Your credit score is one of those chicken and egg type of problems. If you want a good credit score, you need to show you're a responsible user of credit. But to do that, you need to have lines of credit – loans, credit cards, etc.
Buuuuut to get loans and credit cards, you need to have good credit. Yikes!
If you have no credit, you can establish a credit history by getting a store branded credit card, which often has lower credit requirements. Stores like giving you those cards because it's been shown that people spend more on credit. You have no history, which isn't ideal, but it's better than having a bad history.
But if you have bad credit, improving or rebuilding that credit is much harder. Many places won't give you a credit card if you have bad credit.
So what do you do?
You'll have to get a few secured credit cards, demonstrate good credit behavior, and wait for your credit to increase.
How Secured Cards Work
A secured card is like a regular credit card except you need to give a security deposit. The amount of that deposit will be based on your creditworthiness. The amount you deposit will also determine your initial credit line.
The deposit will sit in a separate account, usually earning zero interest, and it acts as collateral in case you fall back to your poor credit ways. That lets the bank cover themselves in case you become a risk but until then they will give you a line of credit.
It functions just like a credit card. You can use it anywhere you'd use a credit card, you make payments on it every month, and there is a credit limit. The only difference is that you have to make a refundable security deposit. Over time, some cards will give you higher credit limits if you make regular payments.
What's nice about some secured cards is that you get a lot of the same benefits as credit cards – like fraud protection, extended warranty, travel assistance, auto rental insurance, etc.
How Secured Cards Build Credit
Secured cards are credit cards too – they're simply “secured” by your security deposit. The card is, for all practical purposes, just like a credit card.
To rebuild your credit you need to do two things:
- Make on-time payments! That's pretty much the ball game – your credit score is a measure of your ability to repay your debts. You don't have to pay off the entire balance (though that's better than paying interest), you just have to make all the payments on-time. Do not miss one or be late!
- Use the card. If you open the card and never use it, that won't help either. You need to charge something to it, pay it off, and show you can go through the steps of being a responsible user of credit.
You should see a credit score increase in 6-12 months of good behavior. Eventually, once your scores improves enough, you can graduate an unsecured credit card.
The Best Secured Credit Cards
I recommend the Capital One® Secured MasterCard® or the Citi® Secured MasterCard®. These are two major card issuers, the MasterCard is accepted nearly everywhere, and neither will gouge you with fees – which are common with some secured card issuers. A good third option is the Discover it Secured card.
The Secured MasterCard From CapitalOne is Capital One's card for people rebuilding credit and has no annual fee. The refundable security deposit can be $49, $99, or $200 depending on your credit and that will result in a credit limit of $200 to $3,000 depending on how much you deposit. Once you make your first 5 monthly payments on time, they will increase your credit line. This is a solid card with no transaction fees (unless it's a cash advance, which you should never do).
The Citi Secured MasterCard has an annual fee of $0 and a refundable security deposit starting at $200. You can deposit up to $2500 and whatever you deposit becomes your credit limit. That money is held in a “Collateral Holding Account” for 18 months without interest. No transaction fees unless it's a cash advance.
The Discover it Secured Credit Card is a good option if the first two aren't available to you, it has the slight disadvantage of being a Discover card and not accepted at nearly as many places as a MasterCard. It makes up for it with a 1% cashback offer on every purchase, 2% at gas stations and restaurants. It has no annual fee and the minimum security deposit is $200 (your credit limit will match your deposit). After one year, they start reviewing your account to see if you can transition to an unsecured account – this can be a huge benefit.
If you can't get these cards, let me tell you how to evaluate a secured credit card because there are some scams out there:
- Watch all the fees. Card companies know that if you have bad credit, you have few options. So a lot of secured cards will be full of fees. An annual fee is almost a given (which is why I recommended the CapitalOne card – it has no fee, nearly unheard of) but you'll also have transaction fees for each time you use it. Avoid those cards unless you have absolutely no choice.
- Make sure the card reports information to the credit bureaus. Some cards don't extend you any credit and are simply glorified gift cards – do not use those. Double check that the card will help you build credit by reporting your activity to one of the three major credit bureaus (Equifax, Experian, TransUnion).
Here's a list of cards that might also fit the bill. I haven't vetted all of these but it's a good list to start your research.