Using a Secured Credit Card to Fix Bad Credit

Is it possible to use a secured credit card to fix a bad credit score? And what, exactly, does "secured" mean in the first place? These are common questions from people with bad credit, so I thought it was time to address the subject here on the blog.

Let's start with the basics:

What is a secured credit card, anyway?

A secured credit card is one that requires a deposit payment from the customer. Thus, you secure it with an up-front payment before you can use it. On average, the initial deposit for these cards will range between $500 and $1,000.

For example, I might pay $1,000 for a secured credit card and then be able to charge that amount over time -- or a percentage of that amount. If I make all of my payments on time, the bank might increase my limit without additional deposits on my part.

Also, if you use the card responsibly and make payments on time, you'll eventually qualify for an unsecured credit card. On average, this takes about a year. So you can think of a secured card as a "gateway" to higher credit limits -- and possibly a higher credit score as well.

Here's a good example:
Get a Classic Black Secured Visa Now


Of course, you must exercise even more caution once you earn a unsecured card. With greater credit limits come greater risks. So it's important to apply the same good habits from the secured credit card to the unsecured one. This means using it sparingly, paying all of your bills on time, and maintaining a low balance relative to your limit.

It's important to note that a secured card will usually carry a higher interest rate than a regular unsecured card. You'll probably have to pay an annual fee of some kind, as well. So be sure to find out about these things in advance, before you sign on with a card issuer.

They Can Help You Fix a Bad Credit Score

If you look at the FICO scoring chart, you'll see that your payment history makes up a large part of your credit score -- more than any other single item. So by paying your bills on time (especially your credit card balance), you can improve a bad score. Sure, it takes time. But it can be done. This is one of the main reasons people used secured credit cards in the first place. The other reason, of course, is that it's easier to qualify for a secured card when you have bad credit -- whereas you might get denied or a regular card.

The best way to improve a bad credit score with a secured card is by making small payments each month, and then paying the balance off. This creates a pattern of responsible usage, which is the key to building a good score.

Secured Cards are Not Created Equal

It's important to note that secured credit cards come with a variety of fees and terms attached. Some have reasonable fees and rates, while others border on "robbery." Some secured cards will even require you to pay an "insurance" fee every month, which is simply an attempt to make more money from your bad credit situation. So shop wisely and read the fine print.

The FTC has offered some warnings about marketing scams relating to these cards. That's not to say that all secured cards are scams -- most are perfectly legitimate. Still, there are some sharks in this industry, so it's worth reading the FTC alert I've linked to above.

Credit Reporting With WaMu Mortgage Repayment Plan

Reader Question:

Last June we fell behind on our mortgage and created a repayment plan with WaMu [which is now part of JPMorgan Chase]. We made our regular scheduled payment along with repayment for 3 months on time. I pulled a credit report and found that for those 3 months WaMu was still showing us 30 days behind and called them about it. They said that was the way they had to report it even though I had made timely payments. I quickly gathered the outstanding balance and paid it the following day to stop being reported as late.

Can they do this? Report late payments on while on a repayment plan? It is now hurting on trying to get a new loan on a new house. I am calling them tomorrow to again request an adjustment in the reporting. Please help I need some ammunition in helping me in my case with them.

Our Response:

Unfortunately, I can't give you much ammunition in this scenario. If you are behind on payments, then you are behind on payments. As such, WaMu / Chase can report you as being late -- even though you're on a repayment plan. If they didn't report this kind of thing, it would encourage people to slide on their payments and pursue repayment plans when they fell behind, without any fear of repercussions.

They also do it to "inform" other lenders about your past financial habits -- which is exactly what a lender wants to know when you apply for a loan. You might call it banks looking out for banks.

An event like this creates a negative entry on your credit reports (as you know), and it can stay on your reports for up to seven years. Even if the status of the entry changes to reflect your full payment, the entry itself can remain for up to seven years.

This is how the reporting system works. It's designed to protect lenders and creditors -- not consumers. It is designed to show everything you've done in the past, from a credit and finance standpoint. Even if you make good on your past mistakes, those mistakes will be captured and reported accordingly.

Using Credit Cards to Establish a Good Credit Score

Our responses to these questions are in green font, interspersed throughout this blog post.

