Consumers with poor credit scores were once locked out of the credit card game. But lenders are beginning to court those whose low scores once typed them as too risky to be offered a credit card.
In the first quarter of 2014, 3.7 million subprime borrowers – those with a FICO credit score below 660 – were issued credit cards, according to Equifax, Inc. That’s a 39% jump from 2013 and the highest level since 2008, according to Equifax data provided to the Wall Street Journal.
Federal regulations tying the hands of card issuers wanting to raise interest rates on existing balances have convinced banks and other credit card issuers to do business with consumers who otherwise might not be offered a card.
That’s good news for consumers with poor credit scores who hope to rebuild their credit with the help of subprime credit cards.
Not surprisingly, the cards offered to those with less-than-stellar FICO scores are accompanied by an array of less-than-stellar fees and interest rates – far removed from the attractive incentives typically offered with prime credit cards. Other than a prepaid card, which doesn't offer any credit and works like a gift card, people with poor credit have two basic choices.
Subprime Credit Cards
Like prime cards, subprime credit cards don't require borrowers to deposit money with the bank before they use them. That's where the resemblance stops. Subprime borrowers can expect to pay maximum interest rates, higher fees and possibly an annual fee, says Igor Tselenchuk, a personal finance and credit card expert in San Francisco. Rates for new purchases can go even higher if you are late with a payment or skip one altogether.
To reduce their financial exposure in the event a consumer defaults, credit limits are often initially set low on subprime credit cards. And very few subprime credit cards offer rewards incentives and perks. Those that do often package those rewards with steep interest rates and fees. For instance: Credit One Bank Credit Card with Gas Rewards card offers 1% back on all gas purchases and there’s no limit to the gas rewards you can earn. However, there’s an annual fee of $35 to $99 and a variable ongoing interest rate of 17.9% to 23.9%.
Interest rates can go much higher. The First Premier Bank credit card has a whopping 36% interest rate for purchases and cash advances. There’s also a one-time processing fee of $75 and an annual fee of $75 the first year, $45 for additional years. On top of that, cardholders are charged a servicing fee of $6.25 per month after the first year. Some of these fees are charged before you ever use your card and will reduce the amount of credit you initially have available. For example, if your initial credit limit is $300, your initial available credit will be only about $225.
“That’s why it is extremely important to read the fine print, understand the fee schedule and pay off the balance of the subprime credit card on time every month,” says Tselenchuk.
Secured Credit Cards
If you have unsuccessfully applied for a traditional prime credit card (one offered to those with a FICO score in the 700’s and up) or are only receiving offers for subprime credit cards with exorbitant interest rates and fee structures, your only alternative might be a secured credit card, says Kari Luckett, content strategist for CompareCards.com.
Secured credit cards are typically accepted at the same places as a traditional VISA or other type of credit card. However, instead of carrying an unsecured credit limit, your line of credit is determined by the size of your security deposit. This money stays put; it isn’t used to make monthly payments.
Luckett says secured cards typically cost a little more in fees and interest than an unsecured card due to the risk of lending to consumers with either poor or no credit history. “Many of them will come with an annual fee, application fees and monthly fees in addition to the security deposit required in order to open the account.”
And they rarely come with perks like airline miles, hotel or other shopping rewards or cash back.
The typical interest rate for a secured credit card ranges from about 11% to 28%.
“Secured cards from credit unions are the exception to this rule where one could easily expect an interest rate of about 9.9% like with the USAA Secured Platinum American Express Card,” says Luckett. “On the flip side, Capital One Secured MasterCard carries one of the highest interest rates of all secured credit cards at 22.9% interest.” To learn more about this option, read Secured Credit Cards.
The Bottom Line
Even though they typically come with high interest rates and fees, subprime and secured credit cards can help consumers rebuild their credit score. If you can spare the cash, a secured card is generally the preferable option because the costs are likely to be lower.
No matter which type of card you carry, the best way to put it to work for your credit score is by making all payments on time and not using more than 30% of your credit limit. That means – if your credit line is $300 – never carrying a balance (including any fees and interest) of more than $100. One more tip: Before you sign up, do some online research on the company you're considering to see whether there are fraud or other complaints against it. If you have a problem with a company after you've signed on, here's how to file a complaint.