Dubai: If you don’t have a credit history, it’s nearly impossible to get a loan, a credit card or even a house. But let’s say you have a poor credit score, what do you do then?
To build your credit score from the ground-up, you need to prove you can repay your dues responsibly, but for that you need to first be given credit or a loan. Here are a few ways you can go about that.
If your aim is to get a credit card, you could start with a secured credit card or co-signed card, or ask to be an authorised user on another person’s card or a ‘supplementary cardholder’, as some banks call it.
You could also get a retail store credit card which offers low credit limits but can be approved easily.
If you want to build credit without a credit card, you might try a credit-builder loan, secured loan or co-signed loan. While some of these ways are free, others carry a fee.
We discuss below two of the above methods in detail; namely, secure credit cards and credit builder loans, while also understanding the risks they entail and their effectiveness in improving your credit score from a poor one.
1. Secured credit cards
Applying for a secured credit card requires a certain amount of security deposit against the credit limit extended to you on approval. This amount gets refunded or adjusted later.
Secured credit cards function a lot like traditional credit cards. The primary difference is that with a secured card, you pay a cash deposit upfront to guarantee your credit line.
The deposit is usually equal to your credit limit, so if you deposit Dh350, you will have a Dh350 limit. The deposit reduces the risk to the credit card issuer.
If you do not pay your bill, the issuer can take the money from your deposit. This is why these cards are available to people with bad credit or no credit.
What are the risks of having a secured credit card? Is it worth the risk?
While credit history may be used to determine eligibility for a secured card, the line of credit it offers requires a security deposit. This security deposit acts as a safeguard for banks to cover any purchases, should you miss payments.
Making your monthly payments on time is just as crucial with a secured credit card as with a traditional card. However, keep in mind that if you default on your payments, the card issuer may keep your deposit.
Also another major risk to keep in mind is that interest rates on secured cards are generally higher than those on unsecured cards.
So if you own a secured credit card, keep an eye on your credit score over time; when it has meaningfully improved, ask your issuer about upgrading to an unsecured card.
How is a secured credit card effective in building credit history?
If you have no credit history, a secured credit card can be a first step to begin building one. If you have a low credit score that makes it difficult to qualify for an unsecured credit card or other loan, a secured credit card can help you rebuild your credit.
This is one reason why that even though secured credit cards require a deposit, and has a rate generally higher than those on unsecured cards, secured credit cards are still recommended by experts as a great tool for rebuilding credit from scratch.
To build your credit history most effectively, it’s widely advised that you use the card sparingly and make only one or two small purchases every month. Also pay your balance in full every month. When you pay in full, you will not be charged interest.
Some research indicates that by using a secured card carefully, it takes only about a year to improve their credit score enough to qualify for an unsecured card.
Some issuers will let you transfer your secured line of credit to an unsecured one, which is better for your credit score because it does not require you to open a new account.
2. Credit builder loans
A credit builder loan is a loan where the borrower does not get access to the money until it is fully paid. Fixed payments are to be made each month towards the total amount of the loan.
You will finally receive the fund amount through access to a savings account with the loan amount in it once the total amount, along with interest, is paid off. By this time, you will have a good credit score built through regular monthly payments.
When you get a credit-builder loan, the money you agree to borrow is deposited into a bank account held by the lender.
You’ll then make monthly principal and interest payments — which are reported to credit bureaus — for a term usually around six to 24 months. When the loan is paid off, you get the money from the account.
The benefits of a credit-builder loan are twofold: You’re building a little nest egg while also building credit.
How is a credit builder loan effective in building credit history?
Since lenders control the funds, and therefore don’t risk anything, lenders that offer credit-builder loans are more willing to give them to borrowers with poor or no credit.
Once you’ve got the loan, the lender reports on your payment history to credit-reporting agencies. This helps you build credit, because you’re creating a history of on-time loan payments.
Lenders report payments on these loans to credit bureaus. If you make your payments on time, this builds positive payment history, which, for example, accounts for 35 per cent of your credit scores.
However, if you’re late making a payment, that’ll be reported, too. And when you don’t have much of a credit history, a single late payment can be a big setback.
The drop in your scores depends on where you started and your current credit — but research show that your credit scores could fall as much as 60 to 110 points, which is significant when you consider that the scores range between 300 to 850.
What are the risks of taking a credit builder loan? Is it worth the risk?
Experts caution that if you have a history of bounced checks, you might not be able to qualify for a credit builder loan.
Also, late payments can lead to interest charges that make your loan more expensive than it needs to be. In addition to interest, late payments also have a negative impact on your credit score.
Moreover, if you have existing debt, a credit builder loan is not your best option. In fact, a global study found that people without debt experienced an increase in their credit score and those with existing debt experienced a three-point decrease in their credit score.
You should also know that there is still an application process that you’ll need to go through. While a low credit score isn’t a barrier, your lender will still look at your banking history
Verdict: Credit builder loans or secured credit cards – which is better of the two?
If you have bad credit, simply relying on cash, prepaid cards or debit cards to make your purchases will do nothing for your credit score because the activity doesn’t get reported to the credit bureaus.
When handled properly, using a secured credit card to help establish or rebuild your credit can demonstrate to your credit card issuer and to the credit reporting agencies that you are a responsible consumer who used credit wisely.
Or if it comes to credit builder loans, one of the most useful features is that you don’t need to have good credit to qualify. Because the loan amount is secured and kept in a savings account, there’s no risk to the lender.
In other words, you can qualify for a credit builder loan if you have the money to put in a savings account per your lender’s requirements. You won’t be denied because you’re not really taking money. You’re simply establishing a good payment history.
In terms of whether you should apply for a credit builder loan or a secure credit card, here’s what experts recommend.
Let’s say you are somebody who hasn’t started building credit or who has recently paid off debt and need help improving your credit score, which is recommended as a better way to go about it – credit builder loans or secured credit cards?
Debt experts suggest how credit builder loans offer a safer way to get your finances in order, as opposed to secured credit cards where there is still a risk of defaulting on your payments and paying higher amounts as interest payments.