Editorial Policy

Do Credit Cards for Bad Credit Really Improve Credit Scores?

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By Eva Norlyk Smith, Ph.D.
November 27, 2009

If you struggle with bad credit, you are not alone. According to the credit rating agency Fair Isaac, more than 70 million people in the U.S. have credit scores low enough to qualify them as subprime borrowers. Because people with bad credit typically can’t get approved for prime credit cards, they instead often turn to the so-called subprime credit cards when they want to apply for a credit card.

Subprime credit cards, or unsecured credit cards as they are also called, have met with much criticism because they come with very low limits, as low as $250, and they charge hefty fees for the services they offer. The new CARD Act of 2009 does put some curbs on the fees that subprime cards can charge by restricting subprime card issuers from charging more than 25% of the credit limit the first year, once the new rules step into effect in February of 2010. However, don’t expect subprime credit cards to become more reasonably priced any time soon. There are plenty of openings for subprime card issuers to continue to charge high fees to card holders.

So, are credit cards for people with bad credit worth the high costs? According to one study, if your aim is to improve your credit score, yes, they are. The study was performed by the credit bureau TransUnion, which was commissioned by Citizens for Equal Access to Credit to conduct a study of 365,000 subprime cardholders over a two-year period.

The study found that low limit credit cards can be an effective way for people with bad credit to rebuild their credit, as long as they pay their card on time. During the two-year period, 37% of the subprime cardholders included in the study saw an increase in their credit score. For about one out of five subprime cardholders, or 17%, the increase in the TransUnion credit score was 40 points or greater. Almost 20% of the cardholders who had a subprime score increased their score to near-prime, prime, or above prime credit score over the 24 months of the study. In addition, 28% opened a prime credit card with a credit limit of $1,000 to $2,500+. Just as encouraging, 58% of the study participants received a promotional offer for a prime credit card during the last twelve months of the study.

Proponents of low-limit credit cards have long argued that they are worth the high costs because without them, millions of Americans wouldn’t be able to get a credit card and begin to increase their credit score. The TransUnion study indicates that low limit credit cards may indeed be an effective way to begin to build or rebuild credit.

Of course, graduating to a prime credit card with a higher credit limit presumes that you follow the basic guidelines for increasing your credit score. The untold story of the study lies in the 63% of participants who either stayed at the same credit level or decreased their credit score. Indeed, more than half of the participants, or 52%, actually had their credit adversely affected, because they had one or more payments more than 90 days late over the two-year study period.

The study says nothing about whether that was because participants didn’t make good on charges they had made, or whether it was because they didn’t realize the magnitude of the fees that come with subprime credit cards and refused to pay these. At any rate, the large number of people defaulting on the subprime credit cards underscores the importance for consumers with bad credit to be well educated about what it takes to improve credit using an unsecured credit card.

For tips on how to qualify the fastest for a prime credit card, see Bad Credit? 5 Tips to Work Your Way up the Credit Ladder.