A bad credit score can keep you from qualifying for a mortgage. But what about having no credit score at all? Turns out, being a so-called "credit invisible" presents just as big a hurdle to qualifying for a mortgage.
There is a solution, though, for consumers who want to apply for a home loan but who haven't built up enough of a credit history to even have a credit score: the secured credit card.
Unlike traditional credit cards, secured cards require cardholders to make a security deposit with whatever financial institution is issuing the card. The card's limit is based on this deposit. This provides some protection to lenders who are working with consumers who do not have an established history of managing credit: If you are late on your payments, lenders can take money from your security deposit to collect the dollars you owe.
Secured credit cards are a good choice for consumers who don't have an established credit history. Financial institutions are far less likely to approve such consumers for a traditional credit card.
And once consumers have a secured credit card? If they make purchases with that card every month and pay them off on time, they will steadily build up enough of a credit history to generate a credit score. Once they have a score, they can realistically begin thinking about applying for a mortgage.
A serious problem
Most consumers have a three-digit credit score that will be high if they have a history of paying their bills on time and not running up too much credit-card debt or low if they have a financial history marked with missed or late payments, bankruptcy filings or foreclosures.
But some people -- mostly younger consumers -- have no credit score because they have no credit history on which to base a score. Consumers build a score by making payments on credit-card debt, auto loans, mortgages or student loans. If you don't have any of these forms of debt, you probably don't have much or any credit history.
The Consumer Financial Protection Bureau in May of this year released a report on credit invisibles. It found that 26 million U.S. adults had no credit histories.
If you are part of this group, a secured credit card can help.
Use it properly
When you make payments on a secured credit card, the financial institution behind it will report these payments to the three national credit bureaus, Experian, TransUnion and Equifax. As you generate a history of on-time payments, you'll establish a credit score. And if you never make late payments, that score will be solid one.
Once you do have a credit score, you can begin applying for other forms of debt. You might apply for a traditional credit card, one that comes with a rewards program or other perks. If you need a car, you can apply for a car loan. Make the payments on your new debt on time, and your credit history will continue to grow in a positive way, giving you a solid three-digit credit score.
"Think long-term when it comes to how a secured card helps your credit rating," said Bruce McClary, vice president of public relations and external affairs with the Washington, D.C.-based National Foundation for Credit Counseling. "Plan to graduate to an unsecured card once your score reaches your desired target. A prime credit score can open access to some very good deals on low interest rates and maximum cardholder benefits."
Getting a secured card
Getting a secured card is a far easier task than is applying for a traditional credit card or a loan of some other kind. That's because banks won't run a credit check when you apply for a secured card. Because of that, your lack of a credit score doesn't hurt you.
Do not, though, pay your credit-card bill late. The issuer of your card will also report late or missed payments to the credit bureaus. That will help you build a credit score, too, a bad one. Be careful, too, to make your credit-card payment in full each month. If you don't, your balance can grow quickly depending on how high your interest rate is.
Right card vs. wrong card
Randy Padawer, consumer education specialist at Salt Lake City, Utah-based Lexington Law, said that there are two types of secured credit cards. One will help your score. One won't.
Some financial institutions that provide secured cards don't report payment information to the three credit bureaus. These cards won't help consumers' credit scores.
"You need to ask the financial institution if they are reporting payment information," Padawer said. "So if you are applying for a card online, you have to put the brakes on and give them a call. It can be disappointing for consumers to find out too late that their on-time payments aren't being reported."
Padawer recommends, too, that consumers apply for a secured card that comes with the highest possible credit limit. There was a time when secured cards came with limits that matched the security deposit that consumers supplied. So if you deposited $500, your secured card came with a credit limit of $500.
Those days are over. Padawer said that some financial institutions will provide you with a credit limit of two or three times your security deposit. If you deposit that same $500, then, you might end up with a credit limit of $1,000 or $1,500.
This is important for credit scores. The less you use of your available credit, the higher your score will be. If you have a higher credit limit, you can charge more without using as much of the credit available to you.
"For me, that's the thing that consumers fit about too often," Padawer said. "Look for the card with the highest credit limit possible. It can make a big difference in the health of your credit score."