Whether it’s a mobile phone contract, monthly car insurance, a mortgage, a loan or a standard credit card, the right credit score is essential to being accepted for personal credit.
Potential lenders check every application against specific acceptance criteria. Together with other data sources and eligibility criteria, the individual credit reports held by the three main UK credit bureaus guide much of this assessment.
Regulated by the Information Commissioners Office (ICO) and Financial Conduct Authority (FCA), credit reports are compiled on every citizen in the UK. They include a range of information, including details from the electoral role, credit accounts & payment history, CCJs, bankruptcy, IVAs, linked people & addresses, previous credit searches and more.
With this information lenders can model the risks a given individual presents to them when lending, and choose to accept or reject their application.
Typically those rejected will not be offered a detailed explanation as to why they have been unsuccessful, but lenders and reference agencies offer much guidance at an aggregate level, which can help people understand why they are likely to have been declined.
Reasons for decline can be due to file hygiene issues (such as a missing electoral role record) or errors in the file. However, where the reason for decline is associated with the information contained within the “credit accounts” element of the report (and an individual is not deemed to already have too much credit) it is usually because the individual has;
People who have (or have had) access to credit and failed to meet the obligations set out in their credit agreement, especially those where the transgression (for whatever reason) is deemed to be of a serious nature.
People often counterintuitively assume that having not used credit (or used very little credit) they are considered a better risk. Whilst the ability to avoid using credit may demonstrate broader financial management, it does not necessarily equip individuals with the tools required to manage credit.
In both of these instances, the individual concerned needs to demonstrate an ability to manage credit, but because of poor or limited credit, their opportunities for being accepted are much reduced.
People in these types of positions find ‘credit building credit cards’ are a valuable tool. Not because they help people build credit any quicker than they would with other credit products, but because these products are specifically designed with a lower acceptance criteria. This ensures they are available to people who would otherwise be declined credit; people who would have no opportunity to demonstrate good credit management.
In many respects, credit building cards operate in a similar way to standard credit cards.
Those that hold them have a pre-agreed line of credit which they can use to make purchases with. At the end of the billing period, a statement detailing activity for that billing period is generated. Card holders are then required to make a payment, which must be equal to or greater than the minimum payment amount, by a specified date. If the balance is cleared in full then no interest is changed. If the full balance is not cleared then interest is payable on the remaining balance.
The spending on the card, together with the repayment history, is shared with UK credit bureaus, and it is these entries to an individual’s credit report which are used as evidence when assessing future credit applications. For this reason it is essential that those using a credit card to build or rebuild their credit score ensure that they do not miss payments, underpay or pay later than the date specified in their monthly statement (direct debit can be a useful tool to help automate payments).
Credit building cards have a number of advantages for people attempting to build their credit score. Some are particular to these cards whilst others are shared with other credit card products. These advantages include:
Lower acceptance criteria for credit building cards means that people with poorer or more limited credit histories can be accepted and use the products to demonstrate a responsible approach to credit.
Many credit cards designed for people wanting to build their credit score offer free online eligibility checker, so that people can understand whether they are likely to be accepted before they make a full application. These tools are useful because searches made of credit reports during applications for credit are recorded within the report. Rightly or wrongly, potential lenders can infer from the number of credit applications whether an individual is struggling financially, so the application should be made sparingly.
Not all products offer free credit reports, but there are a number that do, and if the primary reason for having the card is to build one’s credit score, free access to credit reporting to track progress is a useful feature.
The credit limits available on credit building products are lower than those available on more mass market credit card products. Nevertheless, where they are used wisely for purchases costing more than £100 (and less than £30,000), they can offer their users access to some of the most powerful consumer protection available anywhere in the world.
Some issuers of credit cards for building credit offer additional incentives to individuals applying for their products, including features that might be traditionally associated with cards for people with good credit, like 0% purchases for set period and cashback on their credit card purchases.
Although these promotions are to be welcomed, people intending to use their card for building credit should be careful not to overextend themselves as a result of the promotion.
As some advantages of credit building credit cards are shared with other credit cards, so are some disadvantages. However, the very nature of these products (and the additional risks that offering them bring to bear on issuers) also presents additional disadvantages, when compared with other products. Of course, this belies the fact that those interested in credit building products are unlikely to be accepted for many of the products from which critical comparisons are drawn.
People offered credit building cards are perceived to be more likely to default on their borrowing than other potential customers. Of course, issuers always take steps to ensure that they receive the monies they are owed, but when they lend to people through credit building products they expect a greater level of ‘bad debt’ (‘delinquency’). Therefore, these products are priced to reflect that increased risk, and help mitigate potential loses that issuers might make. In essence, this means credit building products have considerably higher APR rates than standard credit cards.
