Photo (cc) by 401(K) 2013
This post comes from Jason Bushey, who writes about personal finance and credit cards daily on Creditnet.
I recently received this question from a Money Talks News reader:
I’m hoping to clean up my credit, and I’ve read that one way to do this is to build credit with a new credit card. Unfortunately, my credit score is pretty bad. Last I checked it was right around 600. So I have a feeling my options are pretty limited.
Would you recommend a secured card or unsecured card to improve credit? And can you speak to some of the pros and cons of each kind of card? Thanks in advance. — Ron A.
First off, it’s always great to hear from a Money Talks reader who is serious about improving his or her credit scores. The first step to a better score is taking action, so we applaud you, Ron.
Ron has read correctly that opening a new credit card account and using that card responsibly is one of the best ways for consumers to improve their credit scores. However, because consumers with bad credit are unlikely to be approved for the average credit card offer, their decision really comes down to two types of cards: secured and unsecured credit cards for bad credit.
Before we dive into the pros and cons of each category of card, it’s important to note that neither type of card offers 100 percent guaranteed approval. Even though these cards are designed for consumers like Ron with less than perfect credit, not everyone will be approved for these cards.
That said, they are the credit cards that are most likely to be approved for people with bad credit or no credit, and they promote themselves as such.
Here’s the good and the bad when it comes to secured and unsecured credit cards.
Secured credit cards
Secured cards are an excellent option for bad-credit consumers because their approval rates are extremely high and are more or less contingent on whether the consumer can provide the upfront security deposit required to open the account. Often, the deposit ranges anywhere from $200 to $500, is fully refundable, and essentially guarantees the line of credit provided by the card issuer.
The other pros of secured cards are plentiful: Their interest rates are often much lower compared with unsecured cards, and their annual fees are often quite reasonable.
The only minus is the deposit required to open an account. But, again, that money is fully refundable as long as your account remains in good standing.
Many national and local banks offer secured credit card options in-house. When you’re considering a secured card, it’s important to confirm that your payment history will be reported to all three major credit bureaus. If it is, then these cards are a great way to build and improve credit with on-time monthly payments.
Unsecured credit cards for bad credit
For consumers uninterested or unable to meet the security deposit requirement of a secured card application, the next option is an unsecured card for bad credit. Unsecured cards are free to apply for unless otherwise stated — some carry setup fees so be on the lookout for those — and otherwise act and function like an average credit card.
And yet, most unsecured bad-credit cards are considered well below average for a number of reasons, even for bad-credit consumers.
First, their interest rates are sky-high, going beyond the 30 percent threshold — and that’s not the penalty APR. They also tend to carry more fees than secured cards, including the aforementioned setup fees or even monthly fees, and their annual fees are also generally higher.
It’s not all bad. There are unsecured bad-credit cards out there that report to the major credit bureaus and can build credit the same way a secured card can, with responsible use and on-time monthly payments. However, it’s easier for a consumer who carries a balance with this category of card to get behind on the bill because of the sky-high interest and exorbitant fees. Because of this, the risk factor and the costs of these cards are often much higher than their secured counterparts.
I always recommend going the secured card route if you’re hoping to improve credit. They’re simply a better offer, and it’s important for consumers uneasy about putting down a deposit to consider it as an investment rather than a fee. With secured cards, you have the chance to get that deposit money back. The fees you’ll pay to carry an unsecured bad-credit card are nonrefundable, and can make snowballing debt a very real possibility if you carry a balance.
I’d suggest that Ron and other consumers in his situation get in touch with their bank to find out whether or not it offers a secured credit card option, as these are the best cards available for building or rebuilding credit.