“Why would you borrow money for something you could buy outright?”
I heard this question a lot when I was a young ensign in the Navy. I had set up a credit-building loan with the credit union. The very nice loan officer had taken the time to explain that if I built my credit now – when I didn’t need it – I would be able to get financing and the best possible loan rate when I was ready to buy a house or make any type of major purchase later.
The advice I got that day has paid off in spades. Thirty years later, after having bought two houses, refinanced multiple times, and made too many major purchases to count, the money I’ve saved in interest dwarfs the small amount of interest I paid to establish my credit. Nowadays, you can build your credit without spending a dime in interest by setting up a secured credit card. But secured credit cards are not all the same.
“Be careful when selecting any type of credit,” says Dan Picard, Hanscom FCU’s vice president of lending and collections. “You don’t need to choose a secured credit card with fees when you can use your primary lending institution, Hanscom FCU, to obtain a secured no-fee credit card that allows you to utilize 90% of your secured savings.”
What is a Secured Credit Card?
When you borrow money, the lender reports how you manage your payments to one or more of the three major U.S. consumer credit reporting agencies: Experian, Equifax, and TransUnion. These companies keep track of all the information on your credit report. Future lenders can then look at your report to help make a decision on whether to lend to you.
The term “secured” simply means that you have collateral behind a loan. If you borrow money for a mortgage or home equity, your house is the collateral. If you borrow money for a car, the car is the collateral. If you fail to make your payments, the lender can take possession of the collateral — your home or your car — to satisfy the debt.
With a secured credit card, the amount of your credit line is secured against funds in your share savings account. For example, if you secure $500 in your savings account, you may be able to borrow up to $500 on your credit card depending on the financial institution. At Hanscom FCU, you are able to borrow up to 90% of your secured savings with a Platinum Secured Mastercard®. Note: You'll want to avoid "maxing" out your credit limit, which will bring your credit score down. So if you want to borrow up to $500, you should have at least $1,500 in your share savings account to secure your card.
The purchases made with the card and paid on time are reported to the credit bureaus that in turn begin building your credit history. Once you’ve consistently shown that you make your payments on time, the lending institution may unsecure the card and you’ll be free to access the savings account. Typically, this takes six months to a year and is subject to normal underwriting factors, including a credit pull.
What is the difference between a secured credit card and a prepaid debit card?
Although the two cards may seem similar and both have a Visa or MasterCard logo, they are really quite different. A prepaid debit card is “loaded” with your money. It is a means of spending your money with a debit card. You are not borrowing money and thus not building your credit.
With a secured credit card, you are borrowing the money. If you pay the balance in full each month, there are no interest charges. If you carry a balance, you will accrue interest. Ideally, you pay the balance in full each month and build your credit while not paying interest. All the while, you are establishing a history of borrowing and making payments on time.
Best practices for building credit
- As you start out on the road to building credit, use your credit card sparingly, make only a few small purchases each month, and make sure to pay them in full. Never charge more than 33% of your credit limit.
- Learn how to read your credit report and know your credit score. If you have no credit history, you will have an empty credit report. As you use your new card and then go on to borrow for a car or house, your credit report will grow. Think how much easier it is to learn to read your credit report while it is relatively simple versus trying to figure it out on the fly if you you’ve gotten into credit trouble.
- Regularly keep an eye on your credit report and deal with any issues immediately. Our members can get their credit reports and score free once a year. Also, you can get a credit report from each of the three major credit bureaus at annualcreditreport.com.
“Also consider using Hanscom FCU’s free score enhancement product to begin the discussion of building credit,” says Picard.* “Make regular payments via auto pay as soon as your statement is generated rather than the day the payment is due. Use a free credit monitoring service to keep an eye on your credit and to avoid fraud. I myself was just a victim of an unemployment scam related to COVID-19 and, fortunately, had protections in place to prevent access to my credit.”
Bottom line – establish your credit early in life, manage it wisely and it will serve you well.
*Note that Hanscom FCU's Credit Score and Report Review requires a hard pull on your credit, which will temporarily reduce your credit score.
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