The prospect of attempting to rebuild credit after a you’ve had a financial catastrophe or filed bankruptcy can seem overwhelming.
Having said that, there is hope and a light at the end of the tunnel. There is no shortage of strategies to rebuild credit that all work, to some effect.
1. Authorized User Accounts
Establishing new, positive lines of credit is the most effective way to to begin rebuilding credit, especially after filing for bankruptcy protection. And while nothing is a silver bullet, counterbalancing a poor credit report with positive entries is certainly step one.
The problem is that it can be difficult to be approved for new accounts if you have serious derogatory items on your reports like charge offs, repossessions, or a bankruptcy. Thankfully you can add positive information to your credit reports without actually having to apply for new credit.
The Authorized User Strategy
The authorized user strategy pretty simple. Simply ask a friend or family member to add your name to one of his existing credit card accounts as an authorized user. The credit card company issues a new card for the authorized user (you), and mails it to the primary account holder (your family member).
Within a couple of months the credit card account will be added to your credit reports. This accomplishes the goal of getting something good added to an otherwise bad credit report. Plus, you can actually use the credit card as if you had opened the account yourself to begin with.
Downside of Adding an Authorized User
There isn’t much risk to being added as an authorized user. You are not legally responsible any of the primary cardholder’s debt, so there’s no chance you would ever be compelled to make the payments.
There is a risk of credit damage, but only if the primary cardholder misses payments or runs up a large balance. Even then, you can have your name removed from the account and have it deleted from your credit reports simply by asking.
The real risk is for the primary cardholder. If he adds you as an authorized user and you run up a large balance, he’s on the hook to pay it off. He could potentially incur a large amount of credit card interest and even default on the account. Make sure both of you are aware of all of these potential issues before you are added to account.
Beware of ‘Piggybacking’ With Strangers
In the past it was fairly easy to find companies that would arrange the “rental” of an authorized user account to game the credit scoring system. In other words, you could pay to be added as an authorized user to a credit card account belonging to a complete stranger.
While paying to benefit from a stranger’s good credit history might sound intriguing, it’s actually a bad idea for a variety of reasons.
You can make a pretty good argument that illicit piggybacking followed by taking out new loans as a result of your newly improved credit scores is bank fraud. Newer versions of credit scoring models are designed to minimize or eliminate the benefits of illegitimate authorized user accounts.
The Right Way
Millions of consumers establish or rebuild their credit using the authorized user strategy, and have done so for decades. There’s nothing wrong with having a parent or a spouse add you to one of his existing credit cards.
Credit scoring systems approve of the strategy and lenders have no problems with the approach. Just be certain to have your name added to an account that has always been paid on time, has a low balance relative to the credit limit, and is an older account.
2. Secured Credit Cards
One of the more common methods used to rebuild credit credit is the secured credit card strategy.
Secured credit cards can be a great option because they are easy to procure, even for people with credit problems.
How Secured Credit Cards Work
Secured credit cards offer a low risk way for banks to extend credit to people with damaged credit histories. A secured credit card, unlike a prepaid debit card, is actually a real and legitimate credit card account.
When you are approved for a secured credit card, you will be required to make a deposit equal to the credit limit on the new account. For example, to open a secured credit card with a $400 limit you would need to make a security deposit of $400. You’re essentially buying the account with your security deposit.
A lot of people confuse secured credit cards and prepaid debit cards since both require you to put down your own money when opening the account. While prepaid debit cards actually behave more like gift cards, secured credit cards are a completely different animal.
If you charge $50 on your prepaid debit card, then $50 is deducted from your initial deposit. If a you make a $50 charge on your secured credit card then you are responsible to pay the $50 back plus interest if you do not pay off your balance in full.
Secured credit cards are reported to the credit bureaus and will show up on your credit reports. Although most secured credit cards report to the three major credit bureaus there are some that don’t, so be sure to check before you apply.
When managed properly, secured cards can help you rebuild your credit because they can be a positive addition to your credit history.
Having said that, secured credit cards are not a magic bullet that will rid you of your negative credit issues, but they can help to begin offsetting some of your past credit damage. They are a step in the right direction, which is extremely important when you’re trying to get your credit back on track.
Easy but Not Automatic
While getting approved for a secured credit card is typically easy, it’s still not guaranteed. There is still a possibility that you could get denied.
Read the fine print in the application or, better yet, ask the issuing bank about its approval criteria before applying for the card.
The bank can disclose whether they do business with people with troubled credit histories. If it doesn’t then it’s best to apply somwehere else so you don’t waste your time and the potential damage caused by the credit inquiry.
3. Credit Builder Loans
One of the least understood yet most effective ways of rebuilding credit is to take out a credit builder loan from your local credit union. Many local credit unions offer these loans to their members.
A credit builder loan is an installment loan of a small amount such as $500. Credit builder loans also have short payback schedules of 12 months or less.
Credit builder loans don’t work the same way as traditional installment loans. When you take out a traditional installment loan, you immediately get the money once you’re approved.
However, when you take out a credit builder loan the money is held in an interest-bearing savings account until all of the payments have been made. Instead of you getting the money right away, it’s held back as collateral for the loan. This makes the loan of little to no risk for the issuing credit union.
Benefits of Credit Builder Loans
Because credit builder loans are very low risk for the lender, they are relatively easy to get even for people with poor credit. And, when you make the final payment you immediately receive access to the money plus any interest earned, giving you a nice little rainy day fund.
The best benefit, however, is that the you will have added months of positive payment history to your credit report by paying down the loan.
There is very little downside to credit builder loans. In truth, they are a very smart option for consumers who are looking to rebuild credit after a bankruptcy or other financial catastrophe.
