NEW YORK (MainStreet) — The credit crisis and housing meltdown of 2008 shattered the bank accounts and credit scores of millions of consumers across the country. Although credit card companies still bombard consumers daily with special deals and sign-up bonuses, such as 0% financing rates, to get new customers onboard, people with less-than-stellar credit scores tend to get shut out. So, how do subprime consumers repair their battered credit reputations so they can access credit lines and credit cards again?
Taking out a "secured" credit card is one way, said Can Arkali, a principal scientist in Fair Isaac Corp.'s (FICO) analytics and scores development team. (FICO is the company that developed the FICO score for measuring consumer credit risk).
A secured credit card requires the cardholder deposit cash into the account upfront and then just draw on the cash each time the card is used. "It's definitely low risk to lenders," making it accessible to people with poor credit, said Arkali. "As long as they pay their bills on time on that card, they can start to establish a squeaky-clean credit history." And they need to use the card a lot to show consistent behavior, he said.
But like traditional credit cards, consumers should shop around for the best deal before signing up for secured cards. A flurry of companies started offering secured cards in the wake of the 2008 recession in an effort to cash in on the demand.
And potential demand is high: about 56% of U.S. consumers had credit scores that were less than prime in late 2014, according to LeBaron Sims, research manager at Corporation For Enterprise Development, a nonprofit group that promotes policies and programs to build assets for low- and moderate-income households. A prime FICO score is currently above 700, he said.
”A lot of subprime people are being locked out of financial opportunities, whether it's an unsecured credit card or an auto loan," said Jill Gonzalez, an analyst at CardHub, a credit card comparison site. But shop around because deposits and fees vary wildly between cards.
For example, the Capital One Secured MasterCard only requires a refundable security deposit of $49 to get a $200 credit line, noted Gonzalez. Most others insist on a deposit of between $200 and $500 for a $300 credit line.
Annual fees also vary: Capital One and many credit unions charge no fee if the cardholder pays the entire bill each month but will charge fees if there is a balance. Most other banks charge annual fees, ranging from $19 to $49. If there's balance, the fees are substantially larger, ranging from $27 to $175.
Another way to raise a credit score is to open multiple credit cards and make sure each one is paid off each month. "An individual can have a lot more than one credit card, but as long as that individual manages to stay on top of all of their obligations over an extended period of time, this will certainly be evaluated positively by the FICO score," said Arkali.
If there is a balance, make sure it's small.
”Your score falls when you use more than 30% of your available credit," warns Ken Chaplin, senior vice president of TransUnion, a credit reporting agency.
Ditto for closing credit cards. While some debt-strapped people may be tempted to close a credit card account after the balance has finally been paid off, this could actually work against the person. FICO looks at the ratio between the total balances the person owes with the person's total available credit. The lower the ratio, the better. So, if a card, with a high credit limit, is closed, then the ratio of the person's total debt against total available credit would rise. "We could actually see a negative impact on the FICO score from this," said Arkali.
Consumers should also try to show good payment histories on as many different credit niches as possible, whether it's paying utility bills, retail cards, mortgages, installment loans or auto loans. The greater the variety and history of payments, the faster the score improves.
While it can be positive to have multiple credit cards, it's not wise to open them all at once just to cash in on the latest cash-back perk being offered. Each time a person applies for a new card, it counts as a "hard" credit inquiry, which works against a person's credit, said Akali. Also, avoid signing up for cards for trinkets, like a free T-shirt - "those cards often have low credit limits but higher interest rates," said Chaplin.
When it comes to debt, it's best to pay off the credit cards that have the highest interest rate first. "It's called the snowball effect," said Gonzalez. Often people wrongly think they should spread out the payments to all of the accounts equally, she said.
Overall, it all comes down to patience and consistency. It takes seven years for a default or credit misstep to disappear from a credit report and ten years for a bankruptcy to disappear.
“An individual score isn't going to improve overnight," said Arkali, who estimates it could take a year or more before a score significantly rises. "The most direct way to get there is for an individual to consistently pay their bills on time, to keep their overall debt as low as possible, and judiciously apply for new credit.”