This is clear when comparing product using comparison tables, but it is even pronounced when the “down sell” propositions (which tend not to be included within comparison tables) are considered. “Down sell” products are sometimes offered by issuers to the 49% of applicants who they do not legally have to offer the advertised rate to. In the case of standard credit cards, the difference between advertised interest rate and “down sell” is typically around 10%. In the case of credit building cards, the (already high) advertised rate and the down sell rate can be anywhere from 20% to over 30% higher.
As well as using high interest rates to ensure they recoup more from the aggregated pool of customers, credit building card issuers also tend to reduce their overall exposure by limiting the credit they make available to individual customers.
However, a low credit limit on applications needn’t mean an ongoing low credit limit. Many credit building card issuers proactively analyse customer account to look for opportunities to increase credit limits, rewarding the good credit management skills that their customers demonstrate. Assuming customers do not spend to their new credit limit, this can be very beneficial in building one’s credit score as the debt to credit limit (utilisation) ratio declines – which is an indication of good credit management.
A criticism often levelled at credit card issuers is that they set minimum payment levels too low. Therefore interest payments over the lifetime of a debt cleared purely at the minimum per payment period are many multiples of the cost of the items original purchase.
Of course, this is true, but the argument is largely based on an assumption that credit card holders clear their debts using the minimum payment (in the same way that loans must be paid). However, that is not the case. One of the main advantages of credit cards is the freedom they give people to clear their debt as and when they want (or can afford) to do so. Keeping minimum payments low offers customers the maximum control over their own finances. Examples of how different repayment levels will impact the cost of borrowing are included in the product summaries of all products, so customers can make an informed choice over their repayment amounts.
Whilst credit building cards are a great tool for people looking to build their credit score, if they are used badly (which in many instances they are), they will make a bad situation even worse. Individuals applying for credit cards should be under no illusion that simply obtaining a card will improve one’s credit score. In actuality, the opposite is likely to be true in the short term. It is only by using these products appropriately that one’s credit score will improve.
Ideally people with these products will only use them to purchase items that they know they can pay for with accessible money elsewhere. In this way they can always ensure they pay off their credit card balance in full, and thus avoid any interest payments. At the very least, people should have a good understanding of what their minimum payment is likely to be, and ensure they can make that on an ongoing basis. This will mean that they pay considerably more in interest than they otherwise might, but their credit score should also improve.
There are of course wider arguments as to whether those accepted for credit building products should be offered credit in general. Especially where an individual has shown poor financial acumen previously, some believe that society has duty to “protect them from themselves”.
This argument regularly voiced before FCA changes curtailed the worst excesses of the payday industry which flourished during the last recession, but their changes had negligible effect on credit cards. Perhaps because even the highest rate credit card was often many thousands of percent cheaper than typical payday loans.
Credit cards designed for people looking to build their credit are available from a number of different issuers and brands (some cards from the same issuer are marketed under different brand names). These brands include:
Conventional credit building credit cards do not offer the only payment card route to an improved credit score. Though less widely promoted, other products do exist that can help individuals with very poor credit history. This is because although they appear to be similar to credit cards, they never actually lend money.
Secured credit card products are very popular elsewhere in the world (the USA and Canada especially). In some respects, these products are more akin to loans than credit cards. Traditionally, credit cards are unsecured loans products, whereas many loans have been ‘secured’ with collateral (a house, car, boat etc.) which offered the lender a means for recompense if the borrower was in default.
Secured credit cards are not secured specified items, but they do require that cardholders place a ‘security sum’ on account with which to secure their purchases. For example, an individual who had secured a card with a £200 security sum would be able to use their card to purchase a maximum of £200 goods or services. They would receive a statement, minimum payment and repayment date as they would with a standard credit card, but if they failed to make their payment, the issuer would simply cancel the card and take the monies that they were owed from the security sum.
Because these cards never expose the issuer to losses, they can be made far more freely available than traditional card products.
Few issuers in the UK offer secured cards, and when they do, it tends to be to people who have been declined other products.
More widely available than secured cards are credit building prepaid cards. These are like conventional prepaid cards, which only allow people to spend the money they have preloaded to the card, but when ‘credit builder’ functionality is activated, the monthly fee is treated as a loan and its repayments are reported to credit reference agencies.
Obviously failure to pay the monthly fee would impact an individual’s credit score, but because there are no credit checks whatsoever (identity checks are still necessary), they are a straightforward way to start credit building. That said, the sums involved are small and may do little to demonstrate an ability to manage higher debt level. They are, perhaps, therefore best viewed as a stepping stone for people with very poor credit scores, helping them to start rebuilding the confidence of more traditional credit building issuers.;
The information above details how to use credit building credit cards to improve one’s credit score, but it should not be viewed in isolation. Credit cards are one part of someone’s wider financial arrangements. If other areas are not well managed, then good credit card management is unlikely to have any beneficial effect. Mobile phone contracts, utility bills, some monthly insurance contracts, etc. all feed into one’s overall credit score. If these bills are unpaid or paid late, they may do more harm to a credit score than a well-run credit card account can rectify.