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Building Credit With Credit Cards

When people find themselves with bad credit, the most common refrain they hear from friends, family, and the idiots on TV is “…first thing: cut off those credit cards!” He couldn’t be more wrong. Credit repair, like life, is often counterproductive, and the role of credit cards in improving your credit scores should not be. Let me walk you through a worst case scenario.

For our scenario, let’s assume you have terrible credit scores, below 500, with lots of write-offs and bad debt. The last thing you want to do is cancel existing lines of credit for two reasons. First, if you take them, they will report it as a loan every month but they will not show an available credit and you need to show as much available credit as possible. Even a $289 store credit with a $300 down payment is better than $289 owed on a closed account. The second reason we don’t want to take out lines of credit that are still valid is that with such bad credit you won’t be able to open new accounts for a while so it’s best to work with what you have. Reducing that $289 debt to $149 will have a huge impact on your credit score, possibly pushing you above a “drop-dead” 500 credit score.

In a real worst case scenario you don’t have a single active and clean enough account to work with, then credit cards become a necessity if you want to rebuild your credit in your lifetime. There are cards that will approve anyone with a valid social security number but the costs are high. A typical “worst case” card will offer guaranteed approval but your line of credit will only be $300 and card acquisition fees will be more than $240, which are applied directly to the card. That way you get a legitimate credit card that will report your good monthly payments to all three major credit bureaus but you’ll start with a fat balance right away. The key is to pay it off now, so that you show an available balance greater than half of the card’s maximum credit line, in this case less than $149 owed on a card with a $300 limit. This may seem like a very predatory lending practice and it is, however you are not signing for a loan you are “buying” a credit extender. Just paying off this credit card balance with periodic payments will greatly improve credit scores within 3-6 months.

After you’ve had a “worst case scenario” card for 6 months, assuming you haven’t defaulted or defaulted on new loans, you’ll no longer be a “worst case scenario”. Now you can apply for a better card that will actually start with some credit. You usually need a job and one line of credit in good standing for 6 months to get a “step-up” card, which is where the “worst case scenario” card comes in. If you can transfer the balance from your first card to the new one that’s great but you don’t want to cancel the first one even though it seems silly to pay monthly and annual fees to pay for a card you’ll never use. You will keep all these cards until you actually re-establish your good credit. This new card should have reasonable fees but you’ll still pay $60-$100 in setup fees and you’ll have an interest rate on the high end. It doesn’t matter the interest rates because you don’t have to use this card, just let it buy your credit.

After you’ve reported good payments with low balances on both cards for about a year, you’ll see a dramatic improvement in your credit scores. This is because the formula that credit bureaus use to determine who deserves credit is based on who already has credit. The more bad credit you have, the more credit lenders want to give you. At this point you should start replacing predatory cards with high annual fees for good cards with zero annual fees.

Building credit through “bad credit credit cards” is not the only way to improve your credit but it is one of the most important steps if you are really in a deep hole.

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