Published in: Credit Cards | Sept. 29, 2019
By: Kailey Hagen
Your first credit card is often the beginning of your credit history. Start it off on the right foot.
Getting your first credit card is a rite of passage in a way. It opens up new perks and opportunities, but there's also an element of risk involved because if you don't use your credit card responsibly, it could do long-term damage to your finances. There's risk to card issuers, too, because if you can't pay back what you borrow and go into default, they could lose what they lent you.
Credit card companies typically evaluate your credit history to assess the risk in lending to you, and therein lies the catch-22 for first-time credit users. You can't build a credit history without borrowing money, but you'll find few lenders willing to work with you unless you can prove you've borrowed money responsibly in the past.
There are a few options available to those with poor or no credit history, but don't get your hopes too high. These cards don't offer the perks most people expect from credit cards, like lucrative rewards and high credit limits. They're designed as tools to help you work your way toward these better cards by demonstrating a responsible borrowing history. Here's what you need to know about them.
An increasing number of young adults are skipping credit cards because they're afraid of racking up debt, but many of them don't realize that avoiding credit also carries risks. First, it makes it much more difficult to build a credit history. If you don't have a credit history and you want to borrow money in the future, you may only be approved if you have a cosigner with a good, established credit history. This gives the lender greater confidence that it will get its money back, even if you cannot keep up with the payments. If you're unable to find a cosigner and you have no prior experience borrowing money, most lenders will turn you down to be safe.
Credit cards are also a wiser choice from a security standpoint. If a thief runs up fraudulent charges on your credit card, you just contact the company and they'll take off the fraudulent charges and send you a new card. You most likely won't be held liable for anything and the most you can legally be held liable for is $50.
Fraudulent debit card purchases on the other hand can have an immediate impact on your ability to pay your bills and can cause you to incur nonsufficient funds (NSF) fees. You may not be held liable for any fraudulent charges if you report the fraudulent charges right away, but if you delay, you could be liable for $50, $500, or even the full cost of the fraudulent purchases.
Then there's the rewards. When you use cash or a debit card, you avoid the risk of incurring debt, but you also miss out on the opportunity to earn cash back, travel miles, or other rewards that credit card issuers offer. As long as you avoid carrying a balance on your card, using a credit card could actually save you money over the long term when you factor in the money you get back through rewards.
So now you understand why credit cards are useful. But where do you turn when you're ready to apply for your first one? There are two main types of credit cards available to those without a credit history: student credit cards and secured credit cards. I discuss each of them below.
Student credit cards are credit cards marketed toward college students who don't yet have an established credit history. Qualification requirements are much lower than those for traditional rewards credit cards, but that doesn't mean that everyone is approved. Most student credit cards require that you:
If you meet these requirements, you stand a good chance of being approved for a student credit card. These cards typically don't have annual fees and their perks are fairly modest. Your credit limit may only be $1,000 or less per month, and while there are some student credit cards that offer rewards, this isn't the norm. These cards are designed to help you build your credit history so you can become eligible for better rewards credit cards in the future.
if you've been a responsible payer, many banks will upgrade your student credit card to one of its regular rewards credit cards when you graduate from college. This will increase your credit limit and your rewards-earning potential. If your bank doesn't offer to upgrade you, you can contact it directly and request an upgrade or apply for a new rewards credit card on your own.
You might be tempted to close your student credit card once you've gotten a new rewards card, but this is usually a bad idea unless you're being charged an annual fee. Canceling your credit card reduces your average credit account age, which can actually hurt your credit score, making it more difficult to secure new lines of credit in the future.
Student credit cards are your best option for a first credit card if you qualify. But if you don't, either because you're not a student or because you have bad credit already, a secured credit card will fit you better. These cards are so named because they require a security deposit in order to be approved. This is usually a few hundred dollars and is often equal to your credit limit. The idea here is that if you fail to pay back the money you borrow each month, the card issuer can keep your security deposit and won't lose any money.
Secured credit cards are open to people with all credit backgrounds as long as they are able to afford the security deposit. But because they're typically associated with individuals with bad credit, they bring several additional costs. Many of these cards charge annual fees that can be several hundred dollars or more. They also have higher annual percentage rates (APRs), sometimes in excess of 30%, which can cause any balance you carry from month to month to accrue interest rapidly. Rewards are also uncommon with secured credit cards because their primary purpose is to help you build or rebuild your credit history.
Some card issuers enable you to upgrade your secured credit card to an unsecured credit card after a certain number of months of on-time payments and this is probably your best option when you're ready to ditch your secured credit card. If your card issuer doesn't allow this, you can apply for a new rewards card on your own once you've built up a credit history. Cancel your secured credit card if it charges you an annual fee, even though your credit score may take a slight hit. Your card issuer will refund your security deposit to you at this time if you're not carrying a balance.
You should always read through the cardholder agreement for any credit card you're interested in applying for. You can usually find this on the credit card issuer's website. It will explain the details of its rewards scheme, if it offers one, and any fees associated with the card. Here are a few things to look for:
A credit card can help you build a credit history that makes it possible to secure new loans or lines of credit in the future, but if you use that card irresponsibly, it could damage your credit history severely.
Credit cards allow you to make purchases today and pay them off months in the future, but you should avoid this at all costs. If you carry a balance, that balance will accrue interest and this can make it more difficult to pay off. It will also raise your credit utilization ratio -- the ratio between the amount of credit you use and the amount you have available -- and a credit utilization ratio of more than 30% reflects badly on your credit score. Never charge more to your credit card each month than you know you can pay back at the end of the month.
The other thing you must do if you want your credit card usage to reflect positively on you is to always pay your bills on time. Payment history is the single-biggest factor in your credit score calculation and even one late payment can drop your score severely. If you struggle to remember to pay your bill on time, see if you can set up automatic payments or reminders for yourself.
Don't apply for new credit cards too often. Every time you apply for a new credit card, the lender will do a hard inquiry on your credit report, which will drop your credit score by a few points. This isn't an issue if you're approved for the new credit card because your credit utilization ratio will go down and that has a larger effect on your credit score. But if you're not approved, you just lowered your credit score for no reason.
Credit scoring models understand that it's normal for people to shop around when taking out a loan or opening a credit card, so they consider all inquiries that take place within a 30-day period as a single inquiry. So when you are in the market for a new credit card, try to get all of your applications in within one month of each other to minimize the effect on your credit score. Don't apply for a new credit card or credit limit increase for several months after this.
There's a lot to understand when applying for your first credit card, but hopefully the above guide has made it a little easier. It'll probably be a while before you're earning the lucrative rewards you were hoping for, but with consistent, responsible use, you can build a solid credit history that will open up opportunities for better credit cards in the future.
As long as you pay them off each month, credit cards are a no-brainer for savvy Americans. They protect against fraud far better than debit cards, help raise your credit score, and can put hundreds (or thousands!) of dollars in rewards back in your pocket each year.
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