Professor Michael Mullen on Building Good Credit

June 21, 2018

Michael Mullen, Associate Professor of Finance, Business Administration Department, Stonehill College Meehan School of Business, Finance Program Director and Entrepreneurship Minor Director, and Director of the Stonehill College Investment Finance Initiative (SCIFI)

Ask The Experts | WalletHub interview with Professor Michael Mullen

My first thought when I hear the words “fair-credit credit card” is this is a wonderful example of an oxymoron in the English language not unlike examples such as “jumbo shrimp” or “working vacation”. There is nothing fair about the terms of credit cards, especially if you carry a balance from month to month. Credit reporting agency, Experian, reports that the average balance on credit cards at the end of 2017 was $6,354, +2.7% from 2016. Assuming an average annual interest rate of about 17%, that is nearly $1,100 in annual interest expense. But as we move closer and closer to a cashless society, credit cards used wisely are a critical tool for living. People with “fair-credit” ratings (about 20% of the population) fall very low on the credit score range and are considered an above-average risk. Sometimes this is due to a lack of credit history and sometimes to a checkered history of missed payments or credit defaults.

College students or recent college grads are a good example of applicants that typically do not have their own credit history and can fall into the “Fair” category. Each spring semester, I survey graduating seniors in my classes as to whether they have a credit card. The number responding “yes” has increased steadily over the years to about 30% of those asked this past spring. This is not a true scientific survey but yet a good indication of the importance of having a credit card and its increased availability. Getting that first job and building a good history of paying bills on time will make all the difference in building a respectable credit score. Credit cards appear to be readily available for young people offering reasonable credit limits for individuals to prove worthy of better deals over time.

What are the most important things to look for in a fair-credit credit card?

Assuming financial resources are limited, a no-fee card is a must. Regular interest rates are all about the same at 24-25%. So the cost of ownership is critical. Some cards may offer cash back but there is usually an annual fee associated with those cards in this credit category. For recent grads, I would stay clear and assume you will not spend enough to offset the annual fee. Visa or MasterCard are the most widely accepted cards, so if you had to choose only one card, either sponsor would be the best. That is not to say that the others like American Express or Discover are not useful, but personally I have found retailers never turn away Visa or MasterCard. Just about every card now comes with a Smart Chip. That was not always true. For security and convenience, especially if traveling outside the U.S., I consider that feature to be important.

Another strategy I suggest to students to help build a good credit history is a department store card such as Target. Now this cannot be used elsewhere but when getting started in life, Target is a terrific place to shop for most basic needs. The retailer is aggressive in offering its RED card to customers with options that include debit and credit cards. In our household, we use this card frequently during the month when shopping for household goods, food and over-the-counter medications. The 5% cash back on purchases can be a very attractive feature and over time lead to good savings.

Why don't more banks and credit unions offer credit cards to people with fair credit?

I can only speculate that some banks and credit unions consider the risk too high. Others face restrictions, especially to college students, implemented by federal regulation passed during the great recession (2009). According to the FICO 8 system, credit scores range between 300 and 850. A range of 300 to 579 is classified as “Very Poor”. Next up is the “Fair” category at 580 to 669. Experian defines this applicant as a “subprime borrower, meaning their credit standing is less than what is normally desired.” These two categories account for roughly 35-40% of the market. As some bank and credit union balance sheets strengthen with the strong economy, there is a chance these institutions will get more aggressive in seeking customers. But their individual participation is not necessary as nationwide companies such as Capital One, Credit One Bank and First Access are among a good number of institutions that serve this market segment.

Does each credit card company define "fair" credit the same way?

For the most part, the “fair-credit” category is defined the same. I referred to the FICO Score system earlier as more or less an industry standard. This standard has progressed over time and some institutions may prefer stricter scoring (Score 4 or 5) in credit decision-making. But as credit scoring varies a bit from rating agency to rating agency, the population that falls into this category is likely to be about the same at around 20%.

When you have fair credit, is it better to get a credit card with an annual fee or one that requires a refundable security deposit?

With the cost of money so low (defined by the rate a customer earns in their checking account i.e. practically zero), given this choice, I would avoid the fee and make a refundable security deposit. This may not be a preferable situation. But if it allows you to build your credit rating and move you into a better credit category, then the math suggest this would be the better choice.

Do any issuers have a particularly good/bad reputation for offering decent fair-credit credit cards?

A quick survey of available cards suggests that the offerings and related terms of fair-credit cards are very much the same. I am not aware of any particular circumstance that suggests unique issues about reputation from institution to institution.