That being said, there are a few facts regarding credit builder loans that you should understand. First and foremost, credit builder loans are not free. The issuing credit union will charge you interest and fees for the loan, just like you would be paying with other traditional installment loans. However, the interest and fees are generally low because the loan is fully secured.
Another potential issue with credit builder loans is that the accounts might not show up on all three consumer credit reports. Some credit unions only report accounts to one or two of the three major credit reporting agencies.
It’s always best to inquire about the credit union’s credit reporting policy before applying for a credit builder loan. If it doesn’t end up on your credit reports then it’s like a tree falling in the woods.
It’s also important to realize that while a credit builder loan can help rebuild credit, it’s also possible for the account to cause further credit score damage if it’s not managed properly.
The same can be said for any account whether it’s a credit builder loan, a secured credit card, or any other financial liability. If you make the payments on your credit builder loan late then there is a good possibility that late payments will show up on your credit reports and remain there for up to seven years.
4. Retail Store Credit Cards
The fourth option to rebuild credit is applying for a retail store credit card. Retail stores are among the most aggressive card issuers, and are more likely than other lenders to extend you credit. Retail store cards are typically issued with very low credit limits and very high interest rates, which makes them a perfect lending product for consumers with poor credit scores.
How Retail Store Cards Work
Retail store credit cards are similar to traditional unsecured credit cards, but there are a few significant differences.
Like regular credit cards, a retail store credit card has a preset spending limit and does not require a deposit to open the account.
Retail store credit cards differ from regular credit cards in that you are only able to use the card within the chain of stores you opened it with. That means you are limited in your ability to use it–you can’t use just one retail store card to fill up your gas tank, buy groceries, pay for a hotel room, and charge dinner.
Benefits of Retail Store Cards
It’s usually very easy to qualify for a retail store credit card, even if you have credit problems. This ease of approval is probably the most attractive “benefit” for people with poor credit.
Once you are approved for the account it will likely end up on all three of your credit reports, which is what you’re after when you’re trying to rebuild your credit.
Retail store credit cards are easy to qualify for because they carry a low risk for the bank that issues them. While a low risk card is a big plus for them, it means that the terms are much less attractive for you as the customer. These cards come with very low credit limits and high interest rates, making them less than ideal as your regular payment method.
The low credit limits make the account much more difficult to manage. Credit scores don’t like to see balances that consume too much of the card’s credit limit, and that’s easy to do with a retail store card.
A $125 balance on a credit card with a $20,000 credit limit is meaningless, but the same balance on a card with a $250 limit is problematic.
Interest rates on retail store credit cards are also much higher than general use credit cards, like Visa and MasterCard. Rates on retail store cards are commonly in the mid to high 20s, regardless of how good or bad your credit scores are.
That’s about 10 to 15 percentage points higher than the average interest rate on a regular credit card. If you plan on carrying a balance from month to month, it’s going to get very expensive.
If someone were to describe a card with a low limit and a high interest rate you would probably think they were describing a subprime credit card, and you’d be right. Retail store credit cards have very similar terms to subprime cards, which is why they are a double-edged sword. They’re easy to get but they can be problematic to use.
Getting a retail store credit card is a good first step in your credit rebuilding strategy, but it can get you right back into hot water if you don’t use it wisely. As you open new credit accounts and manage them properly, you will be able to qualify for higher credit limits and lower interest rates.
5. Joint Credit Cards
If you’re ready to go beyond secured and subprime credit card offers, this could be a good alternative. However, since a joint credit card requires the cooperation of someone else, make sure you understand what you’re about to get into before you apply.
How Joint Credit Cards Work
Applying for a joint credit is a very similar process to any other application for credit. If you have poor credit, you’ll probably have a difficult time being approved on your own for most decent credit card accounts.
However, if you have a loved one with good credit who is also willing to co-sign for a credit card account then there is a very good chance that you’ll be able to qualify together. Once approved, you would both be responsible for any charges to the account and it will show up on both of your credit reports, which is the benefit you’re looking for.
Benefits of Joint Credit Cards
Opening a joint credit card account can be pretty beneficial if you’re working to rebuild credit. Because most major credit card issuers report account activity to the three major credit reporting agencies, the joint credit card account offers a fairly easy way to have new, positive credit card history appear on your credit reports every month.
Of course you have to make sure the account is managed properly going forward or it could actually work against you.
What to Watch out For
Unfortunately, a joint credit card account can become a problem for the co-signer if he already has good credit. When you ask a loved one to co-sign for a joint credit card account with you, what you are actually requesting is for the co-signer to be legally joined to you and be equally liable for any charges made.
If you miss payments on the account, then your co-signer would be legally responsible for 100% of the debt, including the interest and fees accrued on the credit card account, regardless of who actually made the charges.
Additionally, if you open a joint credit card account with a loved one, charge up a large balance, and carry that balance from month to month, then your actions would seriously hurt your co-signer’s credit scores. This is true even if you make every single credit card payment on time.
Credit scoring models don’t like to see large balances relative to the card’s credit limit. And, the average interest rate on a credit card is somewhere around 15%, which means the debt will likely be the most expensive balance you’ve ever serviced.
Finally, if after you’ve opened the account and you realize that it was a bad idea, then closing the card is the only way to eliminate any further problems.
You can’t just change your mind and ask the card issuer to remove your name from the account. It doesn’t work that way. That’s why co-signing for someone else is not a decision that should be made in haste.
Before asking someone to co-sign for a joint credit card it’s important to honestly consider how your relationship with that person would be affected if the account one day hurt your loved one’s credit scores.
If unforeseen circumstances lead to late payments or a default on the credit card account, the credit scores of your loved one could plummet. Those lower credit scores could prevent your loved one from qualifying for a mortgage, auto loan, a credit card of their own, student loan for their child, and much more.