I have some good news and bad news.
Let’s start with the bad news: A Federal Reserve study found that thirty-one percent of applicants were denied credit in 2019. The culprit? Low credit scores.
The good news? Fixing your credit is easy and some have even managed to raise their score by 277 points within six months. If they can do it, so can you. And I’m about to show you how.
If you have bad or average credit, like 44% of Americans according to Consumer Credit Review, having a secured credit card could help you in the following ways: It’ll improve your payment history, improve your credit utilization ratio, diversify your credit mix, and add to the length of your credit history, all of which have a significant and direct impact on increasing your credit score.
I’ll take you through everything you need to know to get started.
Secured Credit Cards Can Help Improve Your Credit Score
You’re probably familiar with the chart below. It’s a chart showing exactly how your FICO score is calculated.
For people with bad credit histories or “thin files,” finding a way to improve each category above can be difficult.
How are you supposed to improve your payment history, new credit, credit history, credit mix, and amounts owed when lenders won’t approve your applications or offer reasonable interest rates?
Unlike standard credit cards, you have to pay a small security deposit before you’re allowed to start borrowing money with secured credit cards.
But here’s the catch, your credit limit is only approved up to the amount you currently have in deposit.
So if you deposited $200 to open your account, your new credit limit is set at $200. If you withdraw $100, your credit limit will decrease to $100 until you repay the amount in full.
Good credit scores aren’t required, and you can apply online within minutes.
It’s a great way to get the ball rolling if you’re not happy with your score. Or if you want to start building a positive credit history if you’re considered “thin file” and worried about taking on additional debt.
So how does it work? We take you through a simple 7 step process in the next section.
How Do Secured Credit Cards Work?
If you’re interested in rebuilding your credit, follow this simple seven-step process to get started with secured credit cards:
1. Save up to pay for a security deposit on a new credit card.
Every secured credit card will require a deposit. With so much competition in the market, saving as much as $500 to open an account is no longer necessary. Many secured credit cards let you get started with as little as $50 – $100. Either way, you need to begin saving up. I recommend saving around $200 to get started and setting aside $10 or $20 a week to reach that target.
2. Compare different secured credit cards and find one that offers a good mix of benefits.
When it comes to secured credit cards, there are a few critical things to watch out for:
- Annual Fee: How much do they charge you per year to keep the account open? Many cards have chosen to waive yearly fees to encourage more people to apply, so keep looking for those options. According to a Consumer Credit Card Fee Study, nearly seventy percent of cards don’t charge an annual fee. Anything under $40 should be fine too.
- Total Cost: Interest rates are significant. And so are fees. That’s what APR calculates, the total amount you’ll pay on loan by adding the interest rate and any applicable fees to arrive at an annual percentage rate (APR). According to a study on credit cards, the average APR on credit cards was about 16.75 to 23.62 percent. The lower, the better. However, when you’re rebuilding credit, the goal is to pay off your balance each month, so you shouldn’t be in a situation where you’re paying interest on balances you’ve carried over from the previous month.
- Reporting Structure: What’s the point of using a secured credit card to rebuild your credit if they don’t report those payments to the credit bureaus? Some may only say to one but look for cards that report to all three: Equifax, Experian, and TransUnion.
- Option to convert your account to an unsecured card in the future: After a few months of rebuilding credit, you’ll want the opportunity to convert your account to an unsecured card in the future.
3. Apply for a Secured Credit Card
Your options are endless, and the offers keep changing. Once you find a card that reports payments to all three credit bureaus, has a low annual fee, APR, and allows you to convert to an unsecured card in the future, start filling out an application. They’re usually quick and require the following information:
Information About Yourself:
- Phone Number
- Email Address
Information About Your Income:
- Gross Annual Income
- Additional Income
Minimum credit scores aren’t required, but you could still be denied for the following reasons:
- Currently delinquent on other credit card debts.
- Bankruptcy filing.
- Tax lien.
- Insufficient income to pay back debt.
4. Automate Payments to Help You Pay On Time
It can be hard to remember all the payments you have to make every month. That’s why setting up autopay is so essential. When was the last time you manually paid for subscriptions like Netflix or Hulu? Probably never, right? That’s because they automatically deduct the subscription fee from your account each month. Great for them, but great for you too, because you don’t have to worry about paying on time. The same can be done with your bills. There is a small caveat: If you’re living paycheck to paycheck, you may risk going into overdraft if you put your bills on autopay.
5. Start Buying Things, but Keep Your Credit Utilization Low
The goal here is to build a positive credit history. You do that by purchasing items each month with your credit card while ensuring you keep your credit card utilization low. I recommend keeping it below 10%. So if your limit is $500, spend no more than $50 per month. Every time you pay off your balance, you’re improving your credit score.
6. Make Several Payments Each Month If You Can
Making several payments won’t help your score directly, but it could help keep your credit utilization low if you need to spend more each month.
7. Forget About the Rewards
Don’t get tempted with rewards like cash back on purchases. They may seem appealing, but spending too much on your card each month could mess with your utilization ratios and harm your score in the process.
Secured vs. Unsecured Cards
Rebuilding your credit takes time, and there aren’t any shortcuts. After six months to a year of paying on time and keeping your utilization ratio low, you should be able to qualify for an unsecured credit card!
Here are some of the key differences between secured and unsecured credit cards:
Building Credit With Secured vs. Unsecured Credit Cards
Both types of cards report payments to credit bureaus, and the principles of building credit don’t change depending on which card issuer you choose.
Ultimately, if you continue making payments on time, every time, and keep your credit utilization below 10% – 30%, you’ll be on track to building credit regardless of which type of card you wish to use.
Building Credit With Secured Credit Cards: What Not To Do
I was having a look around reddit when I came across this story:
Six months prior, he didn’t have a credit score, and decided to place a $200 deposit on a secured credit card to help improve his score.
After buying a $1,280 computer with a $2,000 credit line from a PC manufacturer, he was shocked to discover that his credit score dropped from 697 to 589.
Why did his score drop by 108 points? Two words: Credit Utilization.
Remember how we talked about keeping your utilization ratio within 10% – 30%? The reason why is because if you don’t, your credit score will drop. Algorithms think that high credit utilization ratios mean that you’re struggling financially and a higher risk of defaulting.
You can learn from his mistake by avoiding large purchases on credit and being diligent about keeping your utilization ratio as low as possible.