Question: I have bad credit and am considering opening a credit card or car loan to rebuild my credit. Would it be better for me if I got a credit card—even though I don’t want one, or should I get a car loan instead? Ultimately, I want to clean up my credit in order to qualify and buy a home. My aim is to improve my credit but I’m worried I’ll make it worse. Help!
– Desperately Seeking A Mortgage (DSAM)
There is no single best approach for rebuilding credit because it will be unique to each person’s situation. A key factor to understand is that the process of rebuilding credit will take time, especially if you have a history of negative information (missed payments, late payments, collections, etc.) in your credit reports. The good news is that negative information doesn’t last forever. The older the negative instances get, the less impact they’ll have on your credit scores. The increase in your credit scores will be gradual—meaning you won’t see a drastic jump in your scores overnight.
At the same time, you also need to show the credit bureaus and credit scoring models that you’ve changed your previous credit patterns by demonstrating positive “good credit behaviors” on all of your other credit obligations. You should also pay close attention to your credit indebtedness on those credit obligations and keep those levels relatively low. Qualifying for new credit when your have poor credit can be challenging because lenders will be less inclined to approve your request for credit—or if they do approve you, they may opt to charge you higher interest rates.
One way to rebuild or establish new credit is to open a secured credit card. This is a credit card where you provide a ”deposit” which is tied to the amount of the credit limit available on the card. For example, if you provide the bank with a $500 deposit, the credit limit would be equal to $500—because it is “secured” by your deposit. The lender will then report this as a normal credit card to the credit reporting agencies and as long as you keep the balance low, it will help you rebuild your credit as you pay the card on time, over time.
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Before you open a secured credit card for the purpose of rebuilding or establishing credit, there are two important things to remember:
1) Credit Reporting. Double check to make sure the card issuer reports to all three of the major credit reporting agencies, Equifax, TransUnion and Experian. While many report to all three bureaus, there are also many who may only report to one or two. This is more common with smaller financial institutions or credit unions but it’s better to find out before you open the card. If the lender doesn’t report the account, you won’t get credit for your positive payment history and managing the account responsibly, which is what you need in order to rebuild or establish your credit.
2) Watch the Charges. Because a large percentage of your credit scores take into account your level of indebtedness, or credit card debt in relation to your credit limits, it’s important to keep your charges to a minimum. Only charge what you can comfortably afford to pay off at the end of the month but also keep in mind that because your credit limit tends to be very low on secured credit cards, it’s easy to appear over-utilized or close to maxing out the account. Be aware that if you charge $250 on the card, that’s 50% of the limit which is quite high and can actually hurt your scores. The best rule of thumb here is to keep those balances low in relation to the limit—the lower the better, as far as your scores are concerned.
If you can stick to these basic rules your credit and credit scores will have no option but to improve. Good luck and keep in touch and let us know how you’re doing along the way.
Do you have a credit-related question? Email us at firstname.lastname@example.org. And for more expert tips and advice on credit and credit scores, check out:
- Credit Score Q&A: Paying Credit Card Balances in Full vs. Minimum Payments
- Your Burning Credit Score Questions: Getting an 850, Women vs. Men, Why is it Called FICO?
- Does High Income = High Credit Score?
- No Easy Answers to Credit Score Questions
- How Credit Inquiries Affect Your Credit Score
Image by Holger Zscheyge, via Flickr