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Building Credit with Cards

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No matter what your feelings are about credit cards or on the card industry as a whole, the fact is that Americans live off of credit. Our houses and our cars are usually purchased with debt, our college educations are usually funded through loans, and many of our small businesses are financed by bank loans as well. So even if we all decide that credit cards are evil and start cutting them up, the fact is we will probably never quit using debt altogether.

And these other types of debt that we need are exactly the reasons why credit cards are a necessary tool. In order to qualify for an auto loan or mortgage, and get a reasonable interest rate, we need to have good credit. We need to have long, unblemished credit histories that demonstrate how responsible we are when people offer to loan us money. And if you don't yet have an auto loan or mortgage, how exactly are you going to do that? Easy. With credit cards.

To draw an example with some arbitrary numbers, let's say you decide to cancel your credit cards in frustration because they decided to rip you off and increase your APR from 12.99% to 16.99%. This is a pretty big step up, but if you have $2,000 in debt on your card this is really only going to cost you an additional $7 per month. Meanwhile, if you are taking out a $100,000 home loan and your limited credit history causes your mortgage rate to be 6% instead of 4%, we're talking about payments of an additional $122 per month. The difference in magnitude is huge.

The point here is that having a credit card is the easiest way to build credit if you can be responsible with it, and even if you slip up now and then and the credit card ends up costing you a little money in the short-term, it will save you a lot more money down the road on much larger and more important loans. So think before you decide to do away with credit cards, and make sure you're not being "penny-wise and pound-foolish."

So with the lecture out of the way, here are some things to look out for if you want to build your credit history.

If you're just starting out with your first credit card, you're in a pretty good place. You aren't necessarily restricted to the kinds of predatory products that are generally marketed toward people with credit problems. Instead, you can probably get a card from a reputable bank that is specifically intended for someone with a "limited credit history." Capital One offers versions of its rewards cards for all types of credit, so you may be able to get a No Hassle Cash Rewards card or something similar. Alternatively, you may be able to reach out to your local credit union or neighborhood bank and get a no-frills card with a reasonable interest rate and low fees.

If you're a college student or similarly young adult, there are also credit cards that are specifically geared towards your lifestyle. And since they're intended for young people like you, credit standards are typically a bit more lax. One great example is the Citibank Forward for College Students, which pays bonus rewards on things like entertainment and dining, and also offers APR reductions for paying your bills on time.

The rebuilder
If you're trying to rebuild rather than build credit, because of some mistakes you made in the past, or because of a bankruptcy filing, then your choices are a bit more limited. You probably won't qualify for an unsecured credit card like those listed above, but will instead need to research some secured credit cards.

With a secured credit card, you have to first post some money upfront as collateral, and then the issuer offers you a credit line based on the amount you post. This way they can ensure that they'll always get their money back. Then you are billed each month on your expenditures, and you're required to pay them or get charged interest, just like a normal credit card, which allows you to build a credit history as well. Only when you close the account will you get the collateral back.

Be careful with secured cards because they often carry a number of different hidden fees, but if you know what to look for you can occasionally find a good one. For instance, NavyFed offers the nRewards Secured card to members of the credit union, which carries no fees and has a rewards program. And if you're not in the military, banks like Wells Fargo, Citibank, and Capital One offer secured cards with low fees that also give you the option to trade up to an unsecured card after 12-18 months of good behavior.

Note: prepaid cards don't help
If building credit is your goal, don't get fooled by prepaid credit cards, because these are in fact debit cards. They carry many of the same extensive hidden fees as the more underhanded secured cards, but all they do is give you access to your own money. They can come in handy if you just need a piece of payment plastic, but they will do nothing to help your credit because it's not a true credit line, and they don't report to the three credit bureaus.

At the end of the day, we need credit and we need loans. And in order to get the best rates and save ourselves bigger headaches down the road, we need established credit histories. While credit cards have earned themselves a bad rep lately, the fact is that in the hands of someone who is responsible, they are still the best way to create and build a credit history.