Alex Holcomb Ph.D., Appalachian State University Assistant Professor of Finance, is featured as an expert from WalletHub's recent piece on unsecured credit cards for people with bad credit.
Here's what Dr. Holcomb offered:
Why are unsecured credit cards for people with bad credit so expensive? And why are there so few options?
A person's credit score is based on their financial history over the past seven years and is calculated based on a multitude of factors. The things that make a credit score "bad" are those that would also make lenders very wary of extending someone a new loan. These are things like: missed or late payments on current or previous loans, too many loans relative to a person's total assets, or current payments that exceed or are very close to exceeding a person's monthly income. These things are evidence of an individual's past behavior towards loan repayment (or rather non-repayment), which is a central component in a lenders decision to make someone a new loan. This includes credit card companies! Credit card companies take a very high risk when they lend to someone with a history of missing or not repaying their old loans; they risk that this behavior will be repeated on the new loan they take out on their new credit card. Most companies will refuse flat out to undertake this kind of risk because if the credit card is not repaid the company has little recourse to recover the money that was loaned on that card. However, some are willing to take a chance on people with bad credit, but in order to justify taking the risk, they must do one of two things. Either the credit card must be secured - which means backed by some asset that can be seized and sold in the event the loan is not repaid, or they must charge a very high-interest rate so that they recover as much of the loan amount in interest as fast as they can if the remainder of the loan is not repaid.
Does it ever make sense to get an unsecured credit card if you have bad credit, considering the high rates and fees as well as the low spending limits?
There are certainly some circumstances where it might make sense to have an unsecured credit card with a very high-interest rate, however, these circumstances are likely to be few and far between. An individual with bad credit is likely in this position because they are already in a precarious financial position or were in the recent past unable to pay all their bills. A person in a bad, or precarious, financial situation is at risk of failing to make their payments once again and damaging their credit even further. Remember that each "negative event" stays on your credit for seven more years, so the only way to get out from under a bad credit score is to keep good credit history for seven years. Thus it may be better to avoid these types of credit cards altogether as the high rates and low limits will make them even more expensive and hard to pay off. If, however, a bad credit score was caused by something that was largely outside of a person's financial control (like a legal settlement) and isn't due to the persons current financial situation, or if a person has moved from a bad situation to a more stable one, then it may make sense to get a high rate unsecured card, use it sparingly, and most importantly pay the balance off on time every time. This can help improve their credit score more quickly than simply waiting for the bad events to matriculate off their history. They will still not want to spend much on it as the high rates will make purchases much more expensive unless they are paid off in full by the end of the period.
What's the most important thing to look for in an unsecured credit card if you have bad credit?
It will depend on why they have bad credit to start with. If a bad credit score was caused by something that was largely outside of a person's financial control (like a legal settlement) and isn't due to the persons current financial situation, or if a person has moved from a bad situation to a more stable one, then they should be looking for a high limit with as low a rate as they can find. They will be able to use their card almost like a normal card as long as they pay the balance every month before it starts to accrue interest. If they have bad credit because they are currently in a bad financial situation, they may simply want to avoid getting a credit card altogether as it is more likely to hurt them in the long run then help them now.
What are the biggest mistakes people with bad credit make when selecting a credit card?
There are very few situations where a credit card is required and a debit card will not suffice, although there are some situations in which a credit card might be helpful or protective. These cases are of limited value when compared to the risk and expense of a high rate unsecured credit card. Unless an individual feels like they are in a position to always pay the balance of the card off before it is due, the biggest mistake they could make is probably to get a card at all.
Read the full article at wallethub.com/credit-cards/bad-credit-unsecured.