If you want to buy a home, finance a car or borrow money to start a business, bad credit can get in your way. It can also prevent you from getting a credit card. And without a credit card, it becomes infinitely harder to show you can use credit responsibly and improve your credit. But you still have options. By qualifying for a credit card intended for those with bad credit, you can start raising your credit score and improving your financial health.
Should you get a secured credit card?
One option is to open a secured credit card. With this type of card, the issuer will require you to open a savings account in its bank and deposit cash there before it will issue you a card. The issuer can use the funds in your savings account to satisfy payment obligations if you don't make your payments. With secured credit cards, you'll often pay higher annual fees and finance changes, and you might encounter other charges, such as application, maintenance or processing fees.
A secured credit card can help you repair your credit and establish a credit history to ultimately qualify for an unsecured credit card. Once you've proven yourself through a record of reliable, on-time monthly payments and responsible use of the secured card your card issuer may graduate you to an unsecured credit card. Or you can then successfully apply to another unsecured-card issuer.
The bar for approval of a secured credit card is set relatively low. Having a savings deposit as collateral means that card issuers willingly take on little or no risk in approving the card. Unlike approval for an unsecured credit card, the secured-card issuer won't overly concern itself with your credit score or lack of credit history.
A good payment history with a secured credit card is a proven way to establish or rebuild your credit history and score, assuming the issuer doesn't keep that history to itself. "It's important to check with the secured-card issuer to confirm that it reports payment activity to all three of the major credit bureaus," says Bruce McClary, Vice President of Communications of the National Foundation for Credit Counseling in Washington, D.C. "It's not safe to assume that all will regularly report your payment activity."
The lowered credit limit of secured cards also forces you to restrict your expenses and do away with frivolous spending. If you're shopping for attire for an upcoming wedding, you'll think twice before dropping $200 for an outfit and consider searching instead for an equally flattering option from your existing wardrobe or a gown from a second-hand store.
The downsides of a secured credit card
You need upfront cash to open a secured credit card, which may be a challenge in itself. And once you do provide it, you won't be able to access the funds if an emergency arises (except through your credit card). Even after you close your secured-card account, the company usually requires a waiting period before it releases the funds.
The Credit Card Act of 2009 prohibits fees from exceeding 25 percent of your deposit in the first year, but secured credit cards' multiple fees annual fees, application or processing fees can quickly add up. Interest rates on these cards are also much higher than unsecured credit cards. Don't be shocked to run into rates higher than 20 percent.
The credit line on a secured credit card generally is limited to several hundred dollars, a small fraction of the available limit on an unsecured card. A credit limit of $300 might prove inadequate, especially if this is your only credit card. The limit may barely cover your grocery expenses.
How to shop for a secured card
When it comes time to shop for a secured credit card, it pays to do your homework and carefully review offers. Avoid falling prey to the many marketing scams that target consumers who have difficulty getting approved for credit cards. Less-than-reputable companies know that consumers with poor credit or inadequate credit histories are more likely to overlook red flags.
Getting a card through a well-known bank Bank of America, Chase or Capital One, for example or a local credit union can help you avoid unscrupulous practices. Don't let a celebrity or financial guru endorsement convince you to lower your guard. Do your homework and check card fees and terms. And avoid offers that try to lure you in with promises of guaranteed or immediate approval.
Can you qualify for an unsecured credit card?
An unsecured credit card is the most common type of credit card. But because unsecured credit cards offer credit limits that aren't backed up by collateral (cash deposits), you generally need at least fair credit (a FICO score of 580669) to qualify. These scores are loose guidelines, however, and each card issuer has its own qualification rules.
"The selection is limited for those with low credit scores who are shopping for unsecured credit cards," says McClary. "The key is to shop competitively to get the best deal on interest rates, fees and rewards based on what is available."
There are several types of unsecured credit cards, including rewards credit cards (such as travel credit cards and cash-back cards) and low-interest credit cards. Typically, cards that offer "free stuff" have higher interest rates and often require higher credit scores to qualify. Some card issuers offer cards to people with lower qualifying credit scores, but these cards usually have higher interest rates and few benefits.
Use your card to boost your credit score
Whether you have a secured or unsecured card, using it responsibly will help you boost your credit score while avoiding fees, penalties and unmanageable debts.
The most important thing you can do is pay your bills on time. Paying on time is one of the key factors in building up your credit. You can better ensure that you don't miss a payment deadline by setting up an automatic reminder on your phone, whether through a text, email or app reminder. Even better, set up an automatic payment system.
You don't want to depend too much on your card, but you don't want it to collect dust in your wallet, either. Issuers of credit cards want to see that you can use credit responsibly. Not using the credit card at all does little to create a credit history. Aim for some credit activity on your card in every billing cycle. Every instance of card use (and subsequent payment) triggers a report from the credit card company about your responsible behavior to credit bureaus.
Every card has a maximum credit limit. Ideally, you should never come close to maxing out your cards. Credit card companies become nervous if they see you use too much of your available credit, because it indicates a higher debt-to-income ratio a sign that you are taking on too much debt in comparison with your income. A good rule of thumb: Try to make sure your monthly balance is less than half of your maximum credit. For a better credit score, keep that balance to less than 20 percent of the maximum.
A less-than-optimal credit score can definitely complicate life, but that number is not etched into stone. Use credit wisely, and you'll eventually have a score to be proud of.
Your Credit History. Consumer.gov. https://www.consumer.gov/articles/1009-your-credit-history
You Don't Have Enough Credit History and Want to Build Your Credit Record. Consumer Financial Protection Bureau. https://www.consumerfinance.gov/consumer-tools/credit-reports-and-scores/not-enough-credit-history-build-credit-record/
Secured Credit Cards. Georgia Consumer Protection Unit. http://consumer.ga.gov/consumer-topics/secured-credit-cards