I'm trying to figure out the best way to establish good credit, so that I'll be able to have a good credit score in the future and hopefully be able to purchase a home without a high interest rate. I'm 18 years old, so I don't have any credit and I'm thinking of starting up a secured credit line. I've read a few of the topics on this website, so I have a general idea of how to improve my credit. However, I do have some questions that I couldn't find the answers to.

First, I was wondering if it matters how many credit cards you have. I understand that it should be most important to make sure that they're all well-maintained (no matter how many you have), but is one credit card enough? 10% of the FICO score depends on types of credit used, so what is a good amount of cards that you should have?

It's possible to establish a pattern of responsible credit use with a single credit card. Responsible usage is what leads to a good score -- whether it takes place across one card or several. If one card is all you need, then there's no reason to open additional accounts.

Secondly, I've read that closing credit cards may or may not be a good idea. But what if I open up a few credit cards, but don't use them regularly? Will that negatively affect my credit score, even if the balances are paid? Or do credit cards need to be used regularly (say, once a month)? What happens if I open up a credit line, but don't use it often? Will the company close my credit card? If so, how often, should we use the credit cards?

We cannot tell people whether or not to open new credit accounts, or how often to use their credit cards. That's entirely up to you. With that disclaimer out of the way, we can say that using a credit card responsibly is one of the best ways to establish a good credit score (but not the only way). In the current economy, some card issuers have been canceling the accounts of inactive customers -- so that's a possibility. You'll have to read the specific terms to see what the company's policy is on this.

For example, if I make a $15 purchase and pay that in full when the bill comes, will it be good for the "utilization ratio" part of my credit score?

The credit utilization ratio does not measure how often you use your cards. It simply compares your balance to your available limit. Here's an example. If your credit card balance (minus interest) is $2,800, and your credit limit is $3,000, then you have a very high utilization ratio -- regardless of how often you use the card. This will have a negative impact on your credit score.

Also, is it true that credit inquiries can lower your credit score?

It depends on the type of inquiry, and the frequency with which they are made. For example, if you apply for 15 department store credit cards in a single month, your score will drop. But a credit inquiry that results from a mortgage application will not affect your score very much, if at all.

Related articles:

• Does canceling credit cards improve a FICO score?
• How to establish credit for the first time

Hope this helps you out some. Good luck.

Mortgage Company Has a Different Credit Score Than Credit Agencies

Reader Question:

My husband and I recently had a little "mishap" regarding our home mortgage in Dec. 08. We were affected by the hurricane in September 08 and our mortgage company agreed to help us by allowing us to not pay the mortgage until Dec., but in December the full balance owed was due. I paid the balance I thought that was owed, but was a few hundred dollars short. When we were notified, we immediately made the proper payments, but our mortgage company reported our payment as 60 days past due. This has greatly impacted our credit score. I called the mortgage company and kindly asked if they could remove that negative reporting, but they said they could not.

We are now in the process of trying to purchase a home. The mortgage company we applied to said that my husband's score was 640 and mine was 619. This shocked me so I purchased all three credit reports. My husband's combined credit score is 682 and my combined credit score is 672. He said we both needed to be at least 620 or above. Why is it that the mortgage company has a different credit score than the three credit agencies? That seems like a tremendous difference in scores!

Brandon's Response:

Wow, I'm sorry to hear about your problem. The good news is that your credit score should rebound fairly quickly, since this is an isolated incident. Your score drops the most immediately after a negative event, but the event will have less impact on your score over time.

Let's move on to talk about the core part of your question. It's possible that the mortgage lender is using their own internal credit-scoring model. Some lenders do this. The raw information still comes from your credit reports, but the lender will interpret the information in their own way. There are actually many scoring models, aside from the FICO model most people are familiar with.

The bottom line is that all mortgage companies have their own preferences when it comes to credit scores and mortgage approval. Most of them will pull all three of your scores from the reporting bureaus and use the middle number, or a combined average. Other lenders will use the lowest of all three scores -- a technique used to charge more interest. And some will even use their own scoring models to interpret the data reported from the credit bureaus.

It's starting to devolve into a credit scoring free-for-all, if you ask me, and it leads to a lot of confusion. Alas, it is what it is.

I recommend doing two things. First, I would ask the lender why their score is so much different than what the bureaus are reporting. They are the only ones who can answer this question with any certainty. Secondly, I would consider using a different lender. The company you are talking to is not the only game in town, and there may be another lender who is willing to be more flexible.