[Editor's Note: Sometimes I forget some of the basic levels of financial trouble that some people have. Today's article fills a gap in addressing how people can get good credit when they don't have good credit.]
Credit cards can be useful, but they can also be dangerous. Because they make lines of credit readily available, if you don’t have strong spending habits, it’s easy to spend yourself into a deep financial hole that can take years to get out of. If the hole is deep enough it will not only impact your current finances, it can also affect your ability to get future credit, and even affect your job prospects.
Because of the risks associated with credit cards, it might seem odd that some financial experts recommend that people with credit problems use credit cards to rebuild their credit. As strange as it sounds, the practice can actually work quite well as long as you do it properly.
Get a Secured Card
There are two main types of credit cards: secured and unsecured.
With a secured card, you have to make a deposit to your card and all or part of the deposit applies toward your credit limit. The deposit acts as collateral against you defaulting on your balance. If you do default, then lender keeps the deposit.
With an unsecured card, the lender simply gives you a credit limit and expects you to pay it back if you use it to make purchases. If you have a spotty credit history, it can be very difficult to get an unsecured card because the lender would need to be able to trust you.
Secured cards function just like unsecured credit cards. You can make purchases, you have to make monthly payments on the balance, and you will also have interest and finance charges. The most important part is that, just like a regular card, the credit card company reports your payment and spending history to the credit reporting agencies.
Secured credit cards are not the same as pre-paid debit cards. Prepaid debit cards essentially function like electronic checks and withdraw money from your checking or savings account. There is no credit involved, you don’t have to make monthly payments on the balance, and the bank does not report anything to the credit agencies. Debit cards give you some of the convenience of credit cards, but they won’t improve your credit score.
Determine How You Will Use the Card
In order to build your credit, you have to actually use the card and make regular payments. If you just sit it, it won’t prove to the creditor that you can be responsible. However, you don’t want to go nuts with your spending either. The amount of your deposit will put some limits on your spending, but if you don’t have a clear plan for how you will use your card, you could end up back in the same boat.
One suggestion would be to designate that card for a specific expense, such as your cell phone bill or gas or groceries. You would use that card solely for that expense and stick within a budget.
The point of having the card is to rebuild your credit, not to spend, so it’s a good idea to use an expense that you would normally pay out of your checking account, and which is much less than the credit limit on your card.
Pay Off the Balance Each Month
Although secured credit cards give you the option of making a minimum payment each month, paying the balance in full will go a long way toward improving your credit rating. If you can’t pay the balance in full, then you should at least make more than the minimum payment each month; and make sure you make those payments on-time, or even early. Even one late or missing payment can undo all of your hard work.
If you find that you can’t keep up with the payments, or that you are not able to pay off the total balance within three months, stop using the card until you can catch up and zero out the balance.
Keeping a balance on the card for long periods of time can actually hurt your credit, and it will also cost you more money in interest and fees.
Keep Track of Your Credit Report
Credit card companies report to all of the agencies every month. Sign up with a credit monitoring service so that you can keep track of your rating and see what the credit companies are saying about you. There are free services like Credit Karma, which are pretty much do-it-yourself; there are also companies that offer a range of credit services for a fee.
Whether you decide to go with a free service or a paid service, you should always check the consumer reviews of credit repair companies to see what their customers think of them. You should also check industry rating sites to see how they rank against the competition.
You can also contact the companies directly to get their list of products and services, and to determine if they offer what you need; some companies just monitor your credit report while others can actually work with you to help rebuild your credit.
Switch to an Unsecured Card
Once you have gotten the hang of using your credit card responsibly, and making timely payments, you can then graduate to an unsecured card. Some companies might even allow you to convert your existing secured card to an unsecured card, and might even refund all or part of your deposit.
Switching to an unsecured card shows the credit reporting companies that the lender trust you, which can raise your credit score.
Don’t let yourself fall back into old habits, however. Once you switch, you need to maintain the momentum and keep making wise spending decisions and paying off the balance.
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