashback), which can be upgraded again if there are attractive offers (when you login into your account) that are larger than the annual fee.

  • Chase Freedom* (annual fee: none). This credit card gives 5 Ultimate Rewards Points per USD for up to 1500 USD of spending in specific rotating categories (such as Amazon, gas purchases, grocery purchases, drugstores, Paypal etc.) which change every quarter of the year. All other purchases receive 1 Ultimate Rewards Point per USD. This card has a foreign transaction fee of 3%, so one needs to calculate carefully if it is worth it to use it abroad. If you also own the Chase Sapphire Reserve Card, you can also combine all these rewards points and use them for travel purchases where each point is at least 1.5 cents worth. In summary, this card can give 1.5% and 7.5% or more cashback (depending on how you can use your points with transfer partners) when combined with the Chase Sapphire.

  • Chase Freedom Unlimited* (annual fee: none). This credit card gives 1.5 Ultimate Rewards Points per USD on all purchases.This card has a foreign transaction fee of 3%, so that it rarely makes sense to use it outside of the US. If you also own the Chase Sapphire Reserve Card, you can also combine all these rewards points and use them for travel purchases where each point is at least 1.5 cents worth. In summary, this card gives 2.25% or more cashback (depending on how you can use your points with transfer partners) when combined with the Chase Sapphire.

  • Discover It* (annual fee: none). This credit card is very similar to the Chase Freedom card, as it gives 5% cashback in rotating categories (such as Amazon, gas purchases, grocery purchases, drugstores, Paypal etc.), which change every quarter. There is no annual fee. Even though, there is no foreign transaction fee, this card is not very useful when used internationally, because the Discover card network is predominantly used in the US. In summary, this card is nice to have and together with the Chase Freedom card you will often cover several purchase categories to receive 5% cashback or more.

Taxation of credit card bonuses

Most credit card signup bonuses have the requirement of spending a certain amount with the respective card, such as spending 3,000 USD within the first three months after opening the card to receive bonus points worth roughly 500 USD. According to US income law, the respective bonus counts as a rebate/discount (of the respective larger purchase amount) rather than income or gain. It is therefore not taxed. Technically, this requires of course that the purchases themselves are not reimbursed tax free by a third party.

The same rules apply to cashback. If you collect cashback, when spending money with your card, you are still spending money and do not have an overall gain. Therefore, you will not be taxed on your cashback. The situation changes if you receive tax-free reimbursement. For example, if you pay 1,000 USD for a flight, which is then reimbursed by your employer with 1,000 USD and you received reward points worth 45 USD, you technically made a profit of 45 USD, which would be taxable as income. However, in many situations employers do not reimburse all travel expenses which they could (such as full per diem or other incidental expenses), so that any cashback profit would not be taxable as long as the total reimbursement is below the allowed tax-free maximum. You would only need to take cashback into account if you also declared losses (instead of taking the standard deductions on your tax return), in which case you would need to calculate accurately.

In general, you should check the tax laws of your respective country yourself, but will probably find that credit card cashback is a slightly unusual case that is often ignored by both taxpayers and tax authorities. In the end, it is your responsibility to declare your taxes accurately.

About the social issue

The US credit card system is extremely unfair and screwed towards the wealthy or at least towards the financially literate. There have been studies indicating that the existence of credit cards lead to an effective transfer of wealth from the poor to the rich. You can read more about it here. In summary, one needs to consider the following aspects:

  • Access to cards. High profile credit cards are only open to people with sufficiently large income and a good credit history. People with bad credit score or low income will often not be able to get good cards or even bank accounts, which means they need to pay mostly cash. If the stores need to price in credit card transaction fees, they will raise the average price of product. Customers paying with credit cards can often recoup this price difference by collecting rewards

  • Merchant fees and cashback. Every purchase using a credit card incurs a merchant fee in the range of 2-3% (in the US), which if you buy a 1000 USD iPhone, your electronic store will only keep 970-980 USD, while 20-30 USD are split between your bank and the payment network (Mastercard, VISA, American Express, Discover). Consequently, merchants will adjust their prices: If half of the customers pay by card with average fees of 2%, the merchant will need to raise prices by 1% in comparison to a scenario in which everybody pays cash. Of course, things are more complicated, because merchants may also benefit from the fact that many credit card may be more likely to spend money than cash users with more transparent overview over their spending.

  • Interest rates and signup bonuses. High profile credit cards promise huge sign up bonuses and significant cashback amounts. The banks do this, because they hope to do other business with them (invest your money, sign up for insurance, finance your house mortgage) and because they hope that you will sometimes carry a balance, so that you will pay ridiculous high interest rates of 20-30 per year. Basically, this means that people who are poorly organized or like to live of credit will pay large amounts of interest, which in turn will allow the banks to make the sweet signup offers.

In summary, you should make your own decision if you want to participate in this system. It may make sense to benefit from the system as it is now, but at the same time support an overall change to the better.

Further resources

  • DoctorOfCredit.com. This is an excellent resource on recent updates / changes of US financial products (credit cards, bank accounts, airline miles etc.).