Credit cards might be the reason you have bad credit (or at least one factor), but they can also be the reason you begin to improve your credit once you are back on your feet again financially. Knowing how to use credit cards to improve your bad credit can help you get a better interest rate on your next car loan or mortgage and improve your overall credit score.
Most New Credit Cards Will Be Off Limits
Credit card issuers look at credit scores when deciding whether to issue credit, and a low score will mean that most of them won’t give you a card. Why? Because a low score means that you have been delinquent on other credit payments in the past, and brands you as more likely not to pay on time in the future.
Sure, you may have turned over a new leaf and be fully able and even determined to pay your bills on time now, but credit card issuers have no way of knowing this. According to their statistics, you are a bad risk, and they can’t make money extending credit to bad risks. Each company has its own criteria, but generally, you will have a very difficult time getting an unsecured credit card with a credit score of under 600, and some may decline you even if you have higher scores, depending on other factors like how much other available credit you have.
The simplest way to build good credit is to pay your bills on time and keep your balances low. One thing you can try is to get a store credit card, which you can only use to make purchases at a particular store or the store’s chain (SAM’s credit cards can be used at Walmart because they are both owned by the same parent company, for instance). Store credit cards often have different requirements for credit scores than other issuers, and in some cases, consumers with credit scores in the 500s can still qualify for a card. The limit on the card is likely to be small, but the same methods for improving bad credit can be used with a store card as for an all-purpose Visa or Mastercard.
Unsecured vs. Secured Credit Cards
Unsecured credit cards are the kind most people have–the card issuer sets an interest rate, a credit limit, and allows you to charge purchases on the card and pay a minimum monthly payment. When this type of card becomes off-limits because of a low credit score, however, there is another option: getting a secured credit card.
Secured credit cards require the cardholder to give a deposit in order to “secure” the card. The deposit can be a percentage of the card’s limit, or in some cases, the entire limit. Requiring a deposit makes issuing the card less of a risk because the deposit can be used if cardholders default on payment.
Secured credit cards are generally available to those with bad credit, with the amount of the deposit required being determined by the credit score. Secured cards may also require an application fee, but should not have other fees. Secured cards will almost always have high-interest rates, usually over 20 percent, but these will only apply if the card balance isn’t paid off each month.
Those with extremely low credit scores because of bankruptcy, foreclosure or government loan default may not qualify for even secured credit cards. In these cases, the only cure for bad credit is time. Most delinquencies reported to credit bureaus only stay on your credit report for 7 years, although a few types of student loans can stay on the report until they are paid off.
Cards To Avoid
Subprime credit cards, also known as fee harvester cards, may charge so many fees that they eat up most of the credit limit on the card. Although issuers are supposed to be limited to charging only 25 percent of the credit limit in fees, some have gotten around this limit by charging a fee before the account is even opened. You should always find out what fees there are for a particular card before opening an account.
Prepaid credit cards, those purchased for a particular amount, which then becomes the limit on the card, should also be avoided when trying to build credit. This is because prepaid cards are not reported to credit bureaus and have no impact on your credit score.
How To Use Secured or Unsecured Credit Cards to Improve Bad Credit
Whether you are able to get an unsecured or a secured credit card, it’s important to follow certain steps if you want to improve your credit score.
1. Use the credit card each month.
Some experts suggest using 30 percent or less of your credit limit, while others say it doesn’t matter how much of your credit limit you use. The point is, you can’t build credit just by having it, unused. For a while at least, you will need to make purchases with the card in order for your credit score to improve.
2. Pay off the balance by the due date.
It won’t help your credit score if you pay your credit card late or don’t pay it at all. The good news is, you can use your credit card to buy things you would normally buy anyway, like food at the grocery store. You can even use a credit card to make payments on many of your monthly bills, which should make it easy to pay off the balance each month. With many cards, you can also set up automatic payments to ensure that you will never be late on a payment.
3. Pay all of your other bills on time.
Having an unsecured credit card won’t improve your credit score if you pay other bills late or default on them. Paying just one bill late or not paying it at all can result in up to a 100-point drop in your credit score if the delinquency is reported to credit bureaus, and delinquencies will stay on your credit report for up to 7 years unless you pay the debt off before then, so it’s important to keep up with all your debts while trying to improve your credit score.
How Long Will It Take For Your Score to Improve?
About 6 months of on-time payments are typically required before credit scores begin to improve. After 6 to 12 months of on-time payments, you may qualify for an unsecured card or an increase in your credit limit. This will not affect your credit score directly, but can enable you to get your deposit back and pay less in fees.
How Much Can You Improve Your Credit Score?
Some consumers have reported a 100-point improvement in their credit score after 6 months, while others see a more modest increase. There are many factors involved in calculating a credit score, so the amount of improvement you see may depend on how many delinquencies you have and how much other credit you have available to you. It may also take more than 6 months to see significant improvement.
Chances are that your credit didn’t get bad overnight, and it won’t improve that quickly either in most cases. Still, credit cards can be a useful tool in repairing bad credit, along with other steps like paying off recent delinquencies whenever possible and having mistakes removed from your credit reports.
What if You Already Have Credit Cards?
If you already have credit cards and want to improve your credit score, you can do so by paying your balances off, or at least getting them down to about 30 percent of the available credit. If you can get issuers to increase your credit limits, this may improve your score by making it look like you are using less of your available credit, but it may not have much of an impact because credit bureaus also weigh the amount of credit you have available.
If you seem to have a lot of credit available compared to your income, it may lower your score and cancel out the benefit of any decrease in the percentage of credit you are utilizing. In addition, most credit cards will not increase your credit limit if your credit score is low.
If you can’t pay down your balances in 6 to 12 months, even getting a secured credit card may not create much of an increase in your credit score. That said, it’s probably worth trying. Even a 20 point increase in your credit score can result in a loan approval or a better interest rate.
Some companies now offer credit card consolidation loans that can help you pay down these debts with a lower interest rate than credit cards offer and a lower monthly payment. The consolidation loan company often pays off the credit cards for you and in some cases closes the accounts, which can have a mixed effect on your credit score but should ultimately improve it.
Getting a consolidation loan and then starting over with a secured credit card may be the best option when you have high credit card balances you can’t quickly pay down. Just beware of companies that tell you they will “settle” your debt by paying only part of it. These programs typically do not result in an improved credit score because accounts that are settled are not reported to credit bureaus as favorably as those that are paid off in full.
Improving your credit score is not an easy fix for financial problems, but it can be useful when you want to buy a house or car and don’t have the ready cash to do so. With a little time and effort, you can usually see some improvement and get into a better position financially, with the added benefit of improved handling of your day-to-day finances as well.