Your credit score makes all the difference when taking out a loan. It will determine the terms you are being offered or whether you will get approved at all. A bad or limited credit history can reduce your chances of getting vital finance, including mortgages, car finance and credit cards.
The good news is that you can build up and restore your credit history while you shop with certain credit cards.
What types of credit cards are helpful to establish credit?
Some credit cards are designed specifically as a simple way to improve your credit score over time. These types of cards are ideal for someone whose credit score has been damaged and, as a result, struggles to get approval for finance, including mainstream credit cards.
These types of credit builder cards are also seen as entry-level credit. If you’ve never borrowed or taken out a loan, it can be difficult to get the all-clear on a loan application. Lenders have no credit history to analyze and don’t know if they can take the risk in giving you credit. In this situation, this type of credit card will help you to build a credit score from scratch.
It gives you access to credit while at the same time giving you the opportunity to build up your credit score.
To get credit with a limited or damaged credit score can be very difficult.
Low barrier to entry and less stringent acceptance criteria means you are likely to get approved even if your credit score is very limited or poor.
The card will in most cases come with a lower credit limit and higher interest rate (APR) to offset the risk to issuers.
Once you get accepted, it’s important to manage your debt effectively and pay off your balance every month.
By doing this you will automatically improve your credit score over time.
A better credit score will increase your eligibility for higher credit limits, better rates and access to more mainstream credit cards.
What are the features of credit cards focused on establishing credit?
The features on a credit card focused on establishing credit will be similar to that of a standard credit card but there will be minor variations within the specific features.
Higher interest rates. The interest charge on a credit card will generally be shown as ‘APR’. APR stands for Annual Percentage Rate and this is what you’ll pay to the card issuer on top of the money you borrow. The APR includes the credit interest rate as well as any compulsory fees and is averaged out over 12 months. The APR on credit builder cards is higher than on standard credit cards to compensate for the deemed risk issuers are taking. Rates of 35% and above are common among lenders.
Lower credit limit. Your credit limit is the maximum balance amount you are allowed on your credit card at any one point. This limit will be calculated by the card issuer and is dependent on various factors, mainly your credit score and your annual income. To protect credit providers and reduce the consequences in case of a default, the credit limit on a credit builder focused card will be much lower. It will generally start between $100 and $1,500.
Credit card fees. On most credit cards there will be a set monthly or annual fee, also called an ‘admin fee’. Additional fees are normally levied when you withdraw cash from an ATM, exceed your credit limit, do not make repayments on time, or use your credit card overseas.
Standard credit card security and protection. Cards are secured by a chip and pin system for physical payments and by a 3 digit security code for online payments. Protection is also provided against suppliers that fail to deliver goods and services or where a product is misrepresented by marketing.
Interest-free period. Credit cards often carry an interest-free or grace period. During this period no interest is charged on outstanding balances. You will benefit from grace periods if you pay your balance off in full every month as it is only applicable on new purchases and, in most cases, not available on cash advances or balance transfers.
No-frills credit card. Typically, a credit builder credit card won’t come with any bonuses or extras. The main purpose of these cards is to build up your credit score. If you keep up with your monthly repayments and manage your credit well, your credit limit could be increased and your APR might be reduced. Some providers do offer a short 0% purchase period and basic cashback structures as an introductory offer but this is not common.
How should I compare these credit cards?
Using a credit card that focuses on improving your credit score is a serious decision. To make sure you are choosing the right option for you, there are a few aspects to consider.
Know the fees and rates. The fee structure on a credit card will give you a good indication if you are able to afford the line of credit. This includes the APR on outstanding balances as well as the mandatory annual fees. There are also circumstantial fees to keep in mind that apply in certain situations, like cash withdrawal fees, late payment fees and overseas transaction fees.
Look out for benefits. Rewards on credit cards designed to establish credit are not common but in some instances the issuer might include basic benefits such as 0% purchase periods and cashback. You can save money on interest and fees by choosing a card that has benefits, as long as you stay within the credit limits and pay off the balance in full every month.
Likelihood of getting approved. The last thing you want to do is to keep applying for credit cards when you keep getting rejected. This will damage your credit score even further and make it more difficult to get credit in the future. There’s often an eligibility calculator that you can use to give you an indication of how likely you are to get approved before applying. This will not affect your credit score and can help you compare credit cards by eliminating options that you are not eligible for.
What is APR?
Credit card interest rates are usually advertised based on the Annual Percentage Rate (APR) that applies to the account. The APR is essentially the yearly cost to borrow. It is an industry standard term which all lenders must calculate in the same way.
APR can be a useful benchmark for consumers comparing credit cards, as it also takes into consideration any mandatory fees on the account.
The APR must be what 51 percent (or more) of people accepted for a card receive. This means that up to 49% of those accepted for a credit card will end up paying a higher rate. That’s why it’s often called “Typical” or “Representative” APR. It’s also important to remember that high fees can be offset by significant perks. A very premium card with a high annual fee is likely to have a high APR (as the APR takes into account the interest rate and the fees), but will also have some benefits for the user.
Are credit cards that focus on establishing credit a good idea?
It helps to look at both the positives and the negatives when deciding if a credit card focused on establishing credit is a good option for your current situation.
Build your credit score. The main benefit of this type of card is the ability to restore or build your credit score while making purchases with it.
Get access to credit. This type of card is an entry level option that will give you access to credit, especially when you’ve been refused elsewhere.
Enjoy standard benefits of credit card ownership. Having a credit card when travelling is much safer than carrying around cash and is often required for certain services like hiring a car. It also provides protection when lost or stolen as you can easily cancel it to prevent fraudulent transactions.
Unfavorable terms. To protect card issuers against the risk of the loan, a credit card focused on establishing credit will often come with high interest rates and low credit limits.
Limited rewards. Although some providers do offer 0% purchase periods and cashback, you are unlikely to get more lucrative rewards like air miles, overseas travel, or vouchers and discounts.
What are some things to avoid with these types of credit cards?
Never miss your minimum repayments. This will result in additional fees and charges and damage your credit score even further. It’s always better to repay the full amount every month to prove to lenders you can effectively manage your debt.
Avoid withdrawing cash. Cash withdrawals on any credit card are expensive. The rates on credit building credit cards are likely to be even higher. If you regularly withdraw cash it might signal to card providers that you are cash strapped and they could refuse you credit going forward.
If you are rejected, wait before applying for another card. Every time you get rejected for a credit card application, your credit score is impacted. It’s best to take a step back and find out why you were rejected before continuing.
Some final questions you might have
Along with your application form, lenders will look at any dealings you have had with them in the past. They will also look at information provided by the credit bureaus, which may include court records and account data from banks and utility companies.
Ideally, yes. Having too many lines of credit open, even if they are unused, could affect your credit score and your eligibility for approval.
Your bank is a good place to start. Having an existing relationship with credit providers can certainly help. However, don’t assume loyalty will automatically pay. Always shop around and compare, there are many independent credit card companies that might offer a better deal than your normal financial provider.
It is the minimum amount you are required to pay towards your outstanding balance every month to avoid additional fees. You might still get charged interest but you won’t be penalized with additional charges.
A late payment fee will apply and it will have a negative impact on your credit score. Any card benefits might also be revoked. If you keep within the restrictions of the lender, this credit card is a simple way to build your credit score and can be a gateway to more favourable terms on a wider variety of financing options.
Chris Lilly is a publisher at finder.com. He's a specialist in credit-based products including business and personal loans, mortgages and credit cards, and is passionate about helping UK consumers make informed decisions about their borrowing. In his spare time Chris likes forcing his kids to exercise more.
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