Credit is important. Credit is how you’ll get a fair interest rate when you need to borrow money. It’s a critical component of your financial life. It can also be dangerous, if you don’t know what you’re doing.
Building credit is important, too, especially when you’re young. You need to prove yourself to creditors and lenders — prove that you can be responsible, borrow money and pay it back, and do so on time. You need to understand that there are costs to borrowing (interest, and opportunity costs), and that nothing is free.
It’s a learning curve, for sure. And for many young people, one big question is this: How do you even get started building credit?
Well, it’s kind of a catch-22: “I can only get a good credit score because I use credit wisely,” and “I cannot start building my credit score until someone gives me credit.” It’s a predicament. Similar to trying to find a first job. You often need work experience to get a job, and you can’t get experience without one — so, what are you supposed to do? There’s no easy answer!
This predicament is why financial institutions have begun to offer “secured” credit cards. The idea behind these types of cards is that you provide collateral (i.e., a cash deposit), and then can use that collateral to secure the line of credit. A traditional credit card is very similar to, and in effect, an unsecured loan, which means the lender is providing a loan without an underlying way to get paid back in the event you do not pay your bill.
So, if you don’t pay the money back, the lender has no immediate recourse. Whereas if you have a secured loan, they’d simply keep the collateral. If you have a mortgage and don’t make your payments, the bank takes your home (the collateral), for example.
As such, a secured credit card will allow you to place a certain amount of money into an account and then treat that amount as your line of credit. That can be a great way to start building credit.
You’ve probably heard that having a positive credit score is critical when considering your financial future. It’s true; your credit score is quite literally your financial reputation, and if you have a poor score, it can equate to thousands of dollars in extra charges over the years. If your score is low, you’re going to be charged more in interest — lenders are taking on more risk, so they’re charging you more to borrow!
So, secured credit cards can offer a door into the world of credit, and a secured line of credit, like that offered by a secured credit card, is an opportunity for young people and those who have damaged their financial reputation to begin building their score back up. One month at a time.
There are, of course, other ways to build credit. You can always get a standard credit card, or apply for myriad other types of credit. But again, these can be more expensive, and riskier to young people simply trying to get the wheels spinning. That’s why a secured line of credit may be the best route for those with bad or little credit history.
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