If you're new to credit and have not yet established a credit history, it can often seem impossible to find a lender willing to approve you for a loan or a credit card. It's a bit of a Catch-22 --- lenders want to see your credit history and how well you've managed credit obligations in the past before they'll extend new credit, but how do you get credit if you don't have credit? It's a frustrating dilemma that most of us face at some point in our lives. Fortunately, one of the easiest ways to establish credit and get a credit card without credit is to start with a secured credit card.
A secured credit card works much like a traditional credit card except that you open the account by making a cash deposit to "secure" the card. The credit limit on a secured card is equal to the cash deposit, which acts as collateral and minimizes the bank's risk in the event that you don't pay the bill. For example, if you deposit $1,000 for a secured card, your credit limit on the card would be equal to $1,000. Most secured cards can be opened with as little as $200, or as much as $2,000.
If you're opening a secured credit card for the purpose of establishing credit there are a few things you need to be aware of. First, secured cards often carry high interest rates and annual fees, so they're not something you'll want to use long term. The goal is to establish and build good credit, after which you'll want to convert to a traditional credit card with lower interest rates and better terms.
Second, not all secured credit card issuers report to all three credit reporting agencies. Because you're establishing credit for the first time, you want to make sure the card is reported to all three credit reporting agencies. Before you choose a secured card, make sure the issuer reports to all three of the credit reporting agencies so that you're getting credit for managing the account responsibly. Remember, if it's not in your credit reports, you won't get credit for the account and it won't help you establish and build great credit.
The purpose of opening a secured card is to establish good credit, and how you manage the account will determine whether you do that. To insure that your secured credit card will help you build great credit, you'll want to stick to two primary rules:
Your payment history accounts for 35% of your credit score, and paying late or missing payments can have a detrimental impact on both your credit reports and your credit scores. This may sound obvious but the first step to establishing great credit is to make your payments on time, every time -- no exceptions.
A significant portion of your credit score factors in the percentage of your balance in relation to your credit limit on your credit cards (often referred to as your revolving utilization). In short, the lower your revolving utilization, the better your credit score, which means you'll want to keep your balances to a minimum.
Keep in mind that secured cards often have very low credit limits, so even a balance of just a few hundred dollars can often wreak havoc on your credit scores. To earn the maximum number of credit score points, you'll want to limit your credit card spending to no more than 10% of your credit limit. As an example, if you have a credit limit of $1,000, you would want to keep your balance from going over $100. (Even if you pay it off every month, you wouldn't want the balance to go over $100 if your primary goal is to boost your credit scores.)