If you have had a shaky credit history and need access to credit, what do you do? The answer to that question depends on the reason you want to get back into the credit market. You may want a credit card for one of two reasons: one, because you need to rebuild your credit, and two, because you need access to credit in case of an emergency. Whatever your reason, if you have bad credit, your general options come down to secured credit cards and unsecured credit cards for people with bad credit. Fortunately, offers for bad credit credit cards are now more affordable since the new credit card law (Credit CARD Act) became effective in February of this year.
If your sole purpose for getting a credit card is to rebuild your credit, your best option is a secured credit card. Pre- and post-CARD Act, secured credit cards are hands down your least expensive option if you have bad credit. In addition to already being relatively affordable, the penalty fees have become much more reasonable for these cards and you are no longer subject to unexpected interest rate increases since the CARD Act became effective.
[Related: Top 3 credit cards for rebuilding credit.]
A secured credit card works just like a regular credit card except that a security deposit is required to open the account and your credit limit matches the amount of the deposit that you put down. There is no limit to the amount that you can deposit, but the minimum is $200. The deposit is fully refundable and you will get it back once you close the account in good standing. The fee structure for these cards is also very affordable. For example, the Orchard Bank Secured MasterCard has no annual fee during the first year and an annual fee of $35 after that. It also has a low regular APR of 7.9 percent.
Secured credit cards do not offer an additional line of credit in excess of the amount of the deposit you put down. However, they are reported to the credit bureaus just like regular credit cards, and therefore will impact your credit score the same way a regular credit card would.
If, on the other hand, you need a credit card because you need to both rebuild your credit and you need access to an additional line of credit in case of an emergency (essentially, you need a small loan), you need an unsecured credit card for bad credit. An unsecured credit card is what most people would consider a regular credit card and will offer the additional line of credit that you need.
While these offers are still relatively expensive, the CARD Act has made these credit cards much more affordable to acquire than they were in the pre-CARD Act environment. The CARD Act’s restrictions on penalty fees and interest rate increases has impacted these offers the same way it has impacted secured credit cards. However, the CARD Act has had an even greater impact on unsecured credit cards for bad credit due to additional restrictions on fees. Specifically, the CARD Act prohibits credit card companies from charging you more than 25 percent of the credit limit in fees during the first year the account is open (excluding penalty fees).
It used to be that a credit card company would offer a consumer with bad credit an unsecured credit card with a $250 limit. The catch? – there were $200 worth of fees charged on the card by the time the consumer actually got to use it.
Now, a credit card company will generally offer a consumer with bad credit an unsecured credit card with a $300 limit. Instead of having $200 charged to the card by the time you get to use it, you now have $100 in fees charged to the card. The $100 in fees includes a processing fee of $25 that you have to pay before the account is even opened, and an annual fee of $75 charged to the card by the time you get to use it. The initial processing fee may seem like a drawback, but it actually is still a lot less expensive than the previous fees and it ensures that the cardholder knows what they’re getting into before they open the account.
Now that your options are better, you should take advantage of whichever type of card best suits your needs. However, you should not jump back into the credit market until you are financially ready, meaning you have paid off your debt and are committed to making timely payments each month.
This is a guest post by Odysseas Papadimitriou. Odysseas is the CEO and founder of cardhub.com and a credit card industry expert. He was an executive of Capital One’s credit card division for 8 years and his expertise in consumer lending extends from marketing strategy, to credit risk management and underwriting.