Credit cards aren’t just for spending or transferring an existing balance - they can also be a useful tool for building up your credit rating too. Find out how.
While we might more readily associate credit cards with spending sprees than using them to strengthen our financial status, some credit cards can in fact help you do just that.
Known as ‘credit building credit cards’, they are designed not for spreading the cost of a purchase or transferring an existing balance, but rather for actively improving your credit rating; something that can be invaluable if your credit history needs a little work and you find it hard to obtain credit elsewhere.
By spending a little on the card and paying it all back when you get your statement every month, you can begin to build up a history of yourself as being someone who can be given credit and repay it in full on time – in short, the perfect borrower.
Using these cards to regularly borrow money and pay it back will build up your credit rating by proving that you are responsible enough to be lent credit without getting carried away and maxing out your credit card. As such future lenders will be more likely to agree to lend money to you when you need it because you will have shown you’re a capable and prompt borrower.
How do they work?
Credit building credit cards work like any other credit card in that you can use them to spend on up to your credit limit. With your monthly statement interest will begin to accrue on your balance unless you pay off your balance as soon as you get your statement.
The crucial thing with these cards is that you do pay off your balance, in full, as soon as you get your statement every month as they often apply interest at a hefty rate to mitigate the risk of lending to those with a less than perfect credit history. If you start rolling your balance over from month to month and continuing to spend while interest tots up on your outstanding bill, you’ll defeat the point of getting the card in the first place – which is to show that you can borrow and repay on time.
But if you discipline yourself to just spend a little each month on your card to be repaid as soon as you get your statement, you’ll start to see your credit rating flourish – give it about 12 months and you should have begun to build up a decent picture of what a responsible borrower you are.
Who are they for?
These kinds of credit building credit cards are primarily designed for those with lower-than-average credit ratings; perhaps you haven’t been the promptest re-payer in the past, or you may have detrimental marks on your credit record due to CCJs (County Court Judgements) or failing to repay past debts. In any case where your credit rating is low and you find yourself being turned down for standard forms of credit, a credit building credit card can help you.
Of course these kinds of credit cards can also be ideal for those who don’t yet have a credit rating. If you’ve never taken out credit before – whether that’s a credit card, loan, or any other form of credit – your credit rating will be non-existent because lenders won’t have had a chance to score your ability to borrow and repay money yet.
By using these credit cards to build your credit rating, you can be in a position to apply for more competitive forms of credit in the future because you will have shown that you can handle credit and repay it. As such credit building credit cards can be a great way to climb the first few rungs of the credit ladder and get to the forms of credit that require you to have a higher credit rating than you currently do.
What are their drawbacks?
These types of credit card do tend to come with higher-than-average interest rates, often around 30% APR, whereas a more competitive credit card might have an interest rate of less than 10% APR. Also, the credit limit is unlikely to be high – perhaps no more than £1,000.
However, these two points shouldn’t be a hindrance at all if you are using your card in the right way. As you should only be spending a little on your card each month which can be easily repaid when your statement comes, you won’t need a high credit limit. And, as you will be clearing your balance every month to show what a good borrower you are, you won’t have to worry about interest mounting up on your balance.
What else should I consider?
As these cards should solely be used for the purpose of borrowing and repaying, it may be a good idea to have a contingency plan in place to make absolutely sure that you can afford to repay the balance when your statement comes.
Whenever you make a purchase on your credit card transfer the equivalent amount from your current account to your savings account, ready to use to pay off your credit card balance at the end of the month. This way you’ll always know you’ll have the money ready and it may even earn some interest in the meantime.
After following this process of borrowing and repaying for at least a year you’ll have built up a decent record of being a responsible borrower and should find you are now eligible for more competitive credit cards or loans – giving you the peace of mind that in future if you need credit, you’ll be able to get it.
