There are a number of strategies to rebuild your credit, but using a secured credit card is one of the most effective. A secured card is just like a regular credit card, except that it requires a security deposit. Especially if your credit is below average or you are just beginning to build your credit, a secured credit card is a great way to demonstrate to lenders that you can manage credit and will consistently pay your bills.
A secured credit card is also a good credit building tool because it is ongoing (also known as revolving), rather than a one time loan. Once you’re approved, you don’t need to focus on constantly re-applying. Instead, you can focus on developing good credit habits and building a good history.
A Recap on Credit
Before we dive into how to use a secured credit card to build credit, let’s recap what your credit is made up of. Of course, there are 3 main credit bureaus that all calculate your scores a little differently. But the differences are minor. Broadly, your credit is affected by 5 categories: your payment history, amounts owed, average account age, variety and type of credit, and new credit applications. By far the two most important parts of the credit score are your payment history and amounts owed, with these two categories making up roughly 65% of your score.
A good payment history is pretty self explanatory- pay all your bills on time. One or two late payments will hurt your credit score a little. Miss a payment, and it’ll bite a little more. Consistently miss payments, and your credit score will start residing in the below average area.
Your amounts owed is a little more complicated. A big part of this category is the ratio of actual debt you carry to your credit limit. Since the FICO score is proprietary, there’s no public information on any ‘golden ratio’ you should actually maintain. However, the consensus among financial experts seems to suggest that keeping your ratio below 35% is probably best.
Establish a Payment History With a Secured Card
If you currently don’t have any credit accounts (including loans) open, you’re not giving yourself an opportunity to establish any payment history at all. By opening a secured card, you’re putting yourself on the map. And if you already have a history, a new secured card gives you the opportunity to counterweight any negative history you might have. As mentioned above, pay at least the minimum on time on every single bill, and you’ll turbocharge this portion of your credit score.
Keep a Reasonable Balance on Your Secured Card
You might be tempted to max out your card every month. Don’t. Not only is this a quick way to start carrying a balance and paying lots in interest, this also makes you look risky(er) to credit bureaus. Instead, keep your balance below half of your credit limit.
Of course, this might be hard at first, since there’s a good chance that you’ll start out with a low credit limit. If this is the case, just charge one or two transactions to your card each month, and pay them off in full with each bill. After several months of on time payments, however, most credit card companies will increase your credit limit, easing this category.
Keep your New Applications Down and Your Account Age Up
Your new applications and your average account age can be very closely linked. If you’re constantly switching from one card to another (and closing your previous cards), both of these categories are going to reflect poorly on you. So pick a card with good features that you can stick with. We’ve put together a list of some of the best secured cards out there. Ideally, pick one with no annual fee. Even better if you can land one that will convert to an unsecured card down the road. This will allow you to eventually get your security deposit back, without having to close down an account that may be bolstering your average account age.
Once you’ve landed a card that you can stick with, these two categories take care of themselves. Every month, your card will continue to raise your average age of accounts. And you won’t have to constantly apply for new credit accounts, keeping your new applications section clear.
Use Your Secured Card with Restraint
Ultimately, building your credit with a secured card is all about using it with a little restraint and a little common sense. After all, a credit score is simply a measure of how well you handle credit and debt. Remember, your credit card isn’t ‘free money.’ Don’t charge more than you can afford to the card, always pay your bills (ideally in full), and don’t ‘card hop’ and you’ll be be watching your credit score rise in no time.