Consumers with bad credit can be severely hampered from obtaining unsecured credit cards with more than a low credit limit. Those with a bad credit history and a resultant low credit score are excluded from prime lending markets as high risk. Many who apply for sub prime cards do so simply to obtain credit and increase their spending power, whilst others utilize them with the direct intent of working to improve their credit scores.
In the wake of tighter lending practices credit limits can be as low as $200. Sub prime cards also carry high fees of up to 25% of available credit limits. Low limits reduce the risks of defaulting customers. Consumers who use such cards to improve their credit should be aware that even with a low credit limit it is essential to maintain a low credit utilization rate of no more than 30% of available credit. Maxing out the cards and then re-paying the full balance by the due date is considered risky behaviour and will do nothing to improve credit.
Consumers who use the cards wisely to improve their credit need to also take into account any fees charged as a further reduction of the available credit. Thus a card holder with a $300 credit limit should use no more than $100 of available credit, but must also factor in and deduct the percentage of fees on a monthly basis. Ideal use to improve credit necessitates a small monthly spend which is paid back monthly in a timely fashion.
Ernest Baynard of the Citizens for Equal Access to Credit, a group no longer available online through its own web site, stated that a two year study conducted by CERC showed that 35% of low limit card holders did improve their credit scores by using low limit cards, whilst another third go immediately into default. Baynard said that without low limit cards many in “undeserved” communities will be left with the pawn shop or maybe the pay day loan lender with no options at all to improve their credit.”
Consumers can improve their credit through using low limit credit cards, specifically with that aim in mind, though it is an often expensive option. Secured credit cards can be used with a higher credit limit as it will be matched by a security deposit held by the credit card issuer. Typically consumers who improve credit by using secured credit cards can transition to unsecured credit in just over a year. Secured cards are available from both sub prime and prime lenders, and there are some low fee cards which offer better deals than resorting to specific bad credit cards with low credit limits.
Consumers wanting to take steps to improve their credit score do need to use credit in most cases to do so. Low limit cards can serve a purpose and help to improve credit and thus be a useful tool when used wisely and cautiously.
Sources: Americanbanker.com