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 also can prevent you from getting a credit card. And without a credit card, it becomes infinitely harder to show responsible credit use and improve your credit over time. But you still have options. By qualifying for a credit card intended for those with bad credit, you can get on the path toward raising your credit score and improving your financial health.
What are Your Credit Card Options if You Have Bad Credit?
You're not out of luck if you don't have good credit. If you need plastic, here are the different avenues you can take:
Secured Credit Cards 101
With a secured credit card, the card issuer will require you to open a savings account and deposit a cash amount 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.
Pros & Cons of Secured Credit Cards
pros
Easy Approval
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.
Build or Rebuild Your Credit
Good payment history with a secured credit card is a proven way to establish or rebuild your credit history and score. Knowing from the outset that 12-24 months of on-time monthly payments may make the difference in your qualifying for an unsecured credit card is motivation to exercise discipline in your credit card behavior.
Lock Down Your Credit Limit to Eliminate Overspending
The lowered credit limit of secured cards forces you to restrict your expenses and do away with frivolous spending. If you're shopping for attire for an upcoming wedding you'll be attending, 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 thrift shop.
Cons
Must Save Enough for a Deposit
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. Even after you close your secured-card account, the company usually requires a waiting period before it releases the funds.
High Fees and Interest
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.
Low Credit Limit Might Be Too Low
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, considering that the monthly food cost for a woman 19-50 years old averages $259.
11 Must-Haves in a Secured Credit 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.
Look for these 11 features as you shop for a suitable secured credit card:
Many secured credit cards charge annual fees — around $40 is typical — and sometimes even monthly fees. However, there's no law requiring credit card issuers to charge annual fees, and there are enough issuers that don't charge them that you should be able to find a card with no or low fees.
As part of your goal to create a positive credit history or improve your credit score, plan on paying off balances in each billing cycle. However, you'll want a low interest rate if you occasionally find yourself unable to pay off the full amount and must carry a balance to the next cycle.
Look for a cardholder agreement that specifies the qualifying time to convert your secured credit card to an unsecured card. Many card issuers are up front about the time requirement — often this is a good-standing payment history for 12 consecutive billing cycles — after which time you can apply for an unsecured card.
Not all secured-card issuers report payment histories to the three major credit bureaus — Equifax, Experian and TransUnion. Look for an issuer that reports payment history to all three bureaus. Without it, you won't see any changes to your credit history or credit score. Some companies only report negative payment history, such as late payments, so you need to determine whether the card issuer will report complete payment history. Also, keep in mind that some companies, in reporting to the credit bureaus, will specify your card as secured.
Determine how your card company calculates your card's credit limit, which is based on the amount of your savings deposit — the collateral. Many card issuers provide cards with credit limits equal to 100 percent of the deposits. In other words, if you deposited $500 to get the card, your credit card limit would be $500. Find out if your credit card issuer will allow you to increase the secured amount over time and allow you to deposit more funds into your secured savings account.
The billing grace period is the time from the date the card issuer sends the bill until the payment is due. By law, the billing grace period must be 21 days or more. Choose a secured credit card that offers an interest-free grace period, so that you can repay your bill in full each month without incurring an interest charge.
Look for a credit card that does not restrict your card use to certain types of purchases.
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.
Although it's not required by federal law, some card issuers pay interest on the savings account deposit backing the credit card. This is a nice bonus, but keep in mind that interest rates on saving accounts today are near zero — so don't expect to make much extra money.
You can benefit from a secured credit card that offers extra perks, such as travel insurance, extended manufacturers' warranties on purchases and free FICO credit score reports to help you build your credit score.
Unsecured Credit Cards for Bad Credit
An unsecured credit card is the most common type of credit card. But because unsecured credit cards offer credit limits that aren't secured by collateral (cash deposits), you generally need at least fair credit (a FICO score of 580-669) to qualify. But these scores are loose guidelines, and each card issuer has its own qualification rules.
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 typically have higher interest rates and few benefits.
Common Questions Answered
Bruce McClary
Expert
Bruce McClary, Vice President of Communications, National Foundation for Credit Counseling for Credit Counseling in Washington, D.C., answers some common questions about unsecured credit cards for consumers with less-than-stellar credit.
Are there many unsecured credit cards that accept applicants with fair credit?
The wider range of options goes to those with the best credit scores, but that doesn't mean the well is dry. The key is to shop competitively to get the best deal on interest rates, fees and rewards based on what is available.
Are there any unsecured credit cards that will accept applicants with lower-than-fair credit?
As is the case with card availability for those with fair credit, the selection is limited for those with low credit scores who are shopping for unsecured credit cards. Credit perks such as reward points are also scarce among the unsecured credit options for people with low scores.
If the issuer of an unsecured credit card accepts someone with fair credit, should consumers expect to see higher interest rates and/or lower credit limits for that card than what would be offered to a consumer with better credit?
Those with fair or average credit should be prepared for interest rates that are not the best available. Right now, the average annual interest rates are around 15 percent on cards issued to those with fair credit. Responsible use of these cards can contribute to credit score improvements that open the door to lower interest rates in the future. The assigned credit limit may start at a lower point than requested, but it can be increased as you establish a record of responsible debt management over time.
What red flags should credit card shoppers with poor or fair credit look for in unsecured credit card offers?
While annual interest rates can be expected to be 15 percent or higher, consumers need to be careful when it comes to other fees. Some subprime credit cards are notorious for having a wide range of high fees. This is why it is important to read the cardholder agreement and terms of use before applying for an account.
If someone has fair or poor credit, would that person be better off getting an unsecured credit card (if approved) or a secured credit card? Will one affect a person's credit score more positively than the other?
This is a decision that should be based on a number of factors, all relating to the costs and benefits that would be the best fit for the consumer. A secured card requires a cash deposit, so this would have to be something the cardholder's budget could afford. It is also important to check with the secured-card issuer to confirm that it reports payment activity to all three of the major credit bureaus. It's not safe to assume that all will regularly report your payment activity. A significant convenience of a secured card is that no credit check is required for approval. This is best for someone who may not qualify for any unsecured line of credit. If payment activity is reported by the credit issuers, both secured and unsecured cards could be expected to have similar impacts on a person's credit file.
How to Use Your New Credit Card to Improve Your Credit Score
Responsible use of your credit card builds up your credit score and history. Specific behaviors promote the credit-rebuilding process a lot more effectively than others. Following these best practices with a secured or unsecured card can help you improve your credit.
The importance of on-time payments may seem obvious,, but it's important to stress that long-term compliance is essential to a good credit score. It's 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. Alternatively, you can set up an automatic payment system.
Potential 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. You should aim for 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.
Credit utilization, which is how much of your credit limit you are using at a given time, factors into your credit score. 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 — that you are taking on too much debt in comparison with your income. If your credit limit is $500, limit your credit card charges to no more than 50 percent, or $250, for each billing cycle.
Credit card companies also want to see that you've managed your finances responsibly enough to be able to pay off your balances. Make sure you demonstrate your responsible behavior by paying off your balance in each billing statement.