How to rebuild credit with credit card

If you have bad credit, a limited credit history or a recent derogatory mark on your credit report, you might have trouble applying for many of today’s top credit cards. But there is another way for you to prove that you can handle credit responsibly—a secured credit card.

Secured credit cards give you access to a small line of credit in exchange for a security deposit (usually the same amount as your credit limit). Since you’re securing the line of credit with your own money, lenders are often comfortable issuing secured cards to people who have little to no credit or who are recovering from financial setbacks like bankruptcy.

We spoke to three cardholders who discovered just how big a difference a secured card with a small credit limit can make.

Here’s what they learned as they used secured cards to build their credit history and improve their credit score—and what you can do if you’re ready to do the same.

How to use a secured credit card

Before we jump into how exactly secured credit cards can be a useful tool when working to rebuild credit, let’s understand how to use a secured credit card.

1. Choose the right card. A secured credit card isn’t designed to be used for everyday expenses, so the factors to consider when choosing the right card will differ from a standard unsecured rewards credit card, for example. Ideally, you are going to want to find a secured credit card that does the following: reports your account activity to the credit bureaus, requires a reasonable security deposit, offers a path to upgrade and doesn’t have outrageous fees.
2. Pay the security deposit. After you apply for a secured credit card and get approved, make sure to provide the security deposit. You are not authorized to use the credit card until you pay the deposit within a certain time frame.
3. Use the card. Once you pay your security deposit, you can start using your secured credit card, but use it wisely. Avoid maxing out your credit card and keep your balance low to maintain a good credit utilization ratio.
4. Pay your balance on time and in full. The point of a secured credit card is to build strong credit, so the best way to go about this is by practicing solid habits. You can start by always paying your balance on time and in full every month.
5. Graduate to an unsecured credit card. It varies by issuer, however, some secured credit cards automatically graduate to traditional unsecured credit cards after you establish a history of on-time monthly payment.

A secured card is an opportunity to show responsible credit habits

Jessica Clark, who runs a cooking blog, Gluten Free Supper, and her husband turned to secured credit cards as a way to dig themselves out of a bad credit hole. “My husband and I had to file Chapter 7 bankruptcy about seven years ago,” Clark said. “We really wanted to purchase a home, but knew that would be next to impossible with having just filed bankruptcy and having bad credit.”

“I applied for a secured credit card and added my husband as an authorized user,” Clark said. “We used our cards regularly, making sure to keep our usage under 30 percent.” This strategy helped them earn the financial freedom to escape a rental market that required them to move nearly every year.

While Clark was working to improve her bad credit, Sam McRae, an injury attorney in Georgia, was in the position of not having any credit history at all. “I was taught to pay everything with cash by really frugal parents,” McRae explained. His cash-only spending had left him with no visible credit file. “After law school, I realized that I didn’t have enough credit to get a loan or a credit card.”

He, too, turned to a secured credit card. Both Clark and McRae were able to use secured credit cards to prove they could use credit responsibly—and both were able to quickly build their credit scores as a result.

Once lenders are able to see you can handle a secured credit card without overspending or missing payments, they will be more likely to increase your credit line, refund your security deposit or give you the opportunity to apply for an unsecured credit card.

Even a small security deposit can make a big difference

When you take out a secured credit card, lenders require you to pay a security deposit. This helps protect the lender if you aren’t able to pay your credit card balance. Most secured cards match your credit limit to your security deposit.

Brian T. Edmondson, founder of Bankruptcy Recovery Foundation, started to rebuild his credit after bankruptcy with a $200 security deposit on a card. But many secured cards allow you to put down even less collateral. For example, the Capital One Platinum Secured Credit Card allows you to start with a deposit as low as $49.

In some cases, you won’t even need to come up with the money in advance. “The secured cards that I used did not require a security deposit upfront,” Clark explained. Instead, the first statement for each card would include a fee in the amount of the security deposit. “I didn’t need to come up with the money until about a month later when the payment was due. It was doable because it was only $200.”

If you’re looking for a higher limit, some secured cards give you the opportunity to put down a larger deposit in exchange for a larger credit line. The Discover it® Secured Credit Card allows cardholders to make a security deposit between $200 and $2,500, with a credit limit to match.

Be consistent with small charges and full payments

A secured credit card gives you a chance to both practice and prove responsible credit habits. The key to building credit with a secured credit card is to use a small percentage of your credit line each month and then pay it off when your statement arrives. This demonstrates to your card issuer, and in turn the credit bureaus that you can responsibly manage credit. As your history of moderate credit utilization and consistent payments grows, so will your credit score.

The general advice from experts is to keep your credit utilization, the amount of your available credit that you use, under 30 percent. So if you have a secured credit card with a $200 limit, that’s going to mean less than $60 in charges each month. “I initially used my secured card to make small purchases here and there,” Edmondson explained. “Such as paying for a few fast food meals a month or buying a small amount of items at the convenience store.”

While that may not seem like much, the goal while building credit with a secured card is not to manage your everyday expenses with credit—the majority of your spending will likely still be covered by cash or debit cards.

The goal is to demonstrate responsible credit use to increase your credit opportunities in the future. In fact, it took only a month for McRae’s secured card to become part of his credit history. “After the secured card was reported on my credit report, I was able to apply and be accepted for an unsecured card,” McRae said.

Understand and keep an eye on your credit score

If you’re hoping to use a secured credit card to improve your credit score, it’s important to know how your credit score is calculated. Your FICO score, for example, is calculated on the following five components:

• Payment history (35 percent)
• Amounts owed (30 percent)
• Length of credit history (15 percent)
• Credit mix (10 percent)
• New credit inquiries (10 percent)

Similar factors are also considered for your VantageScore, although they are weighted differently. Don’t worry, you don’t need to be too concerned with the different credit scoring models. The basic principles of building credit are the same: Make small charges on your secured credit card every month and then pay them off on time and in full.

Most banks and credit card issuers offer tools to help you track your credit score, and many of those tools are free. The best tools for credit monitoring provide insights into recent credit score changes as well as offering tips to help you continue improving your credit.

Use these credit trackers to keep an eye on your credit score and ensure it’s going in the right direction. “I got to see my score slightly rising as I used and paid off the secured card each month,” Clark said.

You won’t be stuck with a secured card forever

If you’re anxious about the costs associated with a secured credit card—or if you’re concerned that people might judge you for carrying a secured card—don’t worry. Secured cards look exactly like every other credit card, and most secured card issuers regularly review your account to determine whether you’re eligible for a security deposit refund.

“If you use a secured credit card to rebuild your credit, at some point you will get your initial security deposit returned back to you,” Edmondson explained. “I just received my initial deposit back from Capital One for one of my secured cards.”

At that point, your secured credit card will effectively become an unsecured credit card, and you’ll be ready to move on to the next step in your credit journey.

McRae continues to use his secured credit card for small purchases—even after building his credit score and moving on to better credit cards. “I still use my secured card to auto-draft my Netflix account and pay it off at the end of the month,” McRae said. “I keep the secured card because it’s my oldest credit card, and the payment history is perfect.”

The bottom line

If you’re struggling to get approved for a traditional credit card, a secured card could be the answer. There are many reasons people turn to secured credit cards. Some are new to credit, while others are rebuilding after a financial setback. The formula for building credit is the same for everyone: prove responsible use by borrowing against your line of credit and paying it off in full.

“Don’t be afraid of credit cards,” McRae said. “If used correctly, they can be a great tool to build your credit score.”

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