February Financial Fitness Challenge--Secured Cards Help Establish Creditworthiness
Susan Tiffany, CCUFC
/ February 8th, 2012
It's a classic Catch-22 of personal finance: You have to have a credit history to qualify for credit. And, you have to have credit to build a credit record.
Similarly, if you've dinged up your credit record with careless habits, it's hard to qualify for credit. Certainly, it's hard to qualify for credit at anything near a reasonable rate of interest.
One promising answer to both dilemmas is to apply for and then prudently use a secured credit card.
Secured card features
A secured credit card trades access to credit for your commitment to keep a certain amount of money in a savings account. In effect, your pledged savings secure the credit you're advanced.
In a typical fully secured card, your credit limit is the same as the amount of money in your security deposit in savings; for some cards, your available credit is less than the amount you pledge in savings.
Some accounts carry an annual fee that reduces the amount of available credit. For example, a $50 annual fee could reduce a $300 savings balance to a $250 line of credit on your secured card.
You'll find that interest rates for secured cards vary quite a bit, too—although, as usual, credit unions lead the pack for consumer-friendly cards. The consumer advocacy group Consumer Action, San Francisco, recently surveyed secured card issuers
and found interest rates ranging from 7.99% to 23.99%, along with a corresponding wide range of fees and annual costs.
The amount of money you keep in the savings account typically earns some interest, but not always. And approval is not automatic: You still could be turned down for a secured credit card if you've been through a recent bankruptcy or been delinquent on other loans.
Having savings is your best defense against needing to rely on credit to cover emergencies.
Secured card benefits
The obvious benefit to having a secured card is that you have access to credit; that provides some flexibility in your budget. It helps to be able to use a credit card to take advantage of a special offer or when cash is tight.
And having an amount pledged in savings means you won't be depleting savings to cover unexpected expenses.
Of course, the key is to not fall into a credit pit with your use of the card. You still have to pay it off, ideally, every month or within a few months. No credit card—secured or conventional—works effectively if you use it to falsely raise your standard of living.
Another benefit to using a secured card is that you can build, or rebuild, your credit history. Make payments on time, consistently, or you'll undo all the benefits.
The ultimate payoff is that after, say, 12 months or so of on-time credit card payments, you'll have developed or redeemed your credit record and be eligible to apply for a conventional credit card.
When that day comes, leave your saved security deposit to continue growing; add to it regularly by using automated transfers from checking. You'll have achieved two major financial goals—establishing credit and
bulking up your savings.
Having savings is your best defense against needing to rely on credit to cover emergency expenses going forward.
Other paths to creditworthiness
A secured credit card is a variation on credit builder loans available at some credit unions. In those cases, you make payments on a short-term loan; the lender puts the payments into a savings account earning interest. When you pay off the loan, you get access to the savings. Here, again, the lender reports your payment record to credit reporting agencies.
As usual, credit unions lead the pack for consumer-friendly cards.
"Credit builder loans are offered as a way for credit union members to do a couple of things: get something good on their credit reports and set aside some money for future use," credit scoring authority John Ulzheimer points out in the New York Times
If you need to establish or rebuild your creditworthiness, talk to the people at your credit union. Whether or not the credit union offers a secured credit card or some similar type of credit builder tool, you'll get straight talk about your options and suggestions for moving forward.
Financial Fitness Challenge
The people at your credit union are serious about helping you achieve and maintain financial health. They bring you this website and other tools to help you make the most of your financial resources. The Financial Fitness Challenge continues to look at ways you can make better financial habits no matter what condition the economy is in.
Susan Tiffany, CCUFC