7 Steps for Building Top-Notch Credit When You Haven’t Always Been Perfect
If you have bad credit or you don’t have credit at all, it can be tough to prove to lenders that you can be trusted with debt. A secured credit card is a great way to establish creditworthiness.
Here’s how a secured credit card works: You put down a security deposit, typically between $200 and $500, and that money becomes your line of credit. Because your deposit protects the issuer if you don’t make payments, you can qualify even if you have bad credit or no credit score. Once you’ve made about a year’s worth of on-time payments, you’ll typically qualify for a traditional credit card.
How Does a Secured Credit Card Work? A 7-Step Plan
Ready to give your credit a boost? Follow these seven steps and you’ll start building good credit in no time.
1. Save up for Your Security Deposit
Your first step is to save the $200 to $500 cash deposit that you won’t need to touch for a year. The reason it should be money you don’t need to spend is that to build good credit, you’ll need to pay off your bill in full every month. You need to keep that money open as a line of credit. If that’s not doable, try saving $10 or $20 a week until you have enough for a deposit.
2. Compare Credit Cards
The big things you’ll want to look for are:
- Low annual fee: Secured credit cards often come with high fees. Look for an annual fee of $35 or less.
- Low APR: APR stands for annual percentage rate, and it’s basically the interest rate and fees you’ll pay to borrow money if you carry a balance. Obviously, the lower the better. But since most credit cards offer a grace period on new purchases before interest kicks in, this shouldn’t be a factor if you’re paying off your balance in full each month.
- Reports to all three major credit bureaus. You’ll only build credit history if your card issuer reports your payment history to the credit bureaus. Look for a card that reports each month to all three bureaus: Equifax, Experian and Transunion.
- Option to convert to an unsecured card. Ideally, you’d want to convert your secured card to an unsecured card, rather than qualifying for a new unsecured card. One reason is that age of credit determines 15% of your credit score. If you get a new unsecured credit card and close your secured card to get your deposit back, your credit score will temporarily drop.
Make sure you apply for a secured credit card, rather than a prepaid debit card. A prepaid debit card won’t report your payments to the credit bureaus, so you won’t build a credit history.
3. Apply for Secured Cards
Once you’ve researched cards, you’re ready to apply. To get a credit card, you’ll need to provide some personal information, including your Social Security number and your employment status and income. Most, but not all, will also require you to have a bank account.
Applying for a credit card usually results in a hard inquiry to your credit report. If you have a credit score, this will probably cause your score to drop by a few points. No worries, though: It’s completely normal, and it’s also temporary.
Based on the criteria we spelled out above, here are some good secured credit card options. All information is current as of March 1, 2021. Terms and conditions can change frequently, so read the fine print before you apply.
Discover it Secured Card
- No annual fee.
- Minimum refundable deposit of $200.
- Reports to all three credit bureaus.
- After eight months, Discover will automatically review your account each month to determine whether you’re eligible to have your deposit refunded and switch to an unsecured line of credit.
OpenSky Secured Visa
- $35 annual fee.
- $200 minimum deposit.
- Reports to all three credit bureaus.
- OpenSky doesn’t require a credit check or a bank account, making it appealing to people with especially poor scores who have been rejected for other secured credit cards. You’ll still need to provide your annual income and your monthly housing payment.
Secured Mastercard from Capital One
- No annual fee
- You may be able to qualify for a $200 line of credit for a deposit as little as $49, depending on your credit.
- Reports to all three credit bureaus.
- Capital One will consider you for a secured credit line in as little as six months.
You’re less likely to be denied for a secured card than a traditional credit card because you’re putting down a security deposit. But there are still a number of reasons you could be denied, like a recent bankruptcy filing, a tax lien, having insufficient income to pay back debt or an extremely low credit score.
If you’re denied, the credit card company will need to tell you why in writing. You’re entitled to a copy of the credit report they used to make their decision. Dispute any information with the credit bureau if you don’t believe it’s accurate. Otherwise, you might want to apply for a card that doesn’t require a credit check, like OpenSky. If you have access to a local community bank or credit union, check to see if they have credit-building options.
What you don’t want to do is apply for a bunch of cards within a short timeframe, as each application will ding your score slightly. Negative credit information typically does the most damage to your score within the first two years, so simply waiting and applying again once more time has passed could be necessary.
4. Automate Your Payment
If you have trouble remembering to make payments, consider setting up automatic payments for at least the monthly minimum to be drafted from your bank account. You can usually do this online or by calling your credit issuer.
However, if you frequently overdraft or you often have just a few dollars left in your bank account as payday approaches, this isn’t a good option. A better move is to set up text alerts to remind yourself when the payment is due.
5. Charge One Small Expense Per Month
Start building your history by charging one small necessary purchase each month. Small is key here. You never want your credit utilization ratio, or the percentage of open credit that you’re using, to go over 30%.
If possible, keep it below 10%. Credit utilization ratio determines 30% of your credit score. Because you don’t know when your issuer will report your activity to the bureaus each month, follow these guidelines even if you’re sure you can pay off the balance in full each month.
6. Ignore Rewards Points
Some companies offer credit rewards points even for secured cards. But while you’re building credit, ignore them. Each point is only worth about 1 cent. If you let credit rewards influence your spending, you’ll quickly erode any benefits you earned.
7. Apply for an Unsecured Card
After you have at least six months of on-time payments, you should see improvement to your credit score. Within a year, you’ll probably qualify for an unsecured credit card. Celebrate your newfound creditworthiness by asking your card issuer if you can convert your line of credit to an unsecured line.
Just remember that all the same rules for responsible credit usage will still apply. You’ll still want to pay off your balance in full each month to avoid interest charges. Swiping your card at least once a month while keeping your credit utilization as low as possible will help you increase your credit score even further.
Rebuilding your credit isn’t easy. The payoff is huge, though. You’ll pay less in security deposits, and you’ll be prepared for a major purchase, like a car or home. Don’t expect any huge results overnight. But with a little diligence, you’ll be well on your way to building good credit.
Robin Hartill is a certified financial planner and a senior writer at The Penny Hoarder. She writes the Dear Penny personal finance advice column. Send your tricky money questions to [email protected].