According to federal court records, Chapter 7 bankruptcy filings outnumbered Chapter 13 filings more than two to one during 2011. Home foreclosures and insurmountable medical bills topped the reasons why many Americans are seeking this last resort for debt relief. Even if you've been dutifully paying your credit card bills every month for years, defaulting on another debt means saying goodbye to premium perks and platinum status.
Because predatory lenders scrape names and addresses from courthouse records, you've probably received mail solicitations from banks you've never heard of. They hope you're willing to tolerate spending hundreds of dollars in application fees, only to end up with an already-maxed out Visa or MasterCard. Instead, seek out only the credit cards for bad credit that can potentially help your credit score.
Prepaid debit cards offer convenience, at a price
It's probably the only thing that could put Suze Orman, Russell Simmons and Kim Kardashian in the same category as Western Union and American Express: the prepaid debit card. As retail banks hike their monthly service fees, retailers and public figures hope that convenience and trust will inspire you to switch your daily cash management to prepaid debit. However, debit cards often carry hidden fees and other pitfalls that make many of them useless when it comes to rebuilding your credit.
Kardashian's card closed up shop after critics called attention to hundreds of dollars in annual service charges. Simmons has hinted that he's trying to find ways for his RushCard to report details of rent and utility payments to credit bureaus, but hasn't yet found a way to make his plan work. Orman's "Approved Card" includes a high yield savings account, but still charges ATM fees to customers who don't enroll in direct deposit. Western Union, Walmart, and a host of check cashing companies hope that inconvenient banking hours will cause you to start managing your cash flow through their own retail debit cards.
Prepaid credit cards don't change FICO scores
Even when issuers call them prepaid credit cards, these cash accounts don't show up on your credit report. To add real value for cardholders, American Express offers a free prepaid debit card that gives you purchase protection and many of the same security benefits as their charge cards. You can reload your AmEx debit card from a linked checking account for free, but you'll pay a fee to deposit cash at Target and other participating retail partners.
Some prepaid debit cards effectively replace checking accounts, as long as you haven't been writing many checks. For example, the Mango MasterCard waives its $5 monthly fee if you load it with more than $500 in direct deposit funds every month. Yet, you'll make a bigger impact on your credit report by opening a share account at a credit union. Most credit unions offer free debit cards linked to checking accounts with low minimum balances. While they're not as convenient to use as retail-based debit cards, your credit union membership will show up on your credit report.
Secured credit cards: back door to the major banks
If you're serious about rebuilding your credit score after a bankruptcy or a repossession, secured credit cards will force you learn two crucial skills: how to save and how to spend strategically. Citibank and Bank of America both offer secured credit cards with annual fees below $40. Both lenders issue you a line of credit in the amount of the security deposit you leave in a linked CD. Paying to borrow from your own savings account may seem like a crazy idea, until you realize that both lenders' cards actually cost less per month than most prepaid debit cards.
According to sources with experience inside the credit reporting industry, you'll get the biggest impact from a secured credit card when you carry a balance just big enough to register on a credit scoring algorithm. On a secured credit card with a typical $300 credit limit, that means leaving just $3 unpaid at the end of each month. Make your payments on time, and you'll get your security deposit back when your lender graduates you to a secured credit card.
Unsecured credit cards can build credit faster
Of course, the best possible scenario for rebuilding your credit involves qualifying for an unsecured credit card from a reputable issuer. Capital One uses its unique consumer profiling database to assess risk when credit scores don't tell the whole story. With either type of card you will be directed to a secured credit card if you don't qualify for unsecured accounts.
Again, keeping your balance as low as possible while making a few regular transactions every month will help lift your credit score. You're not aiming to build a huge credit limit that you can max out. Instead, you're trying to develop a track record of responsibility and reliability that will lead to better rates on mortgages, insurance, and other lines of credit over time. Ultimately, you'll qualify for elite rewards credit cards with significant cash back rebates that you can use to supplement the savings you're building from avoiding finance charges and service fees.
About the Author
Curtis Arnold, a nationally recognized consumer educator and advocate, has been educating consumers about credit cards since 1998. New! Curtis is the author of 'How You Can Profit from Credit Cards: Using Credit to Improve Your Financial Life and Bottom Line' (FT Press, 2008). He is also the co-author of the upcoming Complete Idiot's Guide to Person-to-Person Lending (Alpha Books/Pengiun Group USA, April 2009), a contribitor to The Ultimate Allowance (InnerWealth Publishing, 2008) and is extensively featured in 42 RulesTM for Driving Success With Books (Super Star Press, January 2009).