3 Cards for the Credit-Impaired

People with bad credit are finding they have few options these days when it comes to getting a new credit card.

“All banks are further tightening credit, and who does that squeeze out? Subprime customers,” says Dennis Moroney, research director and senior analyst for TowerGroup, a research and advisory-services firm for the financial-services industry.

Over the past year, credit-card issuers have reduced their existing customers’ available credit by more than 25%, according to a recent report by TowerGroup. And they are in no rush to recruit new clients. The number of new credit-card offers they mailed out during the first quarter fell 67% below that of the same period in 2008, according to the marketing-research firm Synovate.

The Credit Cardholder's Bill of Rights Act of 2009, which goes into effect February 2010, will make conditions more difficult for consumers with thin or damaged credit records. One provision of the law prohibits banks from issuing credit cards with fees that exceed 25% of the credit limit available at the opening of the account or that add up to more than 50% of that limit over the first year. That means subprime cards -- which can charge account-opening, set-up and program fees adding up to $200 on a card with a $250 limit -- will practically disappear, says Odysseas Papadimitriou, the chief executive of Evolution Finance Inc., which publishes CardHub.com, a credit-card comparison Web site.

Another provision of the new law will restrict banks from issuing cards to anyone under the age of 21 unless they have a co-signer.

That leaves young folks who are just starting to build a credit record -- or whose credit has been recently damaged by a bankruptcy, a foreclosure or late payments -- with few options. Here are three types of cards that offer the convenience of using plastic without the risk of falling into debt.

Secured credit cards fell out of favor in the mid- to late-1990s as card issuers focused on more lucrative subprime credit cards. Once the new credit-card law takes effect, though, they’re likely to make a comeback, Papadimitriou says.

To open a secured credit card, issuers require a deposit – generally of $200 or more – that will equal the amount of your credit limit. Beyond that, the card looks and functions like a regular credit card: You get a monthly statement, pay your bills and the card issuer reports the activity to the credit bureaus. Some banks pay interest on the deposit.

These cards can be expensive. Annual fees are common, and some add account set-up and application fees. Some cards don’t offer a grace period, which means you’ll pay some amount of interest regardless of whether you pay your balance in full each month. Since these cards have no credit requirements, it’s important to shop around for the product with the best terms, Papadimitriou says. Below are three options. For more details, use card search web sites like CardHub.com or CardRatings.com.

Citi Secured MasterCard
APR: 13.24% variable
Annual fee: $29
Grace period: 20 days
Your security deposit, a minimum of $200 and a maximum of $25,000, is deposited in an 18-month CD earning 4.07% APY. Early withdrawal penalties will eat into these earnings if you close the account before 18 months.

Bank of America Secured Visa Card
APR: 14.24% variable
Annual fee: $29
Grace period: 25 days
Your security deposit, $300 to $10,000, does not earn interest.

Wells Fargo Secured Card
APR: 18.99% variable
Annual fee: $18
Grace period: 25 days
Your security deposit, $300 to $10,000, will not earn interest.

A debit card linked to your bank account offers the convenience of using plastic, but it doesn’t help you build a credit history. Yet, debt-averse Americans are increasingly turning to debit cards. Last year, consumers charged 48% of their purchases on a debit card, up from 22% in 1999, according to TowerGroup.

Users don’t have to worry about interest charges and late fees, but debit cards are not worry-free. For example, because the money for each purchase comes directly out of your checking account, you risk being hit with steep overdraft fees if you spend more than you have. And although most modern debit cards offer $0 liability for fraudulent charges, should anyone steal your debit card (or card number) and go on a shopping spree, you may have to wait as long as two weeks until the bank investigates the case and refunds your money, says Ed Mierzwinski, the consumer program director for the consumer-advocacy U.S. Public Interest Research Groups.

Prepaid cards are a hybrid of debit and secured credit cards: You deposit a certain amount of cash that you can spend, not unlike a checking account. The benefit of doing this is protecting your bank account from crooks. Some prepaid cards also claim to help you build a credit file.

On the flip side, prepaid cards offer fewer consumer protections. Depending on the program, your deposit may or may not be insured by the FDIC, Mierzwinski says. That means your money is at risk if the card issuer goes belly up. Prepaid cards are also laden with fees, including a typical $9.95 monthly charge and additional fees for checking your account balance, calling customer service or withdrawing cash from an ATM.

And that credit-building perk? The cards that offer it (see below for details) don’t report to the three credit bureaus – Experian, Equifax and TransUnion – that all big lenders use. Instead, activity is reported to a bureau called PRBC (Payment Reporting Builds Credit). PRBC calculates a FICO Expansion score, an alternative credit score used by some lenders for customers who don’t have enough of a credit history to calculate a regular credit score, says John Ulzheimer, the president of consumer education for Credit.com. Ideally, a good Expansion score could convince a lender who also reports to the big three bureaus to issue you a traditional credit card, which could help improve your FICO score.

Prepaid Visa RushCard
The card advertises Visa’s $0 liability policy, but deposits do not have FDIC insurance, according to a customer service representative. (Requests for comment to UniRush Financial Services were not returned.)

Consumers can choose to have card activity reported to the PRBC, an alternative credit bureau.

Fees: You can choose between paying a one-time $19.95 activation fee and no monthly charge thereafter, but then pay $1 for each transaction, up to $10 a month. Or you can pay a $9.95 monthly maintenance fee ($119.40 a year) and no transaction fees when you sign for your purchases. (PIN transactions still trigger a $1 charge.) You’ll also be charged for ATM balance inquiries ($1), receiving paper statements ($1) and account inactivity ($1.95 a month after 90 days for the plan that doesn’t have monthly fees).

AccountNow Prepaid Visa or MasterCard
Deposits are FDIC-insured. The “Credit Builder” feature reports your activity to PRBC.

Fees: You’ll pay $9.95 a month to use those cards, including a $9.95 set-up fee unless you choose to have funds direct-deposited in the account. Other fees include $2.95 for receiving paper statements and $4.95 for withdrawing cash from a bank teller.

Current by Discover
A debit card for teens with parental controls, including setting spending limits and activity alerts. A maximum of $2,500 can be loaded on to the account, which is FDIC-insured.

Fees: $5 a month or $50 a year; four free ATM transactions, $0.50 per transaction thereafter; $5 paper statements (online statements are free).

NetSpend Visa Prepaid Debit Card
Deposits are FDIC-insured and can earn up to 5% APY.

Fees: Three plans to choose from, including paying a $9.95 monthly fee with no charges for purchases, or no monthly fee but a $1 charge for each signature transaction and $2 for PIN-based ones. Other fees include a $5.95 monthly maintenance fee for account inactivity and $2.50 for ATM withdrawals.