Credit cards allow you to build a solid credit history, which can help you do everything from secure a car loan at a better interest rate to getting a mortgage on a new home.
But how do you go about getting your first credit card? If you're an 18-year-old college student with no credit history or a 30-something who has made all his purchases using cash or debit cards, credit cards can be a valuable tool if you use them responsibly. If you're entering the credit card market for the first time, here's advice to help you navigate it and choose the card that best meets your needs.
Check your credit report
Before you apply for your first credit card, check your credit report. Your credit report includes a detailed overview of your credit history, including your current accounts, past due accounts, how much available credit you have and how much credit you're using. Your credit report also will contain information on your student loans and any other money you've borrowed from financial institutions, including a car, bank or home mortgage loan. All of this information will be used to determine your credit score, the number financial institutions use to assess whether to lend you money and at what interest rate.
You can check your credit report and credit score on annualreport.com. This is the only source for getting a free credit report, and you can get one from each of the three credit bureaus (Equifax, TransUnion and Experian) once per year. Check your report for any errors to ensure maximum potential for getting credit. If there are any errors - such as a wrongly reported late payment - contact the company who reported the error and/or the credit bureau to dispute it and get the error removed from your report.
Know what to look for
Once you've checked your report, the next step is to determine what kind of credit card you need. Before you start looking and comparing cards, decide whether you want a card that offers perks and rewards (like cash back on purchases, gas or grocery points or airline miles) or a no-frills credit card that allows you to steadily build credit.
Also educate yourself on credit card terms before you pick a card. Do you know what an intro APR is? How about an annual fee or credit limit? These are three critical things you should know.
An APR, or annual percentage rate, determines how much interest you'll pay on your credit card debt if you carry a balance. You can gauge how much daily interest you'll accrue for carrying a balance by dividing the APR by 365. For example, if a credit card comes with a 19.99 percent annual APR, the daily interest accrued would be around .054 percent
Some credit cards offer an introductory APR to get you to sign up. This offer can last 12, 15 or 18 months depending on the card. During this time frame, you won't be charged any interest on purchases you make, so it's best to make large purchases - and pay them off - during the intro period. After the intro period is over, the interest rate on your card may jump substantially. As you research for a new card, don't just look at the teaser rate, look at what interest rate you'll pay after that period ends.
First-time credit card users also should understand annual fees. An annual fee, which cardholders pay once a year, is the amount a credit card company charges you to use its credit card. A credit card issuer also may offer an $0 introductory annual fee to get you to sign up for the card. After that, the fee may go up to $40, $50 or more. Some credit cards that offer a lot of perks have high annual fees, typically in the range of $95 or more.
Your credit limit also is important. A credit card company may give a first-time card holder with little to no credit history a low limit on their card, if they're approved. This limit can be a few hundred dollars or a bit more, but that should be enough to get you comfortable with using credit cards without getting yourself into financial trouble. After you've had the card for some time and prove that you're a reliable borrower by making all your payments consistently, you always can ask your credit card company to raise your limit. However, if you're just starting out, we recommend a credit card with no annual fee, a low interest rate and a moderate credit limit.
Learn about first credit card options
First-timers will most often want to apply for a credit card that is geared towards people with limited or no credit; that is unless you have other lines of credit reporting to the three major credit bureaus and have established a decent credit history. If you don't fall into this category, here are a few options to consider for getting a credit card with little or no credit history.
Student Credit Cards
Student credit cards exist because most young people haven't had enough of a financial history to build credit.
They're a great option for this very reason. Banks use student credit cards to "test drive" potential long-term customers. With low credit limits and higher-than-average interest rates, they usually serve the purpose of establishing a baseline for a student's future borrowing behavior. Several names you recognize offer top-rated student credit, including Discover, Citi and Capital One.
By the way, most student credit card issuers will require proof of your student status before issuing you a card and some have age restrictions, so check the fine print before applying.
Secured Credit Card
If you have little to no credit history, a secured credit card is another option to consider. Capital One, Wells Fargo and Bank of America all offer strong secured card programs that don't cost a lot of money. Unlike some of the "bad credit, no problem" deals you'll see online, these name-brand cards offer paths to convert a secured card into unsecured credit after a year or two of positive credit behavior. Just keep in mind that in some cases you may need a cosigner (i.e. mom or dad) to get a secured card, especially if you're a college student with no credit history.
So, how exactly does a secured card work?
A secured credit card requires potential cardholders to put down a deposit as collateral. This deposit is typically $200 or more and the amount you put down will generally be equal to your credit limit. For example, put down a $400 deposit and the credit card company will give you a card with a $400 credit limit. To increase your credit limit, you may have to put more money down or show a history of consistent on-time payments.
The benefit of this type of card is that not only do you have a credit card like any other, but more importantly, a secured card helps develop your credit history; however, you should confirm that the card will be reported to all three major credit reporting agencies. Most secured credit card programs routinely report to one or all three credit bureaus. Because an on-time payment history accounts for more than 33 percent of your credit score, on-time payments of any secured debt is one of the fastest ways to build good credit.
Secured cards are a great stopgap measure if you have no credit (or bad credit) because you can use them to build credit and then apply for an unsecured credit card, which make up the majority of the credit card market. When you're ready to apply for a regular credit card, the best place to do so is with the credit card company that currently issues your secured credit card. When you sign up, make sure to ask your credit card company if they will offer you an unsecured card after a designated period of on-time payments.
Secured credit cards can help you establish the financial track record you'll need to achieve many of your future goals. You'll just need to set aside a few hundred bucks for your refundable security deposit and your non-refundable annual fee, if your card has one. You can search for a secured credit card online or to go to a bank or credit union within your community and see if they offer a secured credit program. Many banks do.
Building a credit history won't just help you get a better deal when you borrow, it'll also help you in other financial areas of your life. Insurance companies, for example, set policy rates based on your credit score, while employers in some states use credit reports during the hiring process.
Credit cards offer the most straightforward way to achieve this goal. There are a lot of good credit cards out there, but you have to do your research first. CardRatings.com has several search tools that can help narrow down the choices to the ones that make the most sense, so do your due diligence and you'll likely end up with a low-fee, low interest rate card that helps you lay a solid foundation for your financial future.