Option 3 for credit builders: secured credit cards
I have previously described my personal experience with Bank of America’s Bankamericard Cash Rewards secured credit card. A secured credit card is a risk-free way for financial institutions to extend you credit: the money you deposit is also your credit limit. In other words, you spend your own money; the bank doesn’t lend you anything. Yet you still have the opportunity to build up your credit profile by making on-time payments which would be reported to the Consumer Reporting Agencies (CRA’s).
This option gives you the flexibility of determining your own credit limit. Think of credit limit as available debt. Your ability to manage a large amount of debt available is essentially your creditworthiness. Managing 10k of available credit is going to make your credit profile look better than managing 1k of available credit.
You can also think of the deposit as a rainy day fund: in case of emergency you can simply close the secured credit card account and get the full deposit returned to you. This is money set aside for future use. So instead of storing this money in your checking account earning nothing, you can put it to much better use.
Apart from requiring a deposit, secured credit cards have 4 disadvantages: an annual fee, a high interest rate, the ‘secured card’ note on the credit profile, and the lack of rewards. The annual fee can go as high as $50 per year, but you should only have to pay this fee once since by the first anniversary you should already have a non-secured card. Interest rate can reach 30%, but you should never pay a penny of interest: you are going to pay the balance off every month. Carrying a balance is a bad idea in general and even more so when you’re building credit.
The ‘secured card’ note on the credit profile is actually an interesting point. This note does not affect your FICO credit score at all, but if your creditor decides to perform a manual review of your application, the credit analyst will see the note and generally give less credit to your secured card than he would to a regular card. If you’d rather not see this happen, I know two major institutions that do not report their secured cards as secured: Capital One and USAA.
Some secured cards also have a graduation feature that converts the card to a regular credit card after a certain period of time, usually 12-18 months. Once graduation happens, the ‘secured card’ will completely disappear from the credit report, and it will appear as if you had been having a regular card the whole time. If your card has this feature, you will save yourself a credit inquiry from applying for another credit card. In most cases, the graduated card will retain the original credit limit. If you request early graduation, the credit limit may decrease. Bank of America is known to consistently unsecure secured cards at the first anniversary. Wells Fargo I believe will unsecure your card after 18 months. NFCU (Navy Federal Credit Union) is a hit or miss. I can’t speak for other institutions; check before you apply so you know what to expect.
Honestly though, the graduation feature is not too useful unless your secured card has a high limit. I obtained my first non-secured card 9 months into the building process, at which point I basically stopped using my secured card and could have closed the account to get my deposit back. However, this is my oldest credit card account, so I would rather keep it for eternity to help my credit history.
The lack of rewards bothers some people who want to play the credit card rewards game. I’m not a reward pursuer, though rewards are always nice to have. The three cards that I know have cash back rewards are:
Bank of America Bankamericard Cash Rewards : https://www.bankofamerica.com/credit-cards/products/secured-credit-card.go (you’ll have to ask your personal banker to apply for the Cash Rewards version or ask Bank of America to add the Cash Rewards feature to your card after applying.) The Cash Rewards feature can be found here: https://www.bankofamerica.com/credit-cards/products/cash-back-credit-card.go
NFCU nRewards Secured: https://www.navyfederal.org/products-services/cards/creditcards/nrewards-secured.php
AeroMexico Visa Secured: https://www.usbank.com/cgi_w/cfm/credit/aero_mexico/usb_aeromexico_sec.cfm
If you ever fly to Mexico, the AeroMexico card is the best, hands down. Otherwise, the Bank of America card is the undisputed king on the market as of now.