Reader Question: Re-Establishing Credit with a Secured Card

We often receive emails from our readers along the same lines as Stephanie's recent question below:

I have been working towards improving my credit. I have paid off all old outstanding debts but have only 2 positive things on my credit report at this time (a car loan that has been paid on time for over 1 year and a small utility company). My banker suggested that to further increase my credit rating, I obtain one credit card. Her suggestion is to use the credit card each month for paying recurring bills (utilities, etc.) that I would normally be paying. Then pay off the card within a week of receiving the bill.

This sounds like a good plan to me, however my credit will not allow me to obtain a good deal on a credit card without it being secured or paying enormous fees just to activate. What are your suggestions?

First off, it's a good idea to pay down your debt balances as part of improving your credit. However, it is a bad idea to close the accounts after you're debt-free. In Stephanie's case, it sounds like closing those old credit cards has accidentally lowered her credit score. If she had asked us first, we would have told her it was better to leave the accounts open with no balance.

Now that she's stuck in this situation, opening a new credit card is an important step to rebuild. A secured credit card is probably the most affordable and easy way to start. With a secured credit card, you make a deposit into a savings account to "secure" your credit limit. For example, a $500 deposit will set you up with a $500 credit limit. You get the deposit back with interest when the account is closed or transferred to unsecured status (usually after a year of responsible use). Subprime unsecured credit cards can end up costing you hundreds of dollars in fees, an amount that you will not get back in the future.

Just like any credit card, it is best for your credit to only use up to 10% of the credit limit.  If you have a $500 credit limit, that means you should only spend $50 a month. Paying the debt off in full as soon as you get the statement ensures that you get credit for the on-time payment on your credit report, avoid finance charges and don't start to rack-up larger balances.

With a year or so of positive credit hard history reporting to the credit bureaus, Stephanie should start to see her credit score improve and offers for better credit cards arriving in the mail.

Emily Davidson – Credit.com credit expert and former TransUnion insider. Emily writes about credit reports, credit cards, loans and personal finance as the CreditBloggers.com moderator.