You’ve decided it’s time to focus on building up your credit history. You’ve never had credit in your life, and you are very excited to start this new phase. You’ve done enough research to know what it takes to have an excellent credit score. So you tell yourself that once you get your credit card you’ll only use it for purchases you can afford, you’ll never miss a payment, you’ll keep a low balance-to-limit ratio, and all the other good stuff you’ve learned about building a healthy credit score.
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Armed with all this knowledge and confidence, you start exploring only major bank credit cards, such as Visa, American Express, Discover or MasterCard, because you already know these will help you move into the 700-score territory faster. You finally find the credit card that fits your needs perfectly — it has no annual fee, a low introductory rate, and it gives you tons of rewards for your purchases. It’s a no-brainer.
You quickly fill out all of your personal information, agree to the terms and conditions, and click “Apply.” Now there’s a brief waiting period. The bank is reviewing your information, and you’re anxious to find out how much your credit limit will be. You know it wont be much because you have no history, but you are OK with that. Once you implement your master plan, the bank will have no problem raising your credit limit.
“Sorry, at this moment we won’t be able to approve your credit application.”
This is the only message you get from the bank. No ifs, buts, or maybe, just a simple decline notice. There must be a mistake, you’ve done everything right, and you know you’d be the best customer they can possibly have, how dare them decline you!
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Unfortunately, banks don’t make decisions based on your good intentions. I know what you are thinking: This is harder than I thought. You need to show responsible use of credit to build a good credit score, yet it can be difficult to get a credit card or loan without a good credit history.
As with most things in life, it’s OK to think big but you have to start small. A great way to start is with a secured credit card, which is a credit card that is linked to a security deposit account as collateral. With this type of credit card, you’ll still have to demonstrate your ability to pay for your credit card charges. However, you may qualify even if you have little or no credit history.
Here’s how it works: You deposit money in a security deposit account as collateral. The amount of the deposit depends on your credit. If you have some credit history the issuer may just ask you for a partial deposit. In most cases, though, your credit line is equal to the amount you put in your deposit. Your security deposit provides banks the assurance that will pay them back.
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A common misconception with secured credit cards is that they are pointless since you are depositing your own money. Some may say you are better off with a debit card. However, keep in mind that a secured credit card offers you several benefits when it comes to building your credit history.
For starters, a secured credit card influences your FICO credit scores. Every time you make at least your minimum monthly payment, you are indicating to credit issuers and credit reporting agencies that you can handle credit. Additionally, merchants treat secured credit cards the same as they do other credit cards. That means you can use it to reserve a hotel room or pay for a car rental. You may not always be able to do this with cash or a debit card.
Lastly, after proving you are able to manage credit responsibly, the issuer may send you your security deposit back and qualify you for a traditional non-secured credit card with a higher limit. After a while, you may also start getting offers for other types of credit, such as mortgages and car loans. While debit cards are great tools for other reasons, they don’t have these credit-building advantages. So I like to think of the secured credit card as a savings account that builds your credit.
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