Building credit when you have no credit history brings to mind the old “chicken or the egg” conundrum. After all, credit cards are the most cost-efficient, accessible credit building tools available to consumers, but your credit standing determines your ability to get one. So, what is a credit newcomer to do?
Well, most banks offer starter credit cards – accounts targeted to students and other financially inexperienced consumer cohorts that enable such folks to prove their financial responsibility in a relatively low-risk environment.
The risk is low from the card issuer’s perspective because these cards usually offer spending limits around $300 - $500 and don’t come with rewards/financing deals attractive enough to cost the issuing banks too much money. However, the stakes are high for consumers because while never missing a payment and maintaining a reasonable credit utilization ratio will ultimately translate into higher credit standing and eligibility for better credit cards, mistakes are a ticket to higher costs and increased difficulties across life.
We’ll explain all of that and more in greater detail below.
Why Do Issuers Offer Credit Cards with No Credit?
Credit card issuers determine eligibility for different credit card terms through a process called underwriting, which involves evaluating an applicant’s credit score, income/assets, and debt/liabilities. Issuers want to see proof that you can manage borrowed money responsibly and that your current financial situation can handle a new line of credit before trusting you with much, if any, spending power, let alone rewarding you or setting you loose with a tantalizing 0% rate.
If you’ve never had your own credit card before – even if you’ve been an authorized user on a parent or significant other’s account – you likely have limited or no credit history. In other words, your files at the major credit bureaus lack sufficient information for credit card companies to grant you a substantial credit line or above-average rates and rewards. Your current credit card options are therefore limited to the offers that banks target to first-time users.
These offers give users a chance to prove themselves before issuers have to make a substantial investment in their business. Using one of these starter credit cards responsibly will enable you to garner a better offer in the future, while mistakes will lead to bad credit and a more difficult path to credit card approval.
Don’t Confuse No Credit with Bad Credit
It’s important to differentiate between having no credit and having bad, or damaged, credit because the implications of each status and the credit cards available to the consumer segments they describe are very different.
People have no credit when they lack experience managing credit cards or loans in their own names. People have bad credit when they’ve made mistakes using their own credit cards or loans in the past. Rather than having to prove financial responsibility from a clean slate, people with bad credit must effectively prove that they won’t repeat financially irresponsible behavior. In other words, the burden of proof is higher for the person with damaged credit, and the credit cards they must use to meet this threshold are less attractive than what is available to first-timers.
When looking for a starter credit card, your top priority should be to find an offer that does not charge an annual fee for which you can conceivably garner approval. Four different types of cards may fit that bill, and we’ll break them down below, explaining the order in which you should consider them.
- Student Credit Cards & Credit Cards for Newcomers: These two card segments do not require a security deposit and are therefore far harder to get than secured cards. They tend to offer more attractive terms than secured cards, however, which means it’s worth giving an application a shot. If you get declined, don’t get discouraged, as you can divert your focus to secured cards in order to meet your immediate need for cost-effective credit building.
- Store Credit Cards: While we don’t recommend it, some consumers will choose to make a last ditch attempt at garnering approval for an unsecured credit card after they’ve been turned down for a student credit card or credit card for newcomers. Store credit cards are a logical choice, but finding one that will approve you can be a time-consuming process, not to mention the fact that store cards can only be used at the retailers they’re affiliated with.
- Secured Credit Cards: Repeatedly applying and getting declined for credit cards is bad for your credit. You should therefore take a realistic approach to getting your first credit card, and if you aren’t approved for the first couple of credit cards you try, take what amounts to the surest bet and place a deposit on a secured card so you can get the positive information flowing into your credit reports as soon as possible.
No matter how you approach your search for a credit card with no credit, don’t turn the application process into the lottery. Many consumers use a lottery approach to getting their first credit card, submitting applications en masse (often for cards above their station), but this will hamper your credit building efforts more than it will help them.
How to Make the Most of Your New Credit Card
Once you have your first credit card, your job is to use it responsibly until your credit improves enough to warrant approval for a better card. This usually takes about 18 months. Responsible use entails making on-time payments every month, never approaching your spending limit, and refraining from carrying a balance from month to month. It does not, however, necessarily include actually using your credit card. You can build credit even with your card locked in a drawer or cut into a million pieces, after all.
If you need added incentive to use credit as responsibly as possible, just take a look at how much money a good credit score can save you each month.
Image: Andrey Burmakin/Shutterstock